Key insights from the week that was.
Australian Q2 GDP was the headline data outcome this week.
Ahead of its release on Wednesday, the partials for inventories and trade pointed to material downside risks to growth in Q2. In particular: while the trade balance widened to another record high on commodity price strength, declining export volumes saw net exports subtract 1ppt from GDP in the quarter; private non-farm inventories also surprised to the downside, the business indicators release pointing to a 0.7ppt subtraction in Q2.
However, Q2 GDP actually shocked to the upside, printing at 0.7%, 9.6%yr. On an expenditure basis, public and farm inventories provided a helpful 0.6ppt offset to private non-farm inventories’ -0.7ppt, while private final demand contributed 1.1ppts thanks to strength in consumption and investment.
As a result, the expenditure measure of GDP printed at 0.4%, with the income and production measures 0.6% and 0.9% gains pulling the headline average measure up to 0.7%.
As detailed by the ABS, lockdowns had only a marginal impact on growth in Q2 – NSW’s lockdown only began in the final week of the quarter. While Q3’s contraction will be large and the speed of the initial recovery is at risk because of the severity of the outbreaks in both NSW and Vic, the positive Q2 result eliminates the chance of a 2021 recession and any associated hit to sentiment. For the full detail on GDP by sector, state and industry, see our Q2 bulletin.
Following the release of the balance of payments, now is also a fitting time to highlight the financial flow dynamics present in the quarter and over FY2021. From the latest financial account data, it is evident foreign parent companies remain committed to their Australian subsidiaries, with direct investment in Australia in Q2 2021 and over FY 2021 continuing to grow despite the uncertainties created by delta across the Asian region. Australian companies remain more circumspect on opportunities offshore, though this is a continuation of the pre-pandemic trend, not the result of COVID-19.
Also of note in recent quarters has been the aggressive push offshore by both individual and institutional investors (chiefly our super funds). In the initial recovery, there was a strong outflow of Australian capital to foreign investments, the circa $115bn outflow in H2 2020 more than three times the repatriation seen on COVID-19 concerns in the six months to June 2020. This investing continued at pace in H1 2021, the $120bn outflow on an annualised basis twice the annual average over the 5 years to December 2019. Another interesting point worth noting about this flow is that it was almost entirely equity related (88%), a striking contrast to recent foreign portfolio inflows into Australia which have been heavily skewed to debt (80%).
The striking rise in the scale of Australia’s net equity assets from 2% of GDP to 15% since 2016 and the gaping differential between dividends yields and interest rates has combined to reduce Australia’s net income deficit to a third its peak level back in 2007. The recent investment flow detail suggests a further narrowing of the deficit is possible.
The implications of the above for the Australian dollar are uncertain in terms of their timing and scale. Portfolio outflows are likely to continue as Australian individual and institutional investors leverage into the global recovery. But it is also probable that foreign businesses/ investors will increase their direct investment in Australia in 2022, if not before. The currency effect of the related income flows should prove neutral – at least for now. Until there is need for accrued income to finance spending back in Australia, investors are likely to re-invest it offshore, as Australian parent firms have typically done for their directly-owned subsidiaries.
Moving offshore, China’s official PMIs disappointed this week, the services measure contracting (47.5) as manufacturing stalled (50.1). These outcomes stem from the stringent restrictions imposed by authorities to stop delta’s spread during July/August. Promisingly, the 7-day average for new cases has fallen from over 100 mid-August to less than 30 of late. If this trend is sustained, restrictions will be removed and activity will bounce across manufacturing and services into year end.
Intriguingly, while the 7-day average of daily new COVID-19 cases in the US is now nearing 170k, the manufacturing PMIs from ISM and Markit held near historic highs in August. The economic cost of delta in the US is instead being worn by the household sector. Notably this week, Conference Board consumer sentiment dropped 11pts in August, matching the fall in the University of Michigan survey last week. The ISM manufacturing employment index also fell to a contractionary reading of 49, and ADP private payrolls came in well below expectations. Despite these downside surprises, we continue to expect another very strong reading for nonfarm payrolls tonight, around 850k, driven by the economy’s re-opening. Employment growth will slow materially in coming months, but our base case is that it will remain historically strong. Note though, to that view, leading indicators of activity such as the Atlanta Fed’s GDPNow infer risks are skewing to the downside.
