Key insights from the week that was.
The past week has had an intense focus on sentiment. In Australia, owing to the release of updates for both the consumer and business. And, in the US, as a result of another historic annual CPI print, testing the nerve of market participants and policy makers alike.
The NAB business survey lent clear support to the idea that the omicron wave Australia is experiencing will prove a transitory negative, with the abrupt deterioration in confidence seen in early January (when the December survey was in the field) reversed late in the month (when responses for the January survey were sought). In the latest update, 15pts of the 25pts lost in the December survey were recovered. While conditions deteriorated further in the January survey, from +8 to +3, this follows only a small decline in the December survey, from +11, so is arguably best characterised as full recognition of the shock experienced as omicron spread over December/ January. Consistent with the global backdrop, the January edition of the survey highlights that price pressures rather than activity are the major risk, the survey’s labour cost measure pointing to wage gains well in excess of the latest reading on the ABS Wage Price Index, while the quarterly pace of purchase costs accelerated from 2.8% in December to 3.4% in January.
Costs are also front of mind for Australian consumers. In February, the Westpac-MI consumer sentiment index reported a 1.3% fall to 100.8, a level at which the number of optimists equals pessimists. Success in containing omicron without a need for harsh restrictions proved favourable for views on the economy and the labour market. Expectations for the economy are currently materially above long-run average levels (circa +7% and +14% respectively for the 1 and 5-year views) while unemployment expectations are 21% below average.
Despite these very positive aggregate views, individual households remain under pressure, with family finances versus a year ago down 9pts in the month to a below average read, and perspectives for the year-ahead 1.5pts lower, also to a below-average read. After the release, Chief Economist Bill Evans detailed in depth the forces behind these developments, namely surging energy prices; higher interest rates; and Australian consumers’ recognition that they carry a significant debt burden. The second and third factors are also clearly at play in the housing market, with ‘time to buy a dwelling’ down 2.4% in February and 30% over the past year to be 28% below average despite house price expectations remaining strong, that index up 8.7% in February to be 25% above average.
For those interested in considering all the risks and opportunities ahead, following last Friday’s release of the February edition of Market Outlook, Tuesday saw the Westpac Economics team come together to discuss the key themes for Australia’s economy and global financial markets in our Market Outlook in conversation podcast. On the RBA, also note that Governor Lowe appeared before the House of Representatives Standing Committee on Economics today following last week’s release of the RBA’s latest Statement on Monetary Policy.
Offshore, US inflation and the consequences for FOMC policy remained the focus for market participants. Through the past week and a half (ahead of last night’s January CPI report), a number of FOMC members broadly affirmed the Committee’s 3-4 hikes in 2022 baseline from the December meeting. This group included regional Presidents George, Daly, Harker, Mester and Bostic. After the January CPI release, which was modestly above expectations at 0.6% in the month but primarily of concern as it left the annual rate at a new 40-year high of 7.5%, St Louis Fed President Bullard stated he had revised his preferred course to a 50bp hike at the March meeting to be followed by another 50bps of hikes by “July 1”.
We remain of the view that the best course of action for the FOMC is to raise rates at a modest pace, forecasting once per quarter from March 2022 to September 2023 to a peak of 1.875%. As discussed in the Market Outlook in conversation podcast, we hold this view for a number of reasons: (1) fed fund rate hikes are not the only form of tightening coming in 2022/23, with a material reduction in the Federal Reserve’s balance sheet also due; (2) for activity, it is term interest rates that matter not fed funds and these rates are already many multiples of fed funds’ 0.125%, with the 2-year yield at 1.58% and the 10-year yield circa 2.03%; and (3) real wages are currently going backwards at almost a 2%yr pace as at January. Coupled with the dramatic deterioration in housing affordability through the pandemic, (2) and (3) highlight that US household’s real purchasing power is currently under considerable pressure and likely will remain so. Surplus savings and wealth accrued during the pandemic can help to offset and keep consumption stronger that it would otherwise be, but only if confidence in the outlook remains intact. As household consumption is more than 70% of the US economy, as goes the consumer so goes the nation.
Before concluding, it is worth noting that, consistent with our expectations, it looks as though China’s economy is readying for a strong 2022. In our February Market Outlook, we noted that Q4 GDP pointed to momentum building into year end and outcomes coming in stronger than first estimated. This week we received further support for our 2022 thesis as the financing data came in well ahead of expectations. Roughing two-thirds of the near CNY6.2trn aggregate financing gain came from new loans by banks, with the rest funded through markets. The breadth of these gains argues in favour of broad-based strength in investment in 2022, with flow-on benefits to household income and consumption.
