Key insights from the week that was.
This week provided cause for optimism over US inflation and global equity markets rallied as a result. Domestically, strength was seen in business conditions and confidence, but consumer sentiment weakened further under the weight of real income loss and rising interest rates.
Beginning with Australian consumer sentiment. Our Westpac-MI consumer sentiment survey fell another 3% in August, taking the index down to 81.2, almost 23% below its November 2021 peak. Driving this decline has been a marked deterioration in views over the economy’s prospects for the year ahead and consumer spending on ‘major household items’, with both sub-indexes now around 30% below their prior peak. Notably this is despite confidence in the labour market remaining near record highs. While the outlook for nominal household income growth is robust, rapid inflation and rising interest rates have hit consumers’ discretionary spending capacity hard. Arguably the pace and scale of change is creating additional anxiety.
Another key theme discussed by Chief Economist Bill Evans after the release of the latest consumer sentiment survey is the hit to housing market expectations. Clearly, households have been unnerved by the acceleration in house price declines across Australia, the Westpac-MI ‘time to buy a dwelling’ index down another 2.3% in August to be 41% below its prior peak and 34% below average. House price expectations meanwhile slumped 7.5% in August to also be 41% below its prior peak and 23% below average. For a detailed view of the outlook for housing, see our latest Market Outlook in Conversation podcast.
The strength evident in business conditions and confidence in July is a stark contrast to the state of the economy according to the consumer. Consistent with our view of the economy, the NAB business survey indicates Australian businesses experienced a strong start to Q3. Tailwinds from earlier policy stimulus and the burst in activity associated with re-opening look to not only be supporting strong conditions and capacity utilisation now but also robust growth in new orders. Business confidence also showed strength in the month, although the intensification of cost pressures and ongoing labour market tightness points to a degree of fragility. Confidence and conditions will be tested further over the coming months as the RBA’s tightening cycle impacts end demand and capacity constraints continue to be felt.
Moving offshore, it has been a particularly interesting week for the US. Last Friday, nonfarm payrolls surprised materially to the upside, with 528k jobs reportedly created in July. Hourly earnings also beat expectations in the month, gaining 0.5%. These outcomes were seen by the market as potential concerns for the FOMC because strong growth in employment and wages has the potential to prolong the current historic inflation episode. But, as discussed in Market Outlook in Conversation, other data for the labour market conflict with nonfarm payrolls, instead indicating a material deterioration in conditions is underway.
Of late, job openings and the hiring rate have turned down, and initial claims have begun to edge higher. But most importantly, whereas nonfarm payrolls suggest almost 1.7 million jobs have been added to the US economy over the past four months, the household survey indicates 170k people have lost or left their jobs over the same period. In part, this is a matter of timing, with the household survey stronger in 2021; but it is also a consequence of nonfarm payrolls counting the number of jobs not the people employed – with the cost of living having risen as much as it has and wage outcomes disparate, there is currently good reason for an individual to seek a second or third job. We also have to recognise that the payrolls count assumes new businesses are always being established and begin hiring immediately, with the validity of the assumption not tested until data becomes available a year later.
A slower pace of job creation and household income would be a challenging headwind for the US economy to face currently given the state of consumer confidence and the rapid pace of inflation. On the latter at least, this week brought some good news, with the detail of the July CPI report providing strong evidence that the US is past peak inflation. On a 6-month annualised basis, the inflation that came as a result of pandemic supply disruptions looks to be coming to an end; and, in the past two months, clear evidence has emerged of prices pressures from service sector re-opening beginning to dissipate. Further, that wage growth is materially below the pace of inflation and, on some measures, is slowing faster points to little-to-no support for a new wave of demand-driven inflation over the coming year. We therefore remain of the view that US inflation will slow further into end-2022 and be back near the FOMC’s 2.0%yr target by end-2023, allowing the FOMC to conclude their rate hike cycle at 3.375% this December and then begin a sequence of rate cuts from December quarter 2023.
Finally on China. The trade data beat expectations yet again in July, with annual growth in exports holding around 18%yr. While annual CPI inflation lifted in the month, at 2.7%yr it is low versus the developed world; further, the deceleration in the PPI in July points to limited upside risk ahead. The primary economic concern for China therefore remains the spread of COVID-19 within its borders. The virus is seemingly under control in key production regions. But outbreaks in prime tourist regions such as Hainan raise the risk of the virus spreading more broadly across the nation, and consumers consequently deciding to delay or cancel planned domestic holidays. We continue to highlight that the key risk to growth in H2 2022 is the recovery in consumer spending. While early days, recent developments clearly raise the risks around this sector.
