Key insights from the week that was.
Seeing need for time to assess the outlook after a cumulative 400bps of tightening since last May, the RBA decided to leave the cash rate unchanged in July. As discussed by Chief Economist Bill Evans, this outcome reflects a clear preference from the Board to base their next decision on updated staff forecasts and the quarterly inflation report. We do not believe this decision will give way to a prolonged pause. Instead, in August, the Board will be faced with another elevated read on inflation. We expect the headline and trimmed mean inflation measures to print at 6.3%yr and 6.1%yr respectively in Q2, more than twice the top-end of the RBA’s 2-3% medium-term inflation target.
With Governor Lowe having recently cited persistent upside risks to inflation, we believe such an outcome will lead the RBA to act in August and September, resulting in a 4.60% cash rate in September which we see as the peak. The economic consequences of such a contractionary policy stance are, in our view, material, with GDP growth to slow to just 0.6%yr in 2023 and remain well below trend in 2024 at 1.0%yr. A series of rate cuts from May 2024 through late-2025 will be required to return GDP growth to trend. For more detail on Australia’s outlook, see our latest edition of Market Outlook.
Despite the anticipated further tightening and weak outlook for activity, this week’s housing market updates were generally constructive. CoreLogic’s home value index managed to post another broad-based gain in June, at least in part thanks to weak turnover. The rise in housing finance approvals in May further highlighted borrowers interest in the market; but, whether this uptrend can be sustained given elevated and rising interest rates remains an open question. A sizeable pipeline of work is currently holding up housing construction but, abstracting for high-rise volatility, dwelling approvals’ weak trend suggests housing construction activity will decline over the coming year. Housing supply is therefore likely to remain constrained to end-2024 and beyond, supporting the level of both prices and rents.
Offshore, the US was in focus this week.
The FOMC minutes emphasised that June’s pause came as members sought to assess the lagged impact of tightening thus far. The decision was unanimous, though Fedspeak suggests some members were in favour of a hike – overnight Dallas Fed President Logan opined that it would have been “entirely appropriate to raise the federal funds target range at the FOMC’s June meeting”.
The revised dot plot from the June meeting suggests only two members of the Committee are comfortable to leave the fed funds rate where it is, with the median expectation being two more hikes this year. However, apparent in the minute’s Committee discussion is the high degree of uncertainty clouding the outlook. As an example, while nonfarm payrolls continue to show strong momentum, averaging 339k per month the past year, other measures of employment are much softer. In particular, household employment has averaged 202k and job openings have declined by 2mn positions since March 2022, albeit from a stellar peak of 12mn.
Other forward-looking indicators of activity and employment are troubled by month-to-month volatility. The ISM services survey is a case in point. Both the headline and employment measures were robust in June, respectively 53.9 and 53.1. However, over the past year, they have each traded wide ranges, 49.2-54.0 for employment and 49.2-56.4 for activity. Also, at its current level, the activity measure is 2.8pts below the average of the 5 years preceding the pandemic. On that basis, it is unsurprising that the price measures from the ISM surveys continue to retreat, pointing to a sustained downtrend in inflation.
The ISM manufacturing survey meanwhile was unquestionably weak in June, deteriorating to 46.0, a full 8pts below the 5-year pre-pandemic average. Further, June’s weakness was broad based, as production, employment, export orders and prices all deteriorated. All manufacturing sub-indices are now in contractionary territory. While there was an improvement in new orders in the month, the sub-index is almost 11pts below its 5-year pre-COVID average.
Of the other US data to hand, new factory orders rose a modest 0.3%mth, though ex-transportation, factory orders slipped 0.5%mth. The strong 3.8%mth jump in transportation reflects broad global trends: an uptick in car manufacturing as manufacturers seek to fulfill a backlog of existing orders; and the ramping up of EV production. Residential construction spending meanwhile grew 2.1%mth in April, driving a 0.9%mth increase in total spending. Increased demand for housing and limited inventory warrant continued growth in residential construction.
Out late last Friday, China’s official NBS PMIs are also worthy of note. Both the services and manufacturing PMIs were in line with the market’s downbeat expectations at 53.2 and 49.0 and so were taken as further evidence of downside risks to the outlook. However, contrasted against the above outcomes for the US as well as China’s pre-pandemic experience, these outcomes actually speak of resilience – the NBS manufacturing survey being just 1.5pts below the average of the 5 years to 2019 against the US ISM’s -8pts. In stark contrast to the US data, Chinese manufacturing also continues to expand capacity, fixed asset investment in May up 6%yr year-to-date. Within the sector, value add is also on the rise, high-tech sector investment growing 15%yr year-to-date.
Those in the market anticipating a surge in policy measures from Chinese authorities are therefore likely to be disappointed as progress towards the Central Government’s long-term ambitions continue to be made. Instead a multi-faceted but passive approach is likely to incentivise local government authorities, SOEs and the private sector to move the economy forward.
