Independent analysis of Australia's macro economy

Friday, January 11, 2019

Weekly note (11/1) | Powell ‘put’ reassures markets

The first full week of 2019 saw global equity markets rise strongly as risk sentiment improved notably following an unexpectedly dovish shift in communication from the US Federal Reserve. This was also supported by positive reports emanating from trade negotiations between a US delegation and officials from China, while late last week the People's Bank of China announced a new round of policy easing targeted at increasing liquidity in the banking sector to ward off the risk of a slowing growth outlook in the world's second-largest economy.

The turnaround in risk sentiment came last Friday when US Federal Reserve Chair Jerome Powell speaking to the American Economic Association in Atlanta ameliorated market concerns that further policy tightening could accentuate a slowing outlook
 for economic growth by saying that "we (the Fed) are always prepared to shift the stance of policy and to shift it significantly".   


While key data continues to show strength in the US economy, highlighted by a much stronger-than-expected employment report in December (see here), forward-looking indicators have been pointing towards a slowdown in activity in the domestic economy. In this context, Chair Powell highlighted a preparedness to balance strength in incoming data with the risks of a slower growth outlook, with "muted inflation readings" affording the Fed flexibility in its policy decisions. The comments were well received by markets, who had been left greatly disappointed late last year when the Fed indicated an expectation for continuing with policy tightening in 2019 as covered in our previous weekly.


Wednesday's FOMC minutes then reiterated the change in Fed commentary, which pointed to a patient data-dependent approach in 2019 with the path for policy tightening now "less clear than earlier" due to financial market volatility, which has potential spill-over impacts for consumption and investment, and renewed concerns over the global growth outlook driven in part by trade tensions. From a fundamental perspective, Committee members remain confident in the outlook for the domestic economy with output growth anticipated to run above potential in 2019 driven by household spending and business investment, though assessments will clearly now be more nuanced to the risks that have unsettled markets over recent months.     


Over in Europe, the European Central Bank (ECB) minutes from December expressed both optimism and caution. Confidence in underlying economic conditions  despite a recent weakening in incoming data  had led to the conclusion of its near 4-year long 2.6 trillion asset purchase programme (APP), though risks to the growth outlook while still assessed as broadly balanced were "moving to the downside" due to geopolitical and trade uncertainties and market volatility. In particular, the minutes described the outlook as "fragile and fluid, as risks could quickly regain prominence or new uncertainties could emerge".


While asset purchases have now concluded, the Governing Council's measures to ensure ample stimulus remains in place include; forward guidance for key interest rates to remain on hold "at least through the (European) summer of 2019" and an intention to reinvest payments from maturing bonds purchased under the APP "for an extended period of time" after when it starts to raise key interest rates. Additionally, the minutes indicated that the ECB may revisit providing another round of cheap long-term loans to the banking sector.


Continuing the trend of softening data pointing to slowing momentum in the European growth outlook, a measure of economic sentiment in the region eased for the 12th consecutive month during the week driven by the consumer, services and construction sectors. More positively, euro area data for November showed stronger-than-expected outturns from retail trade and the labour market, where the region's unemployment rate fell to a decade-low 7.9%, which features as our chart of the week.


Chart of the week

At the completion of an optimistic week in markets, equity indexes in the US had risen by around 2.5 to 3.5%, Asian markets gained between 1.5 to 4% and Europe lifted by around 1%. As a proxy for improved risk sentiment in markets, the Australian dollar posted a 1.4% gain against the US dollar this week. The spread between US 10 and 2-year bond yields narrowed from a little above 17 basis points to around 16 basis points over the week.
     
 
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In Australia this week, the data flow was decidedly soft fitting with the trend experienced in other major advanced economies recently. Separate indicators from the Australian Industry Group (AiG) showed activity levels slowed in the nation's manufacturing, services and construction sectors in December. 

The AiG's Performance of Manufacturing Index eased to a sub-50 reading for the first time since August 2016 indicating that activity levels had contracted in December. In the services sector, the AiG's headline measure was still expansionary at 52.1 despite slowing in the month, however the employment sub-index fell sharply to indicate that firms had been reducing staffing levels. The weakest read came from Friday's AiG Performance of Construction Index (PCI), which fell by its sharpest rate in more than 5 years to 42.6. This result was weighed heavily by contracting activity in residential construction for both houses and apartments, which respondents had reported was due to a range of concerns including; tighter financing conditions, falling property prices, soft investor demand and oversupply with projects reaching completion. 


This followed a weak report for building approvals for November that was released by the ABS on Wednesday (for our full analysis see here). Total dwelling approvals fell by 9.1% in the month driven by weakness in house and unit approvals compared to expectations for a broadly-flat outcome. Though statistical volatility likely overplayed the monthly result, the trend was broadly consistent with the PCI data. While the near-term outlook is supported by a highly elevated pipeline of work, residential construction appears likely to become a drag on overall economic growth, possibly towards the back end of 2019. 


In better news, retail sales for November came in stronger than forecast by posting a rise of 0.4% in the month as Black Friday promotions drove a heavy increase in online spending (see our analysis here). The significance of online retail in Australia continues to surge and the November sales promotion period will become of increasing importance to the sector. Recent history indicates that it may also be driving a shift in consumer behaviour by encouraging a bringing forward in spending in the lead-up to Christmas, which then, in turn, may attenuate spending in December.


Lastly, the nation's trade balance was softer than anticipated in November due to rising spending on imports for capital goods (see our analysis here). Both coal and iron-ore export volumes weakened during the month but this was moderated by the surging LNG sector, where export values increased to a new record high $4.56bn in November.