Independent Australian and global macro analysis

Friday, August 30, 2019

Macro (Re)view (30/8) | A conciliatory shift in trade rhetoric

In what has become a familiar pattern, US-China trade rhetoric found a more conciliatory tone over recent days following the significant escalation at the end of last week. A spokesman from China's Commerce Ministry commented to the press that talks with the US should now be focused on reducing rather than escalating tariffs, and that "the most important thing at the moment is to create necessary conditions for both sides to continue negotiations". It was also reported that Chinese and US trade officials were discussing a potential round of negotiations to take place in September. Markets were buoyed by these developments, though only time will tell if they prove to be lasting.  

In the US this week, the 2nd estimate of GDP growth in Q2 was revised down from 2.1% to 2.0% annualised, as expected. Once again, it highlighted the strength of the US consumer, with personal spending revised up from an already rapid pace of 4.3% to 4.7% annualised. A robust labour market has been key to this, as has resilient sentiment despite rising trade tensions and increased gyrations in equity markets. However, there were signs that sentiment may be beginning to fray with the University of Michigan's consumer sentiment index falling by its most in 6½ years to a reading of 89.8 -- its lowest since October 2016. One in three consumers cited concerns around the impact of tariffs, notably
on the $300bn tranche of consumer-related products originating from China due to start September 1. Weaker sentiment has the potential to slow consumer spending, which would be problematic from the US economic outlook given that business investment contracted in Q2 and is at risk of a further slowdown, while net exports were also weighed by uncertainty over trade policy.   

Political developments were the main focus in Europe this week. The recent collapse of Italy's government appears to set to reach a quick resolution after President Mattarella asked Giuseppe Conte, leader of the 5-Star movement, to form a coalition with the opposition Democratic Party. This development relegates Matteo Salvini's League party from office, despite polls indicating it is the most popular with voters in Italy. Markets interpreted the news favourably on the basis that it improves the prospects of a more fiscally prudent government as well as limiting potential conflict with the EU. Over in the UK, the prospect of a no-deal Brexit increased after PM Boris Johnson's request to the Queen to prorogue parliament was granted. As such, parliament will now be suspended between September 12 and October 14. Parliament is due to return on September 3, which leaves a little over a week before the suspension starts for the 'Remainers' to gather support. The suspension finishes just before the EU Summit on October 17, with the withdrawal date then occurring on October 31. 

— — 

In Australia this week, partial indicators for construction and business investment came to hand ahead and mainly presented downside risks for next week's National Accounts and GDP growth figures for the June quarter. Activity in construction work contracted by a much weaker-than-expected -3.8% in Q2 compared to the consensus forecast for -1.0% (see our review here). The annual decline in work done accelerated to its weakest in 18 years at -11.1%. 

The weakness in Q2 was predominantly driven by a 5.5% decline in private sector residential activity -- its weakest quarter in 8 years -- as the downturn in the construction cycle gathered pace to an annual contraction of -9.5% (
shown as chart of the week, below). The weakness was broad based in Q2, with new residential construction falling by 5.3% to -9.9% over the year, and alterations down by 3.3% to -5.8% on a year earlier. Given that dwelling approvals data on Friday showed renewed weakness with a 9.7% fall in July to be -28.5% over the year (see our review here), residential construction is likely to remain a headwind for the domestic economy well into next year. Non-residential activity also fell by a notable 6.6% in Q2 as the annual pace swung from 4.6% to -3.3%. Engineering work also fell by 1.1% in the quarter to be down by 15.9% through the year, which reflects the wind-down from the completion of major projects in the resources sector and slower growth in public infrastructure work. 

Chart of the week

Thursday's capital expenditure survey showed that private sector business investment fell by 0.5% in Q2 against an anticipated 0.4% increase, with the annual decline moderating to -1.0% from -1.7% (see our analysis here). The details for Q2 confirmed weakness in construction, with investment in buildings and structures down by 3.3% in the quarter and -6.6% through the year, though equipment spending was upbeat rising by 2.5% in the June quarter and by 5.7% in year-on-year terms. The patchy details point to another a subdued contribution from business investment to GDP growth in Q2. The 3rd estimate of investment plans for 2019/20 was slightly higher than anticipated at $113.4bn and implies a 10.7% rise in capex spending compared to the previous financial year. However, that is slightly less constructive than the 12.3% increase implied by the 2nd estimate from 3 months ago, which may highlight caution due to increased uncertainty around global and domestic economic conditions. 

GDP growth in the June quarter National Accounts is expected to print at 0.5% in Q2 next Wednesday, with the annual pace slowing to 1.4% from 1.8%. As outlined in our preview (see here), the key dynamics are a weaker global economy and slowing domestic demand conditions, driven by soft growth in household consumption and weakness in residential construction, with subdued business investment and a rebound in resource exports. The other main highlight next week is the Reserve Bank of Australia's September policy meeting, in which the Board is expected to remain on hold at 1.0%. August's meeting minutes highlighted an increased focus on developments in the global economy given escalating trade tensions and geopolitical uncertainties, with the Bank's commentary here likely to be instructive to its policy outlook.

Thursday, August 29, 2019

Preview: Australian Q2 GDP

The ABS is due to release the National Accounts for the June quarter today at 11:30am AEST. A sharp loss of momentum occurred in the domestic economy over the second half of 2018, which then extended into 2019 as output growth decelerated to a well below-trend pace of 1.8% over the year to the March quarter  its slowest since 2009.

The key dynamics have been a weaker global economy impacted by trade and geopolitical tensions, while in Australia domestic demand has pulled back noticeably with household consumption slowing in response to enduring low income growth and weak housing market conditions, and by a downturn in the residential construction cycle. Indications are that these headwinds intensified further over the June quarter, with the median forecast for growth in Q2 at 0.5% and 1.4% in annual terms according to Bloomberg.    

As it stands | National Accounts — GDP

GDP growth in the March quarter was 0.4%, which was slightly below the consensus forecast for 0.5% but an improvement on the 0.2% pace from Q4 2018. Growth over the year slowed from 2.4% to 1.8%  a pace that is essentially 1 percentage point below Australia's trend or potential growth rate of around 2.75%.     

Activity in the global economy slowed through the March quarter as rising tensions between the US and China and other geopolitical uncertainties in Europe weighed on export volumes. The impact was most acutely felt in the trade-exposed manufacturing sector causing sentiment to deteriorate and, in turn, investment plans to weaken

Amid the strengthening headwinds from abroad, the domestic economy continued to decelerate over the first quarter of 2019. The slowdown in household consumption growth intensified with consumer sentiment softening noticeably in response to an enduring period of low income growth, while already weak conditions in the housing market were accentuated by uncertainty in the lead up to the federal election weighing on discretionary spending. The residential construction cycle continued to roll over as the pipeline of work to be done, though still elevated, came down in most states  particularly in NSW following the completion of higher-density projects  while dwelling approvals were tracking sharply lower over the year. 

Business investment was subdued on net in Q1 as trading conditions and confidence levels softened responding to the rising uncertainties from abroad and over the outcome of the federal election. Strength in construction in the non-mining sectors was largely offset by residual weakness in the mining sector where remaining projects moved closer to completion and this also weighed on equipment spending. Amid the backdrop of a weaker external sector, the nation's export performance was impacted by adverse weather conditions disrupting supply chains in the resources sectors, while imports declined to reflect a lower Australian dollar and, more specifically, softening domestic demand conditions. However, ongoing spending in healthcare initiatives and infrastructure investment kept strong growth in public demand in train bolstering the economy from weakness in the private sector.   

Key dynamics in Q2 | National Accounts — GDP

Household consumption (+0.3% in Q1, +1.8%Y/Y) — Retail sales volumes increased by just 0.2% in Q2 and annual growth slowed to its weakest since 1991 at 0.2%. It is too early for the combined impacts from the Reserve Bank of Australia's consecutive rate cuts, tax relief for low-and middle-income earners and more buoyant housing market conditions to be reflected in these data, though they may benefit discretionary spending over the second half of the year. Despite robust gains in employment, the unemployment rate remained around 5.2% and spare capacity more broadly stayed elevated. Q2's subdued update of the Wage Price Index confirmed slow income growth remains a headwind, with consumption growth to again be driven by spending on essential goods and services.  

Dwelling investment (-5.1% in Q2, -9.5%Y/Y) — The downturn in the residential construction cycle intensified in Q2, with private new home building contracting by 5.3% and alteration work falling by 3.3%. Total residential activity declined by 5.1% in the June quarter and by 
9.5% over the year  its weakest annual pace since 2001.     

Business investment (-0.5% in Q2, -1.0%Y/Y) — Business investment was patchy again in Q2, with weakness in buildings and structures in contrast to a solid and broad-based lift in equipment spending. Softness was evident in non-mining investment reflecting increased uncertainty over domestic and global economic conditions.       

Public demand (+1.5% in Q2, +5.1%Y/Y) — Growth in public demand remains strong, rising by 1.5% in Q2, which is likely to add around 0.4ppt to activity in the quarter. The details were mixed with spending up by 2.7% driven by health initiatives, while investment declined by 3.2% despite a robust pipeline of electricity and transport-related projects that are required to support population growth in the capital cities.

Inventories (-0.9% in Q2, -0.3%Y/Y) — Inventories recorded a sharper-than-expected fall in Q2 and could subtract around 0.4ppt from GDP growth. The weakness was broad based across mining, manufacturing, wholesalers, retail and accomodation and food services.    

Net exports  (+0.6ppt in Q2, +0.9ppt yr) — Net exports are expected to add a sizeable 0.6ppt to GDP growth in Q2. Driven by resources, export volumes increased by 1.4% in the quarter, while imports fell by 1.3% reflecting weak domestic demand conditions. An escalation in iron ore prices (which has retraced more recently) and a lower Australian dollar drove a 1.4% rise in the terms of trade in Q2 providing a boost to national income. 

Australian dwelling approvals fall by 9.7% in July

Australian dwelling approvals posted a sharp 9.7% fall in July, mainly due to volatile high-rise units, though house approvals also weakened. The total level of approvals has slowed to around a 7-year low.   

Building Approvals — July | By the numbers
  • Total dwelling approvals (including the private and public sectors) on a seasonally adjusted basis fell by 9.7% in July to 12,944 (seasonally adjusted) against the median forecast for a flat outcome. Last month's 1.2% fall was revised to -0.8%. 
  • The decline in dwelling approvals over the year increased from -25.0% (revised from -25.6%) to -28.5%. 
  • Unit approvals were down by 19.6% in the month (prior rev: -2.5%) to 4,573 and by -43.5% on a year earlier (prior rev: -36.7%)
  • Approvals for houses fell by 3.1% in July (prior rev: +0.4%) to 8,371 and are down by 16.2% over the year (prior rev: -14.5%).
  • In trend terms, total dwelling approvals fell by 3.2% in July and by 24.0% over the year, with houses -1.0%m/m and -15.4%Y/Y and units -6.8%m/m and -35.0%Y/Y.

Building Approvals — July | The details 

The total number of approvals at around 13,000 has fallen to the levels that prevailed between mid-2012 to mid-2013. House approvals at around 8,300 were at their lowest since April 2013, while units approvals at around 4,500 have weakened to a 7-year low. The 19.6% slump in unit approvals in the month was driven by a sharp decline from high-rise units in Sydney and Melbourne.

The available underlying data, which is not seasonally adjusted, indicates improving momentum from houses, and that could support a stabilisation in building approvals in the coming months. Housing market conditions and sentiment have been on the improve since May's federal election, with additional support from a lower RBA cash rate and APRA's changed guidance for less restrictive credit assessment criteria. Over the medium to long term, strong population growth should help to lift dwelling approvals from these low levels.

The state details were notably volatile in July and are shown in the table, below.  

The fall in approvals over the past year has been experienced across the nation, as highlighted by the chart, below.

The value of alteration work to existing residential properties posted a 0.4% rise in July to $727m to be up by 4.8% over the year. In the non-residential category, the value of work approved slumped by 9.9% to $3.75bn, which largely offset a 10.5% gain in June, while a large base effect saw the annual pace swing to -18.6% from 25.8%, though the trend is positive. 

Building Approvals — July | Insights 

A volatile result in this update that was driven by the high-rise unit category. The weakness in approvals over the past year has now well and truly flowed through to residential construction activity, which contracted by 9.6% in year-on-year terms according to this week's Construction Work Done report for Q2. Ongoing weakness in approvals will mean residential construction will continue to be a headwind for the domestic economy, though there are tentative signs that a stabilisation will emerge in the coming months.   

Wednesday, August 28, 2019

Australian CapEx falls in Q2; 2019/20 investment plans $113.4bn

Australian private sector capital expenditure (capex) unexpectedly declined in the June quarter, driven by weakness in construction activity consistent with yesterday's construction work done data, while the third estimate of investment plans for the 2019/20 financial year was slightly higher than anticipated. 

CapEx — Q2 | By the numbers
  • Capex spending in Q2 fell by 0.5% (-$156m) to $29.228bn, which was a sizeable disappointment on the median forecast for a 0.4% increase. The intially reported 1.7% decline in Q1 was revised to -1.3%. Over the year, capex spending declined by 1.0% compared to -1.7% in Q1.

  • Equipment, plant and machinery investment increased by 2.5% in the quarter (prior rev: -0.5%q/q), or by $351m to $14.16bn. As a result, the annual pace accelerated to 5.7% from 1.9%. 

  • Investment in building and structures declined by 3.3%q/q (prior rev -1.9% from -2.8%), or by -$508m to $15.068bn, which further increased the annual decline from -4.7% to -6.6%.

  • Estimate 3 for capex in the 2019/20 financial year was nominated at $113.4bn, which was a touch higher than the median forecast for $113.0bn. This was an upgrade of 14.9% on estimate 2 for 2019/20 and a 10.7% increase on estimate 3 from the previous financial year.

  • Total capex spending in 2018/19 according to estimate 7 was $122.119bn -- a slight decrease of 0.1% on estimate 6.


CapEx — Q2 | The details 

Total capex spending fell by 0.5% (-$156m) in the quarter to be down by 1.0% over the year. Looking into the details, the weakness was attributable to the non-mining sector, which in aggregate fell by 1.3% (-$287m) to $21.206bn, though it is still positive through the year at 1.4%. In particular, the decline was driven by a 2.4% contraction (-$472m) from 'other selected industries' (mainly services) in the quarter to $18.845bn, with the annual pace decelerating from 4.2% to 1.6%. The decline in Q2 was driven by buildings and structures at -5.1%, though equipment investment lifted by 1.5%. The manufacturing sector saw capex rising by 8.5% in Q2 (+$185m) to $2.361bn to be broadly flat over the year (-0.4%). Q2's increase was driven by broad-based gains from buildings and structures (+17.5%q/q) and equipment (+7.0%q/q). 

In the mining sector, capex posted its strongest quarterly outturn in 5 years at +1.7% (+$131m) to $8.022bn, with the annual decline slowing sharply from -12.2% to -6.8%. However, buildings and structures were still a drag -- albeit very modest -- at -0.4%, with equipment spending up by 10.0%. 

Capex spending in Q2 was led by New Wales (+4.2%q/q, +8.7%Y/Y) and Western Australia (+4.8%q/q, -6.1%Y/Y), the latter posting its strongest quarterly rise in 6 years, and the Northern Territory (+10.0%q/q, -55.7%Y/Y), which, together with the asset and sector data, suggests the drag from completing resources projects may now be in the past. However, those gains were surpassed by declines from Victoria (-2.7%q/q, +11.9%Y/Y), Queensland (-5.9%q/q, -9.8%Y/Y), South Australia (-3.7%q/q, -2.9%Y/Y) and Tasmania (-9.8%q/q, -5.4%Y/Y).    

Investment intentions by firms for the full 2019/20 financial year as per the 3rd estimate was nominated at $133.4bn, with markets anticipating a figure of $113.0bn. This implies that capex intentions are 10.7% above the level they were from a year ago, and have also increased by 14.9% compared to 3 months ago. 

While appearing upbeat, the 10.7% year-to-year rise is less constructive than the 12.3% year-to-year increase implied by estimate 2 for 2019/20. In addition, the 14.9% rise from estimate 2 is only slightly stronger than the average rate of increase between estimates 2 and 3 over the past 5 years.

The implied 10.7% year-to-year increase in capex in 2019/20 is expected to be broad based, with mining investment intentions pointing to a rise of 20.7% to $38.08bn. Non-mining investment intentions are pointing to a 6.2% rise to $75.322bn, with services industries up by 5.8% to $65.987bn and manufacturing lifting by 8.6% to $9.335bn. 

CapEx — Q2 | Insights 

The fall in capex in Q2 was driven by weakness in buildings and structures, which is consistent with yesterday's weak Construction Work Done update. The details for equipment spending were more upbeat at +2.5% in the quarter, and this component will help to offset some of the weakness from the construction activity. Overall, it looks to have been another patchy quarter for business investment, likely making only a subdued contribution to GDP growth in Q2. 

Investment plans for 2019/20 appear slighly less constructive than they were 3 months ago, likely weighed by increased uncertainty in global and domestic economic conditions, which is despite the passage of the federal election and the Reserve Bank of Australia twice cutting the cash rate in June and July. Notwithstanding, investment in the mining sector remains on track to end 6 consecutive years of decline in 2019/20, while the outlook for non-mining investment is still positive. Both of these factors are supporting the growth outlook over the medium term.   

Preview: CapEx Q2

The ABS is due to release its capital expenditure (capex) survey for the June quarter today at 11:30am (AEST). The capex survey provides a partial estimate of business investment over the quarter, as well as firms' investment intentions for the next financial year. Following a 1.7% decline in the March quarter, capex spending is expected to lift in Q2 and likely be driven by the non-mining sector. Investment intentions may have been made more clear following the outcome of May's federal election, though global uncertainties have intensified over recent months and have been a headwind to investment plans in other economies. 

As it stands Capital Expenditure

Capex spending fell by 1.7% in the March quarter to $29.3bn against expectations for a 0.5% rise. From a year earlier, capex fell by 1.9%.
 Q1's weakness was broad based, with spending on buildings and structures falling by 2.8% to $15.5bn (-5.5%Y/Y) and equipment, plant and machinery easing by 0.5% to $13.8bn (+2.4%Y/Y).     

Investment in the mining sector continued to unwind as remaining projects in the LNG sector moved closer to completion, with a 1.3% fall in the March quarter to $7.8bn. As a result, the annual pace of decline steepened from -11.2% to -12.9%, though that is well down from the Q3 2016 trough of -37.2%. Non-mining investment posted its first quarterly decline since Q3 2016 after contracting by 1.9% to $21.5bn (+2.8%Y/Y). That reflected a 7.4% fall from the manufacturing sector to $2.1bn (-8.5%Y/Y), as well as a 1.2% decline from 'other selected industries' (mainly services) to $19.3bn (+4.3%Y/Y).

The 2nd estimate of capex plans for the 2019/20 financial year was $99.1bn, which was a 7.6% upgrade on estimate 1 and 12.8% above estimate 2 from the previous financial year. Importantly, intentions for mining investment lifted by 21% from a year earlier to $32.4bn, pointing to its first year-to-year rise since 2012/13. Meanwhile, the gradual uptrend from the non-mining sector remained intact with expectations for 2019/20 at $66.7bn, implying a 9.2% year-to-year increase. 

For a full review of Q1's data see here

Market expectations Capital Expenditure

In today's release, capex spending is expected to have improved in Q2 with the median forecast according to Bloomberg situated at a 0.4% rise around a wide range of estimates from -1.7% to +3.0%. 

Regarding investment intentions, Q2's report will include the 3rd estimate of expected capex for the full 2019/20 financial year. The median forecast for estimate 3 is $113.0bn, between a range of estimates from $101.0bn to $118.0bn. There will also be a finalised outcome for total capex spending in the 2018/19 financial year, which is likely to be little changed at around $122.0bn. 

What to watch Capital Expenditure

Markets will be focused on the 3rd estimate for investment plans in 2019/20, which were reported by firms between July and early-August. Since Q1's survey, there has been a range of developments to consider. Firstly, the outcome of May's federal election removed some uncertainty for firms over policy changes. Secondly, global uncertainty has continued to intensify in response to rising trade tensions and has been a headwind for investment plans for firms in other economies, particularly in the manufacturing sector. Thirdly, the Reserve Bank of Australia delivered back-to-back cash rate cuts in June and July. So, what will be the collective impact of these (and other) factors? 

For context, the median forecast of $113.0bn implies a 14% upgrade on estimate 2, an outcome that would be in line with the average rate of increase from estimate 2 to estimate 3 over the past 5 years. It also points to a 10.3% rise on estimate 3 from 2018/19, which on face value is slightly less constructive than the expectation for a 12.8% rise indicated by estimate 2 for 2019/20. 

This moderation aside, the key dynamic is that investment intentions appear on track to end 6 consecutive years of decline that was driven by mining investment rolling off from its mid-2012 peak following the construction-led boom that occurred in the early part of the decade. With the unwind in mining investment close to reaching the end of the line, the outlook is more favourable with the focus expected to turn to capex spending to maintain production.     

Meanwhile, the outlook for non-mining investment is positive and is supported by non-residential construction work and a healthy pipeline of projects in transport and electricity-related infrastructure, though weakness was evident in these areas in Q2 as highlighted in yesterday's Construction Work Done data (see here). Q1's survey also showed that equipment spending by the non-mining sector was projected to rise by around 10% in the current financial year.      

Tuesday, August 27, 2019

Australian construction activity contracts sharply in Q2

Australian construction activity contracted by a much sharper-than-expected 3.8% in Q2, as the downturn in private residential work intensified, weighed also by weakness in commercial building and infrastructure work. 

Construction Work Done — Q2 | By the numbers

  • Construction activity fell by 3.8% in Q2 to $48.778bn, a sizeable downside miss on the median forecast for a 1% fall. Work done in Q1 was revised to show a larger fall of 2.2% compared to the initially reported decline of 1.9% decline. The contraction in activity through the year accelerated to -11.1% from -6.1%.  
  • The headline results in Q2 were;
    • residential work fell by -5.1% to $18.033bn (-9.6%Y/Y)
    • non-residential work declined by -6.6% to $10.473bn (-3.3%Y/Y)
    • engineering work contracted by -1.1% to $20.271bn (-15.9%Y/Y)  

Construction Work Done — Q2 | The details 

Breaking down the details, private sector work in aggregate fell for the 4th consecutive quarter in Q2 after slowing by 4.7% to $37.498bn. Activity over the past year slumped to -10.5% from -4.5%.

Within this, residential activity fell by 5.1% in Q2 -- its 4th straight quarterly decline -- to $17.832bn as the contraction over the past year intensified sharply to -9.5% from -1.6%. The turning point in the cycle occurred in Q3 last year and activity has continued to pull back ever since. In Q2, dwelling construction fell by 5.3% -- its 4th consecutive quarterly fall -- to be -9.9% through the year (houses -5.5% in Q2 and -8.9%Y/Y; units -5.1% in Q2 and -11.2%Y/Y), while alteration work fell by 3.3% in the quarter and by -5.8% year-on-year.

Commercial or non-residential building work (including offices, shops and warehouses etc) posted a particularly sharp 7.3% contraction in the quarter to $7.598bn to be down by 3.8% over the year. While non-residential approvals have slowed since the second half of last year, there is still a reasonably strong pipeline to work through. Meanwhile, private engineering (infrastructure) work fell by 2.5% in the quarter to $12.068bn to be down by 15.7% over the year, likely an indication of residual weakness in the mining sector associated with completing projects. 

In the public sector, total construction activity was down for the 4th straight quarter, though Q2's was a modest 0.8% fall coming in at $11.28bn. However, the annual pace has now declined to -13.0% and has been slowing since Q2 2018. Infrastructure work lifted by 0.9% to $3.076bn to be -16.1% over the year. Activity declined in the previous 3 quarters, seemingly a temporary period of weakness given there is a strong pipeline of transport and energy-related projects to be completed by state and local governments. Public building work posted a 5.1% contraction to $3.076bn, which turned the annual pace negative at -3.7% compared to 4.7% at the end of Q1.

The chart, below, aggregates the outcomes from the private and public sectors.

The state-based outcomes, inclusive of the private and public sectors, are shown in the table, below. Weakness in residential activity continues to be noticeable across the mainland states. Non-residential work was noticeably weaker in Q2, highlighted by New South Wales swinging from +10.3% to -5.6%, Victoria slowing from -0.1% to -8.9% and Queensland pulling back from -0.1% to -4.7%. Infrastructure work was mostly soft across the states in Q2, though New South Wales posted a 5.6% rise, and Western Australia saw its first quarterly increase in a year.      

Construction Work Done — Q2 | Insights

This was a very weak update, highlighted by an intensification of the slowdown in the residential construction cycle, a weakening in non-residential construction work, a further easing in private infrastructure work and softness in the public sector. This creates downside risks for Q2's GDP growth outcome given the weakness from residential construction, as well as from non-residential construction and infrastructure, with more information to come to hand on these components in tomorrow's capital expenditure survey for Q2.

Friday, August 23, 2019

Macro (Re)view (23/8) | Trade tensions rise further challenging policymakers

US-China trade tensions escalated significantly again late this week, as China announced its countermeasures in retaliation to the US's recently announced tariff on a $300bn tranche of consumer-related goods imported from China, only for the US respond a matter of hours later by increasing existing tariffs. 

Starting with China, its Commerce Ministry announced that due to the "US's unilateralism and protectionism" a tariff ranging from 5-10% will be levied on $75bn tranche of US-produced goods, including agricultural products such as soybeans and crude oil, which will have a two-stage phase-in starting on September 1 and then December 15 to match the dates of the latest US-implemented tariffs. It will also reinstate auto tariffs that had been suspended following constructive negotiations at last year's G20 Summit in Buenos Aires, with US-produced vehicles to be hit with a 25% tariff and auto parts to attract a 5% tariff, starting on December 15. 

In the US, President Trump was quick in responding, stating via Twitter that the recently-announced 10% tariff on the $300bn list of consumer-related goods will be increased to 15%, starting from September 1. In addition, the 25% tariff currently applied to a $250bn tranche of Chinese-originated goods, mainly relating to industrial products, will rise to 30%, starting on October 1. This particular tariff initially started at 10% back in September last year, before rising to 25% in May after it was delayed from a planned January 1 increase following the progress made at the G20 Summit. President Trump also ordered US parcel companies to "search for and refuse all deliveries of Fentanyl from China". 

This latest tit-for-tat caught markets completely by surprise, which had been setting themselves for a speech by US Federal Reserve Chair Jerome Powell at the Jackson Hole Symposium as the key event of the week. During his speech, Chair Powell outlined the new challenge that the Fed is faced with in terms of assessing the response of monetary policy settings to global trade tensions. Fundamentally, monetary policy is the tool at the Fed's disposal to help meet its goals of full employment and price stability based on its assessment of macroeconomic conditions, though it is of great uncertainty how trade tensions now interact within that framework. On this point, the divergence of views within the Fed's policy-setting committee was clearly evident in the minutes from July's meeting where it ultimately delivered a 25 basis point rate cut to "insure any further downside risks" to the economic outlook from "weak global growth" and "trade policy uncertainty". However, of the 10 voters to the decision, 2 had dissented against any cut at all, while another 2 had called for a larger reduction of 50 basis points.

Chair Powell acknowledged the greatly changed circumstances since the Committee's last meeting, including a further escalation in trade tensions, weak data from Germany and China, geopolitical uncertainties in the UK, Italy and in Hong Kong and volatile financial markets in which long-term bond yields have plunged. Despite all of that, Chair Powell still communicated a constructive view of US economic conditions highlighting strength in consumer spending and in the labour market. Importantly, Chair Powell avoided the "mid-cycle adjustment" statement used to describe the rate cut at the Committee's last meeting, which had unsettled markets given they hold aggressive expectations for easing, and instead opted for the less-committal commentary it has been using that it "will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective".

Global risks are also a key focus at the European Central Bank (ECB) as highlighted in the Account of its July policy meeting. Notably, "softening global growth dynamics and weak international trade were still weighing on the euro area outlook". Furthermore, these downside risks were now seen to be "more pervasive" and could thus "necessitate a revision to the baseline growth scenario". There were also concerns expressed around inflation, in particular that a persistence of weak outcomes were weighing on inflationary expectations. That was evident again this week, with headline inflation slowing to a 1.0% pace over the year to July -- its softest since late 2016 -- while annual core inflation held at 0.9%, with both running well short of the ECB's target of below, but close to 2% (shown as chart of the week). As a result of a faltering growth and inflation outlook, the Governing Council is widely expected to unveil a package of stimulus measures at its next meeting in September, likely to include a rate cut, as well as potentially restarting quantitive easing and providing further details on a tiering structure to ease pressure on banks from negative deposit rates charged on excess reserves.      

Chart of the week 
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Domestically the Reserve Bank of Australia released its minutes from the August Board meeting, which was the highlight in an otherwise quiet week for local events. Following consecutive rates cuts of 25 basis points in June and July the Board held the cash rate steady at 1.0% in August, though it signaled that it is not only domestic economic conditions that are key for policy deliberations for the near term and will be taking an increased focus on developments in the global economy. Given the recency of its earlier rate cuts, the Board's stated position is that it is now "appropriate to assess developments in the global and domestic economies before considering further change to the setting of monetary policy". The Board retains an explicit easing bias, which it appears prepared to act on if its outlook for growth and inflation relative to the forecasts it presented in August's Statement on Monetary Policy were to falter, due either to headwinds generated domestically or from offshore influences. 

Clearly notable was that concerns from the Board regarding the global economic growth outlook had risen, as "the escalation of the trade and technology disputes had increased the downside risks". In particular, the impact of the global trade tensions were noted as having "a negative effect on investment in many economies". However, its impact on financial conditions was also noted as being responsible for increasing volatility in markets, particularly for foreign exchange and equities, which had contributed to the shift to more accommodative stances from central banks across the globe sending long-term bond yields to historic lows. Staying with the global theme and with its own cash rate heading lower, the Board had discussed the various unconventional monetary policy measures used in other economies over recent years. While it was unable to reach a definitive analysis of particular approaches, it noted that effectiveness tended to increase when working as a package of measures rather than in isolation.  

From a domestic standpoint, the Board anticipates output growth to slow further below trend in 2019 to 2.4%, down from its forecast of 2.6% back in May. However, it acknowledges that the risks over the near term indicate that growth could end up being softer than anticipated, mainly because considerable uncertainty exists in the outlook for household consumption, which is the largest component of the domestic economy. Growth in spending on goods and services by households has been slowing over recent years, weighed mostly by an enduring period of low wages growth and weak housing market conditions. A more recent headwind has come from the labour market, wherein conditions have softened highlighted by a rise in the unemployment rate and accordingly "there appeared to have been more spare capacity...than previously appreciated", meanwhile forward-looking indicators point towards employment growth moderating from its robust pace over the second half of 2019. That was largely the reason why the Board cut the cash rate in June and July, with stronger labour market conditions required to generate faster wages growth, underpin consumption, and in turn lift inflation back to target. On the other hand, the Board is clearly optimistic that some of the downside risks mentioned will dissipate next year helped by their earlier-than-expected rate cuts, tax relief for low-and middle-income earners, and improving housing market conditions.

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Friday, August 16, 2019

Macro (Re)view (16/8) | Markets under pressure from weak outlook

A weak economic outlook continued to drive the shift to risk aversion as markets doubled down on their efforts from last week. That was despite some rare and seemingly good news on the US-China trade front, with US President Trump announcing that around half of the $300bn tranche of consumer-related goods produced in China due to face an import tariff of 10% starting on September 1 would now be delayed until December 15 to ameliorate concerns of price increases dampening household spending in the lead up to Christmas. Household spending is an area of the US economy currently running at a robust pace and led GDP growth in Q2, reiterated this week by a stronger-than-expected result from retail sales in July rising by 0.7% and 3.5% over the year. 

However, US-China tensions remain fractious with China again vowing to retaliate against this latest tariff and called on the US to meet it "halfway" in finding a resolution, though comments from President Trump were less concilliatory in saying that any deal needed to be "on our terms". Adding to concerns this week were political uncertainties emanating from 
Italy and Argentina, escalating protests in Hong Kong,  as well as unequivocally poor data from China and Europe pointing to a further deterioration in the outlook for the global economy.  

In China, growth in retail sales (7.6% vs consensus 8.6%) and industrial production (4.8% vs 6.0%) over the year to July was much weaker than expected, while fixed asset investment just missed to the downside at 5.7% (vs 5.8%) on a year-to-date basis. The outturn for industrial production was the lowest since 2002 and highlights the pressures being faced by the manufacturing sector from a slowing global economy and weakness in exports prompted by trade tensions. The weakness from these reads together recent softness in credit data has increased expectations in markets that new stimulus measures will be required to ensure output growth does not falter below the 6-6.5% range targeted by authorities.

The second estimate of Q2 GDP growth in the euro area was unchanged at 0.2% quarter-on-quarter and 1.1% year-on-year. Most notably, growth in Germany -- the largest economy in the bloc -- contracted by 0.1% in Q2 and flatlined over the year, with the nation's sizeable export sector (more than 40% of GDP) struggling from the uncertainties abroad and from earlier structural adjustments working through the automotive industry. Initial signs from the German government were that it was reluctant to come forward with additional fiscal stimulus measures, though by week's end there were reports indicating more willingness to consider pulling away from their balanced budget rule imposed back in 2014 as a counter-cyclical response to support activity. Weighed by weakness in Germany, total industrial production for the euro area fell by 1.6% in June and by 2.6% over the year indicating the downturn in the manufacturing sector across the bloc is intensifying. Support will be forthcoming from the European Central Bank, with Governing Council member Olli Rehn saying on Thursday during an interview with the Wall Street Journal "it's important that we come up with a significant and impactful policy package in September".

Underlining concerns within markets regarding the global economic outlook and that the policy stance of the US Federal Reserve is too tightthe 10-year US Treasury yield traded below that for the 2-year Treasury on Wednesday for the first time since 2007. Inversion of the 2/10 yield curve was a psychological event for markets given it has portended each of the past 5 US recessions with an average lead time of a little more than 18 months, though the spread had turned positive again by the end of the week. While the Federal Reserve has already begun lowering rates, the rationale used at its last meeting to justify its 25 basis point cut of a "mid-cycle adjustment" is clearly misaligned with what markets deem necessary. However, there are also genuine concerns in markets that monetary policy will not be sufficient to remedy the current slowdown, with much more support needed from fiscal policy and structural reforms. 

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The labour market was the key focus of developments in Australia this week, with updates received on employment for the month of July and wages growth in the June quarter. Both data points continued to indicate that conditions within the labour market are running well below capacity, with subdued wages growth likely to keep inflation pressures contained thus pointing to further easing from the Reserve Bank of Australia by year's end.

The domestic economy added a net 41,100 jobs in July -- well clear of the consensus expectation for a gain of 14,000 -- and rebounded from a decline of 2,300 in June (revised from +500) that was its first monthly fall since September 2016 (see our full review here). Employment growth over the year strengthened from its already robust pace of 2.4% to 2.6% and has been predominantly driven by the full-time segment (3.0%Y/Y). However, with the participation rate rising to a new record high for the third time in the past 4 months reaching 66.1%
, the unemployment rate was unchanged at 5.2%. Spare capacity remains prevalent with the key measures retracing some of the improvements achieved in the previous month as the underutilisation rate lifted to 13.6% and the underemployment rate increased to 8.4%.

Persistent and elevated spare capacity remains a headwind to wages growth, as confirmed by the Q2's subdued update of the Wage Price Index (reviewed here). While the quarterly outcome of 0.6% surprised to the upside of expectations (0.5%), that was boosted by a 0.8% rise from the public sector -- its fastest quarter-on-quarter gain in 5 years -- and was due largely to a 1.5% rise in Victoria reflective of a state government initiative to recalibrate wages to match the other states. Growth in the Wage Price Index through the year 
remained contained at around 2.3%, with the private sector just shy of that pace and trailing the public sector at 2.6%, which is shown as our chart of the week, below. With the underlying detail confirming broad-based softness across the industries and states, there was little to suggest inflation pressures will move materially higher. Furthermore, subdued wages growth continues to pose risks for the outlook for household consumption, which was again highlighted as the key uncertainty facing the domestic economy in a speech by RBA Deputy Governor Guy Debelle during the week.   

Chart of the week

Also of note this week, Westpac-Melbourne Institute's Index of Consumer Sentiment rebounded by 3.6% in August to a 'neutral' reading of 100.0, which turned over most of the 4.1% fall from the previous month in which confidence fell to an outright pessimistic level of 96.5. Supporting the turnaround was a 9.6% rise for the sub-index measuring consumers' expectations for the economic outlook over the next 12 months, likely influenced by the RBA's June and July rate cuts. However, though overall views towards spending lifted, the gains were less constructive suggesting that the federal government's tax cuts and an improving housing market are yet to fully take hold. Views towards the housing market continue to strengthen, with the indexes for both purchasing (+3.0%) and price expectations (+5.1%) rising solidly in August, which is broadly consistent with the recent indicators from auction clearances, notably in the major markets of Sydney and Melbourne, and CoreLogic's price data. 

In the business sector, NAB's Business Survey for July reported that confidence improved in the month (from +2 to +4) but remains at a below-average level and, matching with the weakness evident in the sector across the globe, is lowest for manufacturing firms. Overall business conditions eased from +4 to +2 and also remain below their long-run average level. Here, weakness was again notable in manufacturing together with the retail and wholesale sectors, while conditions are most buoyant in the mining sector supported by elevated commodity prices and a lower domestic currency. The survey's forward-looking indicators pointed to employment tracking at a modest +15,000 pace per month over the second half of the year, though note the employment data have largely run well above expectations so far in 2019. Meanwhile, forward orders remain very weak at a reading of -3 suggesting that business conditions will remain soft over the coming months, though capacity utilisation has improved to be around its average level.