Macro (Re)view (29/5) | Risks to the optimism

Optimism over the near-term outlook was a key theme this week reflected by a tilt in global equities towards the cyclical areas of the market previously left behind in the rally off the lows from late March, a step in the right direction regarding fiscal aid in Europe and signs that activity was improving as economies reopen. However, the risks around this more upbeat assessment of conditions remain significant and perhaps even underappreciated given that the reopening of economies is only in its very early stages, global cases of new viruses are still rising due to outbreaks in developing countries and geopolitical tensions are ratcheting up.      

In Australia this week the data flow included updates on construction activity and capital expenditure in the March quarter ahead of next week's national accounts. At this stage, GDP is likely to have contracted in Q1, though there will be more inputs available on Tuesday before assessments can be finalised (see here). In the data at hand, construction work done fell by 1.0% in the quarter, which was better than consensus (-1.5%) and an improvement from the 2.9% decline in Q4 (see here). In a surprise outcome, the magnitude of the decline in private sector activity (-0.6%qtr, -8.7%yr) was less severe in Q1 than in the public sector (-2.5%qtr, 1.1%yr). The other important aspect of the report was continued weakness in the residential construction cycle (-1.6%qtr, -12.4%yr), with activity having now fallen by almost 16% since its most recent peak in mid 2018.  

Capital expenditure by private sector firms fell by a further 1.6% in the March quarter — consensus and Q4's outcomes were much more pessimistic at -2.8% and -2.6% respectively — as the decline over the year deepened to -6.1% (see here). On a sectoral basis, mining sector capex advanced (4.2%qtr, 6.9%yr) against weakness from the non-mining side (-4.0%qtr, -10.8%yr) and this will become an increasingly key theme in the domestic economy over the year ahead. Indicating the impact on investment from the COVID-19 crisis had been immediate, firms lowered their outlook for capex in 2019/20 by 3.8% to $115.4bn. Looking ahead, capex intentions for the 2020/21 financial year were lowered by 8.8% to $90.9bn (see chart, below). This means that intentions have fallen by 7.9% compared to the same estimate a year ago, which is a complete reversal to what was forecast 3 months earlier that had capex on track to rise by 8.2% over the year. The concern is around non-mining investment that is projected to plunge by 16.9% over 2020/21 (services -18.4% and manufacturing -6.1%). Certainly, until this outlook improves progress on lowering unemployment will be constrained. The positive is that mining investment is set for an upward trajectory of 10.4% coming after 6 consecutive years of decline.

Chart of the week

In other domestic developments, the ABS's latest business and household COVID-19 surveys were released. For businesses, there continues to be a very significant impact on cash flow with 72% of firms reporting that revenue had fallen as a result of the pandemic. Serious consideration should also be given to the finding that 74% of businesses reported they were now operating under modified conditions (such as with a reduced workforce or shifting to online platforms). A structural change of this magnitude occurring as quickly as it has in this instance has the potential to weigh on output well past the easing of restrictions and highlights that the risks around the recovery are not confined to the demand side of the economy only. In the household survey, details around the labour market were a little less constructive than in the previous reading, indicating that another very weak outcome for employment will be reported in May. Lastly, in an appearance before a Senate Select Committee on COVID-19 during the week, RBA Governor Philip Lowe noted that the economy appeared to be tracking slightly ahead of its baseline outlook, though there were still "a lot of challenges coming down the track". In response, Governor Lowe reiterated the continued importance of fiscal support and highlighted that his view the Bank's policy settings were working well, though if needed its bond purchases could be stepped up again, while the prospect of negative rates was "extraordinarily unlikely". 

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Switching the focus offshore, tensions between the US and China continued to escalate after China's parliament voted in national security law to be imposed on Hong Kong. In a press conference on Friday, US President Trump flagged that his administration would move towards ending the special trading status Hong Kong has had with the US since 1992, though for the time being markets viewed these warnings as less severe than feared as equities advanced on the day and over the week. Meanwhile, Federal Reserve Chair Jerome Powell spoke of the risks that a second wave of the virus would pose to the economic recovery in terms of its impact on confidence and reiterated that the central bank would be "strongly committed to using our tools" to assist where it can in lowering borrowing costs and keeping credit lines flowing. In terms of data in the US this week, GDP was revised to show a slightly larger contraction of 1.3% quarter on quarter in Q1 (-5.0% in annualised terms), while more timely indicators for the month of April showed further deterioration as durable goods orders collapsed by 17.2%, personal spending plunged by 13.6% and initial jobless claims lifted by another 2.1 million in the past week, though there was some better news evident in the fall of continuing claims of unemployment benefits from 24.9 million to 21 million. The one result that surprised to the upside was on personal income, which soared by its most on record rising by 10.5% in April reflecting the impact federal assistance payments under the CARES Act to households. 

Across the Atlantic, sentiment was boosted by the European Commission's announcement to propose a €750bn fiscal package to provide recovery funding to the member states most impacted by the COVID-19 crisis. The proposal would involve a common bond issuance by the EU, with disbursement of €500bn in grants and €250bn in loans. The major sticking point has been the issue of whether recovery funding should be disbursed in either grants or loans, though this solution provides something of a comprise, acknowledging the resistance that a grants-only plan has been met with by nations including Austria, Denmark, Sweden and the Netherlands. The advantage of grants is that it will assist countries that entred the crisis with high debt levels, particularly as some of those are heavily reliant on the tourism sector that will be slow to reopen. At this stage, it is still a long way from a done deal as all 27 member nations will need to ratify the proposal, though it does already have a significant level of support from Paris, Berlin, Rome and Madrid. If agreed upon, the two largest beneficiaries stand to be Italy and Spain, receiving €81.8bn and €77.3bn respectively.