The status quo was confirmed in the US this week as President Biden announced the renomination of Jerome Powell to chair the Federal Reserve. Initially, the response was steeper yields from the front of the curve through to the belly, reflecting increased confidence in a more condensed timeline to raising rates than currently indicated by the Fed. However, a significant repricing subsequently occured on the news of the emergence of a new Covid strain in Africa. In the minutes from the Fed's November meeting, it was outlined that "some participants" on the FOMC had pushed for a more accelerated QE taper schedule than the $15bn per month reduction ultimately settled on. But the FOMC notes that it is open to adjusting the pace "if warranted by changes in the economic outlook". While the taper process could end sooner than currently implied in mid-2022, the news on the virus has given markets some pause for thought. Ideally, the Fed wants new QE purchases to have ended before it starts raising rates, and preferably with a lag in between.
A faster taper was being discussed in light of the persistence of price pressures, which has increased uncertainty within the FOMC around the inflation outlook. The consensus view remains that supply/demand imbalances associated with the pandemic are driving up inflation but are expected to diminish in 2022. However, the more hawkish voices on the Committee are citing factors such as a broadening of higher prices and faster wages growth as reasons why it may need to act sooner rather than later. This is where the balance of risks currently sits and this was reinforced by the Fed's preferred inflation gauges rising further in October. Headline PCE inflation lifted from 4.4% to 5.0%yr while core PCE inflation advanced to 4.1%yr from 3.7%, with both running at their fastest since the early 1990s. Despite the concerns over inflation, the US consumer remains in very robust shape. In fact, growth in real spending rose 6.6% over the year to October to comfortably outpace the rate of inflation. Beneath the surface, demand for goods expanded by 7.3%yr and remains at a highly elevated level, while services consumption (6.3%yr) continues to recover from the depths of the pandemic. This configuration of outcomes means that the rotation back towards pre-pandemic shares of goods and services is taking longer than the Fed expected and is a key reason for the extended run of high inflation prints.
Over in Europe, concerns around its Covid situation have increased through the week, with the news of the new strain adding a layer of complexity. This comes at a time when the euro area economy had looked to be accelerating on the strength in services sector activity as the flash composite PMI was posted at 55.8 in November from 54.2 in October. Capacity constraints remain a headwind for manufacturers and are contributing to price pressures, though activity levels were still consistent with expansion in the sector. The account of the ECB's late October meeting highlighted the upside risks to the inflation outlook and that, in that scenario, retaining optionality in its monetary policy response was key. Accordingly, the account notes the consensus view was that the March 2022 end date for adding new net PEPP purchases remained appropriate. Interestingly, ECB Executive Board member Isabel Schnabel in a Bloomberg interview indicated the PEPP could remain on standby after March 2022, casting some doubt on expectations that its other QE program (APP) may be repurposed. In the UK, BoE Governor Andrew Bailey spoke of the "hazardous" situation central banks faced giving forward guidance on rates amid a highly uncertain economic outlook. Lastly, across the Tasman, the RBNZ got its second increase for the hiking cycle away this week, raising rates by 25bps to 0.75% as inflation continues to run well above the target range. The latest Monetary Policy Statement upped the projection for the policy rate to peak at 2.6% in 2024 from 2.1% previously.
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Switching to Australia, risks appear to be tilted to the upside going into next week's Q3 GDP report that will provide the accounting of the impact of the Delta lockdowns. Consensus is currently for a contraction in Q3 GDP of around 3%, though the indicators that were released through the week were not as negative as anticipated, indicating estimates are more likely to be revised up rather than down at this stage, albeit with a few other key inputs (inventories, government spending and net exports) yet to come to hand. My preview of the Q3 national accounts can be accessed here.
The decline in construction activity was -0.3% in Q3, much less severe than the 3% fall expected (full review here). While New South Wales weighed heavily (-8.1%q/q) due to the temporary suspension of construction work during the Sydney lockdown, there were broadly offsetting rises posted in Victoria (5.8%q/q) and Queensland (5.5%). The outcome in Victoria was a notable surprise, with the construction shutdown appearing to have occured too late in the period to have hit reported activity. The details of the report showed building work nationally was down 0.9% in Q3, with non-residential volumes falling 2.2% as residential work stalled for the second quarter in succession. In the latter, capacity constraints from labour and materials shortages are an increasing headwind. A 0.4%q/q rise in engineering work attenuated the weakness in the building activity.
The upswing in Australia's capex cycle was full of running when the Delta lockdowns hit. A 2.2% fall in capex in Q3, broadly as expected, has halted the momentum but this should prove to be a temporary setback (full review here). A negative impulse to GDP will flow through from a large fall posted in equipment spending (-4.1%q/q) as the lockdowns saw firms delay purchases, while the global supply chain pressures may have been an additional headwind. Meanwhile, buildings and structures capex was near flat (-0.2%), weighed by the temporary shutdown of construction sites in Sydney. Encouragingly, firms appear to have looked through the lockdowns as investment plans for 2021/22 were upgraded sharply by 8.3% on the previous estimate to $138.6bn. Taken with the upbeat expectations for future conditions reported in recent surveys, this indicates firms are intending to make up for lost time in Q3 by elevating capex spending plans through the remainder of the financial year. Strong business investment is likely to become a key driver of economic activity in 2022 as the reopening rebound is cycled.
On the recovery, the data through the week was consistent with a sharp rebound. Private sector activity expanded at its fastest pace in 5 months as the composite PMI reading for November accelerated to 55.0 from 52.1 in October. However, this was being accompanied by increased price pressures with input costs lifting at a record pace. In the labour market, the ABS's payroll jobs index accelerated by 1.4% over the second half of October as restrictions were being eased. Meanwhile, retail sales surged at their fastest pace in 11 months rising by 4.9% in October, coming in well ahead of market expectations (2.5%).
