Australia trade balance back in deficit in May

Australia recorded its largest trade deficit since December 2015 in May, its second deficit of the past 3 months. The trade deficit was $3bn in May, swinging from a $1.4bn surplus in April, with both exports (-6.9%) and imports (2.6%) contributing to the deterioration. The effects of the Gulf conflict, the data centre build out and volatility in gold exports are all playing a role. Nonetheless, the Australian dollar on a trade weighted basis is up more than 4% year to date.  

The trade account was in deficit by $3bn in May as import spending ($46.6bn) exceeded export earnings ($43.6bn). Australia ran trade surpluses every month from the start of 2018 through to February this year. But this result for May was the second deficit of the past 3 months, though the shift has lacked a defining driver. 

The $1.7bn deficit in March came as imports surged (12.9%) to facilitate the data centre build out and due to the fuel price shock from the Gulf conflict. However, the deficit for May was driven by a slump in exports (-6.9%). Even incorporating the rebound to a surplus in April ($1.4bn), the 3-month average for the trade balance was in deficit (-$1.1bn) for the first time since October 2016. 

Exports largely reversed their April rebound (7.2%) with a 6.9% fall in May, coming to $43.6bn - still up by 4.6% over the year. Non-monetary gold was a key factor, with those exports falling by 35% from the prior month. Meanwhile, non-rural goods declined (2.9%) on the back of weakness in iron ore (-9%). 

Spending on imports was up 2.6% to $46.6bn all told in May. That elevates imports to new record highs, having risen by almost 17% over the year. Capital goods rose sharply in the month (8.2%) but are off their recent peak in March when data centre investment went to new levels. A near 8% rise came through in consumption goods, boosted by a surge in new vehicle purchases (24.6%).    

Intermediate goods have gone on a tear following the surge in oil prices stemming from the blockade in the Strait of Hormuz, rising 9.5% in March and 13.8% in April. But that slowed in May to a largely level movement (0.3%). Fuel imports in May were $8.6bn, more than double their pre-conflict level in February ($4bn).  

Australian dwelling approvals fall 1.1% in May

Australian dwelling approvals for May fell by 1.1%, their fifth decline in the past 6 months as high-rise unit approvals have scaled back. By contrast, house approvals (3%m/m) brought strong momentum into the RBA's tightening cycle, reaching their highest level since the stimulus-driven surge coming out of the pandemic in late 2021. Meanwhile, data centres continued to see non-residential approvals soar. 

Residential approvals were down 1.1% month-on-month in May to 17k, a downside result on expectations (0%) but still up by 5.3% over the year. This saw the 3-month average (17.2k) ease back slightly, though approvals are still up sharply from cycle lows seen a couple of years ago.   

Approvals continued to diverge across segments. Unit approvals fell a further 7.3% to 6.3k (-5.9%yr); however, house approvals lifted 3% to their highest since September 2021 (10.7k) and are up by more than 13% over the year. The key question for the housing segment moving forward is the impact of the RBA's tightening cycle, with dwelling construction a highly interest-sensitive sector. The tax changes to housing around the treatment of capital gains and negative gearing in the recent federal budget shape as another key uncertainty. Housing prices are wavering on these effects; however, underlying demand for housing due to population growth over recent years remains strong.   

In the non-residential segment, data centres continued to dominate. Work approved increased 41% on the back of a 22.9% gain in May, surging to record highs at almost $11bn in the month, up around 65% on a year ago. Much of the activity in data centres is concentrated in New South Wales and Victoria.  

Macro (Re)View (26/6) | USD continues resurgence

A tech-led sell-off due to ongoing valuation concerns in the mega-cap sector weighed on global equities and by extension risk sentiment more broadly this week. In the FX, that backdrop hit cyclical currencies the hardest, with the euro and Australian dollar seeing the largest falls against an in-form US dollar - the DXY index sitting at its highest levels in more than a year, boosted by the recent hawkish Fed repricing. Meanwhile, safe-have demand saw bond markets rally, driving US 2-year and 10-year Treasury yields down by nearly 10bps over the week. In the UK, PM Starmer's resignation had little discernible impact on Sterling or UK assets.     

Strong Australian data was helpful for an RBA that elected to maintain its tightening bias at last week's meeting. However, markets remain unconvinced further tightening is required, leaving pricing for another hike this cycle largely unchanged at a one in three chance. The labour market added around 40k jobs in May, outperforming consensus (32.5k) but only rebounding from the seasonal fall in employment around Easter following downward revisions to April (-40.7k). Nonetheless, the unemployment rate fell back to 4.4%, partly reversing its rise to 4-year highs of 4.5% the month prior (see here). Meanwhile, job vacancies - despite falling 2.1% in the three months to May - remained at a little above 2% of the labour force, levels consistent with robust labour demand. 

Headline inflation fell 0.7% month-on-month in May, slowing the annual rate from 4.3% to 4%; however, that was mainly due to the ongoing effect of the excise tax cut on fuel prices (-11.9%). Core inflation, the RBA's main focus, firmed in May (0.4%) to lift further above the target band, up from 3.4% to 3.6%yr (see here). That is likely to reaffirm the RBA's view that the earlier cash rate hikes were justified and that it may yet tighten further. Household spending lifted 1.3% month-on-month in May, likely also contributing to that narrative (see here).

In the US, data confirmed inflation pressures are on the rise. The PCE deflator was up 0.4% month-on-month in May seeing the annual rate lift from 3.8% to 4.1%, a 3-year high. The core measure that the Fed sets policy to was in line with expectations at 0.3% month-on-month, firming from 3.3% to 3.4% year-on-year, significantly above the central bank's 2% target. Markets assign a 70-80% chance to the Fed hiking by year-end. The same report showed that that personal spending lifted above expectations with a 0.7% month-on-month rise, continuing to defy very weak sentiment.

Comments by ECB President Lagarde to the EU parliament were seen as broadly balanced, keeping the door open for further rate hikes while playing down the need for aggressive tightening. That stance acknowledges the uncertainty of the outlook as well as the risks to growth being weighted to the downside. By contrast, the ECB's Schnabel said that as things currently stand, more hikes would be needed.

Australian household spending up 1.3% in May

Australian household spending rose by 1.3% in May, defying headwinds from cost-of-living pressures, RBA rate hikes and weak sentiment. That was well above expectations for a 0.5% rise; however, spending was boosted by travel-related refunds as the effects of the Middle East conflict continued to impact the data. Meanwhile, the halving of the federal excise tax continued to drive petrol prices down.   

The household spending indicator rose by 1.3% in May, a continuation of the volatile profile in recent months following the conflict in the Middle East. This was after spending rose by 1.7% in March - driven by the fuel price shock - only to fall by 1.1% in April, weighed by refunds for travel due to mass flight cancellations in response to the conflict. In May, spending in all categories contributed to the headline increase, reflected in the chart below.     

Notably, discretionary spending performed to post its strongest rise (2.1%) in well over two years going back to January 2024. This included strength in clothing and footwear (2.7%), boosted by early end-of-financial-year sales, while hotels, cafes and restaurants (1.9%) lifted alongside major sporting and cultural events.  

  

Transport-related spending, currently the most volatile category, rose 1.4% in May. That was a rebound from the sizeable fall in April (-4.7%), due to travel refunds returning to more normal levels. The ABS's release noted that if airfares and refunds were removed, household spending would have only risen by 0.6% month-on-month. Meanwhile, the volume of fuel sales was estimated to have declined 0.4% month-on-month.  

Australian employment 40.3k in May; unemployment rate 4.4%

Australia's unemployment rate fell back to 4.4% in May, halfway to reversing its rise to 4-year highs of 4.5% in April. That was driven by a 40.3k increase in employment (vs 32.5k expected), which rebounded after falling during the Easter holiday period. But downward revisions showed a much larger fall in April (-40.7k) than was initially reported (-18.6k). In a separate release, job vacancies fell slightly for the 3 months ending May (-2.1%) but remained at levels consistent with robust labour demand. Alongside solid household spending data in May, RBA rates pricing was little changed, with markets leaving the door open for a further rate hike without being convinced one is required.        

Employment rose by a net 40.3k in May, a gain that was concentrated in the part time segment (35.2k) as full time employment lifted modestly (5.2k). This essentially confirms that the decline in employment in April was due to seasonal effects over the Easter holiday period. But today's report showed that decline was significantly larger than first reported by the ABS, revised to -40.7k from -18.6k previously, implying the weakest result since December 2023. Incorporating revisions, employment gains averaged just 6.4k over the past 3 months, a clear slowing in the momentum seen through the first quarter of the year. 

The headline unemployment rate printed at 4.4% in May, in line with expectations and falling back from 4.5% in April - its highest since late 2021. The unemployment rate avareged 4.2% through the first quarter of the year, another sign that labour market conditions have slowed. The more expansive underemployment rate (including those wanting more hours) was 5.9% in May, reversing a modest fall to 5.8% in April. Combined, total underutilisation stands at 10.2%, down from 10.3% in April but has trended higher since the end of last year. On the supply side, labour force participation was 66.7% in the month, rising from a downwardly revised 66.6% in April. Participation remains at historically elevated levels but is off cycle highs above 67%.  

The hours worked measure continues to show effects of seasonal volatility. Fewer people taking leave during the Easter holidays contributed to hours worked rising by 0.9% in April, despite the fall in employment. In May, that reversed as hours worked declined by 1.1% month-on-month to see annual growth slow from 3.2% to 0.5%. Both part time (-0.8%) and full time hours (-1.1%) declined in the month.  

Preview: Labour Force Survey — May

Australia's Labour Force Survey for May is out at 1130 AEDT today. This follows a very weak report for April where a near 19k fall in employment sent the unemployment rate to a 4-year high of 4.5%. Seasonal volatility around the Easter holiday period is widely thought to have been influential, driving expectations for a rebound in today's report. The RBA left rates on hold at last week's meeting, pausing its tightening cycle after three straight hikes. Governor Bullock expressed no immediate concern over the rise in the unemployment rate, but pricing for any further tightening this year has been wound back to a 1 in 3 chance.  

May preview: Rebound expected 

Expectations that the April report was heavily affected by seasonality around Easter has seen consensus fall on the side of forecasting a rebound in May. Employment is expected to rise by 30k (range: 15-45k), more than reversing the 18.6k decline in April. As the chart below shows, April was an outlier result on recent form given that employment was coming off four straight upside surprises. The unemployment rate is expected to tighten slightly by falling back to 4.4% from 4.5% currently (range: 4.3-4.6%).   

 

April recap: Unemployment rate reaches 4-year high 

The unemployment rate lifted to its highest since late 2021 at 4.5% as employment fell by almost 19k. These were significant downside surprises on the forecast outcomes for a 17.5k rise in employment and a steady unemployment rate at 4.3%. Seasonal volatility likely played a role as the survey period coincided with the Easter holidays, though that is yet to be confirmed.

April was the weakest month for employment since last November, with the 18.6k decline including falls in both the full time (-10.7k) and part time segments (-7.9k). That saw the unemployment rate rise from 4.3% to 4.5%, even as a decline in the participation rate (66.7%) reflected fewer people entering the labour force in April. 

Notwithstanding this, underemployment (including those wanting more hours) declined from 5.9% to 5.8% as hours worked posted a strong 0.8% month-on-month increase. Combining unemployment and underemployment, total underutilisation rose from 10.2% to 10.3%.  

Australian CPI 4% in May

Australian inflation fell in May (-0.7%m/m) as the federal excise tax cut saw fuel prices drop almost 12% after their 7% decline in April. This was the largest fall for a single inflation reading since the June quarter at the outset of the pandemic. Annual headline CPI slowed from 4.2% to 4%, defying expectations to rise to 4.3%. However, underlying inflation continued to rise, consistent with the domestic inflationary pressures that prompted the RBA to raise rates three times already this year before last week's decision to pause.  

Headline inflation fell by 0.7% month-on-month in May after rising 0.4% in April. As alluded to above, that was the largest fall seen in either a single month or quarter since the start of the pandemic in 2020. The halving of the fuel excise tax (in effect until the end of June) saw an initial fall in average petrol prices of 7% in April and that was followed up by an 11.9% decline in May. At the weekend, the federal government announced a 1-month extension of the measure but a lower rate to smooth the increase to fuel prices that will come from the eventual return of the full excise tax.  

Aside from falling fuel prices, holiday travel costs also had a significant influence of the decline in headline inflation in May. Domestic travel prices fell a little over 12% in the month following the Easter holiday period, while international travel declined slightly (-0.8%). This drove a decline in services inflation (-0.7%m/m), though it firmed slightly to 3.7% in annual terms. 

The parts of the basket that pushed up most on inflation were groceries (0.6%) and housing construction costs (0.9%), both arguably increases the RBA would see as consistent with second-round inflationary pressures. 

Taking a broader view, trimmed mean CPI increased in May, indicating that underlying inflationary trends remain in place. In the month, the trimmed mean rose 0.4% following April's 0.3% lift. This saw the annual pace increase from 3.4% to 3.6%, in line with expectations. That implies underlying inflation has returned to its pace from around the middle of 2024. 

Back then, the RBA had the cash rate set at 4.35%, the level where it currently sits after the three earlier hikes this year. Despite pausing its tightening cycle at last week's meeting, the RBA reaffirmed its hiking bias judging that upside risks to inflation had not abated - even after the US-Iran agreement to reopen the Strait of Hormuz. Markets price the chance of another RBA hike this cycle at around 50/50.  

Macro (Re)View (19/6) | Hawkish Fed supports USD rise

The backdrop of the US-Iran agreement continued to support sentiment, with brent crude sliding to pre-conflict lows below US$80/bbl during the week. Equities advanced broadly, but upside in the US was capped somewhat by a hawkish Fed at Chair Warsh's first meeting at the helm. This drove a flatter curve in the US and boosted the dollar. Despite the BoJ hiking rates by 25bps to 1%, USDJPY remains firmly above 160 and at highs since mid 2024. 

The first meeting led by Chair Warsh saw the Fed hold at 3.5-3.75% but the overall tone was more hawkish than expected. The main driver was the FOMC's updated projections, which now point to a rate hike by year-end - a notable shift from the rate cut implied in the March forecasts. A focus on returning inflation to target by the pledge that the FOMC 'will deliver price stability' was the clear message across the communications set, including a now trimmed-down decision statement and at the post-meeting press conference. Additionally, Warsh stressed that he would refrain from giving policy guidance, firm in the view that the FOMC should use market pricing as a signal rather than the other way round.

The Bank of England kept rates steady at 3.75%, voted through on a 7-2 majority by the Monetary Policy Committee. The only change to the vote split from the April meeting came from Megan Greene joining Huw Pill in voting for a 25bps hike. The core of the MPC in leaving rates on hold continued to place more weight on weakness in the labour market and in the economy more broadly than on hiking as a risk mitigation strategy to the energy price shock. 

The UK May CPI data on the eve of the meeting was a factor that helped the MPC maintain this approach. Headline inflation held at a 2.8%yr pace (vs 3% exp) while core conflation rose less than expected to 2.6%yr (vs 2.7%) from 2.5%. In his policy comments, Governor Bailey noted that tolerating above-target inflation due largely to energy prices was currently an appropriate trade-off for the MPC to manage given the recent data had provided 'greater confidence' that underlying disinflationary trends in the UK economy remained in place. 

In Australia, the RBA paused the cash rate at 4.35% this week after three straight hikes were judged to have left policy 'well placed' to respond to an outlook of 'heighted uncertainties'. The Board, however, left no room for doubt adding the line to its existing tightening bias that 'increasing the cash rate further' was possible as upside risks to inflation remained. That looks like a move aimed at ensuring financial conditions do not start to loosen, with market pricing for a rate hike by year-end now only seen as a roughly 50/50 prospect. 

At the post-meeting press conference, Governor Bullock said that rate hikes were already weighing on household spending and slowing the housing market. In addition, there was little concern attached to the recent rise in the unemployment rate and the lacklustre Q1 GDP growth outcome, with Bullock saying these are the sorts of data points that are required to reduce inflationary pressures. For more on this week's meeting, please see my review here.