Private sector demand contracted by 0.1% in Q2 turning the annual pace from +0.4% to -0.3% to its weakest rate since the onset of the GFC a decade ago. This reflects slowing growth in household consumption, as well as weakness in residential construction and business investment. For households, consumption growth in annual terms has slowed to a 6-year low at 1.4% against the headwinds from low income growth, the downturn in the housing market and a clear weakening in sentiment over the first half of the year compared to the second half of 2018. The deterioration in the residential construction cycle continues to gather pace, with activity contracting by 4.4% in Q2 to be down by 9.1% through the year — its sharpest rate of decline in 7 years. Business investment was also soft falling by 0.4% in Q2 and 1.6% year-on-year, impacted by the wind down of major projects in the resources sector and by uncertainty around global economic conditions and over the direction of domestic policy in the lead up to May's federal election. In contrast, public demand remains robust, rising by 1.5% in Q2 and by 5.2% over the year, with support coming from spending on healthcare initiatives and infrastructure investment. Our chart of the week (below) highlights the divide between private and public sector demand over the past year. Despite tensions between the US and China weighing notably on global trade flows, the same cannot be said for Australia given that net exports added a sizeable 0.6ppt to activity in Q2 and 1.2ppts over the past year. In addition, surging commodity prices boosted national income by 1.2% in Q2 and 5.4% over the year to power the nation to its first current account surplus since 1975 (see here).
Chart of the week
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To events from offshore, the increased optimism around trade developments continued this week as the US and China agreed to meet next month in Washington. Negotiations between the sides had stalled after a meeting back in July failed to achieve progress in reaching a deal, prompting US President Trump to announce a new round of tariffs on consumer-related imports, to which China responded by implementing tariffs on US agricultural products and vehicles. However, there was no indication by either side that these most recent tariffs would be rescinded or delayed.
The impact of tariffs and uncertainty over trade policy more generally has been a major headwind to the manufacturing sector across the globe driving a sharp slowdown in activity over 2018 before falling into contraction this year. According to JP Morgan's Global Manufacturing PMI, activity contracted for the 4th consecutive month in August at a reading of 49.5. The underlying details showed new orders and export volumes had contracted at their sharpest rates in around 7 years in July, while sentiment in the sector had also fallen to its weakest since 2012. At the country level, US manufacturing slipped into contraction in August for the first time since 2016 based on the closely-followed ISM index, which printed at a weaker-than-expected 49.1 in August. Notably, every sub-component of the index is now declining, as new orders and output deteriorated to multi-year lows. In the euro area, the sector remains firmly in contraction with IHS Markit's manufacturing PMI at 47.0 in August — just off its weakest reading in 6½ years. Conditions in Germany, the bloc's largest economy, are currently at their weakest in nearly 7 years with firms cutting back sharply on employment in response to a deterioration in demand from clients that are unwilling to commit to orders given that investment plans have been scaled back in the face of an uncertain global economic outlook.
In contrast to the decoration in manufacturing, the global services sector has remained resilient, though conditions now appear to be easing. The JP Morgan Global Services Business Activity Index declined to its lowest level in 3 months in August at 51.8, though it is still in expansion. With output growth slowing, the internals of the report highlighted an easing in new business orders and employment. This was due largely to a sharp slowdown in activity in the US services sector, with output falling from 53.0 to 50.7 in August, indicating that growth has slowed to its softest pace since early 2016. It is becoming increasingly clear that trade and economic uncertainty are a strengthening headwind for the sector as confidence among services firms fell to a new record low. The euro area's services sector is, by contrast, remaining more resilient, with activity firming from 53.2 to 53.5 in August — its 73rd consecutive month of expansion. The result for August was supported by an increase in new work orders, while backlogs also came down. However, there are justifiable causes for concern that the deterioration in manufacturing may be starting to cross over into the services sector, with employment growth slowing to its softest pace since the turn of the year, while confidence in the outlook over the next 12 months fell to its weakest in 6 years.
The week's main highlight from offshore was Friday's US non-farm payrolls (employment) report for August, which contained mixed details. Employment increased by 130k in the month, including a 25k boost of temporary workers for next year's census, which was well below the 160k expected by markets. However, the unemployment rate matched expectations, remaining at 3.7%, despite workforce participation lifting from 63.0% to 63.2%. Meanwhile, growth in average hourly earnings surprised to the upside at 0.4% in the month (expected 0.3%) and 3.2% over the year (expected 3.0%), and average weekly hours per employee lifted slightly to 34.4 hours. Given these mixed details, a definitive assessment of the labour market is difficult to form, which is a good illustration of why there is such a divergence of views by FOMC members around the appropriate policy stance ahead of the Federal Reserve's policy meeting in two weeks' time. Just this week, St Louis Fed President James Bullard outlined the case for a 50 basis point cut, while others such as the Boston Fed's President Eric Rosengren have argued for rates to be left on hold for the time being. Remarks on Friday from Federal Reserve Chair Jerome Powell were consistent with his recent commentary, outlining that the Committee anticipates a broadly constructive outlook for the US economy, though it is mindful of the "significant risks" posed by trade and geopolitical developments and will "... continue to act as appropriate to sustain this expansion". Following these comments, financial markets firmed expectations for a 25 basis point cut to be delivered at the September meeting.
Ahead of next week's European Central Bank meeting, divergence is also evident within the Governing Council. At what will be President Mario Draghi's penultimate meeting in charge, markets broadly expect a package of stimulatory measures to be announced, likely including a rate cut and quantitative easing. Most of the conjecture has been around the latter, with an increasing number of members publicly stating their reticence to re-starting quantitive easing, though the Governing Council's doves are likely to win out.
In contrast to the decoration in manufacturing, the global services sector has remained resilient, though conditions now appear to be easing. The JP Morgan Global Services Business Activity Index declined to its lowest level in 3 months in August at 51.8, though it is still in expansion. With output growth slowing, the internals of the report highlighted an easing in new business orders and employment. This was due largely to a sharp slowdown in activity in the US services sector, with output falling from 53.0 to 50.7 in August, indicating that growth has slowed to its softest pace since early 2016. It is becoming increasingly clear that trade and economic uncertainty are a strengthening headwind for the sector as confidence among services firms fell to a new record low. The euro area's services sector is, by contrast, remaining more resilient, with activity firming from 53.2 to 53.5 in August — its 73rd consecutive month of expansion. The result for August was supported by an increase in new work orders, while backlogs also came down. However, there are justifiable causes for concern that the deterioration in manufacturing may be starting to cross over into the services sector, with employment growth slowing to its softest pace since the turn of the year, while confidence in the outlook over the next 12 months fell to its weakest in 6 years.
The week's main highlight from offshore was Friday's US non-farm payrolls (employment) report for August, which contained mixed details. Employment increased by 130k in the month, including a 25k boost of temporary workers for next year's census, which was well below the 160k expected by markets. However, the unemployment rate matched expectations, remaining at 3.7%, despite workforce participation lifting from 63.0% to 63.2%. Meanwhile, growth in average hourly earnings surprised to the upside at 0.4% in the month (expected 0.3%) and 3.2% over the year (expected 3.0%), and average weekly hours per employee lifted slightly to 34.4 hours. Given these mixed details, a definitive assessment of the labour market is difficult to form, which is a good illustration of why there is such a divergence of views by FOMC members around the appropriate policy stance ahead of the Federal Reserve's policy meeting in two weeks' time. Just this week, St Louis Fed President James Bullard outlined the case for a 50 basis point cut, while others such as the Boston Fed's President Eric Rosengren have argued for rates to be left on hold for the time being. Remarks on Friday from Federal Reserve Chair Jerome Powell were consistent with his recent commentary, outlining that the Committee anticipates a broadly constructive outlook for the US economy, though it is mindful of the "significant risks" posed by trade and geopolitical developments and will "... continue to act as appropriate to sustain this expansion". Following these comments, financial markets firmed expectations for a 25 basis point cut to be delivered at the September meeting.
Ahead of next week's European Central Bank meeting, divergence is also evident within the Governing Council. At what will be President Mario Draghi's penultimate meeting in charge, markets broadly expect a package of stimulatory measures to be announced, likely including a rate cut and quantitative easing. Most of the conjecture has been around the latter, with an increasing number of members publicly stating their reticence to re-starting quantitive easing, though the Governing Council's doves are likely to win out.
