Macro (Re)view (22/11) | Waiting and watching

Developments on the US-China trade front continued to the main focus of global markets this week as prospects for the finalisation of the phase one agreement before year's end appeared to be fading. Six weeks have now past since top-level delegates from the world's two largest economies met in Washington and agreed to the outline of a partial deal in what were the most tangible signs of progress in the 18-month long trade and technology dispute. Concerns over progress were raised this week after the US Senate passed legislation that in effect intensifies scrutiny around the extent of Hong Kong's autonomy from China, which has been the source of escalating anti-government protests in Hong Kong over recent months. The legislation that is expected to be ratified by US President Trump will require Hong Kong authorities to demonstrate it is maintaining a sufficient level of autonomy from Chinese rule to retain its special status as a separate jurisdiction under US law, as well as introducing the possibility of human rights sanctions on officials. While the move drew condemnation from China, it is unclear how it may impact trade negotiations with the US. Later on in the week, Chinese Vice Premier Liu said he was "cautiously optimistic" that the phase one agreement could be finalised, while an article from the South China Morning Post indicated that both sides would likely support postponing the introduction of new tariffs set to start on December 15 if a deal is unable to be reached before then. Overall, the uncertainty saw equity markets softer through the week, driving a flattening of the yield curve with the spread between US 2-year and 10-year treasury yields coming in for 9 straight sessions (see chart of the week, below).

Chart of the week 

In the US, the minutes from the Federal Reserve's (Fed) meeting at the end of October were released. At that meeting, the Fed's policy-setting Committee cut its interest rate target range by 25 basis points for the third consecutive occasion, citing risks to the economic outlook from global developments and muted inflation. Following this period of easing, the minutes reiterated the message that the Committee has shifted to wait-and-see mode from its earlier proactive policy stance, though it remains mindful it will have more work to do if downside risks were to materialise. The Committee expects that a strong labour market will continue to support the household sector and underpin the domestic economy from weakness in business investment and exports due to trade tensions and slower growth offshore, though as the events of this week demonstrate, this is a rather precarious balance and explains why the risks are assessed as remaining "tilted to the downside". The latest indications are that activity in the US economy is tracking at a below-trend pace, based on IHS Markit's 'flash' composite Purchasing Managers' Index (PMI) reading of 51.9 in November. Conditions could be set to improve in 2020 with activity in the manufacturing sector rising to a 7-month high at 52.2 and services firming to a 4-month high at 51.6. The consumer is key to growth prospects over the year ahead and while sentiment according to the University of Michigan's index improved by 1.4% over November to a reading of 96.8, a 1.4% decline in the assessment of current economic conditions amid trade and political uncertainty warrants caution. 

In Europe, IHS Markit's flash PMIs for November were in line with the previous two months by indicating that activity in the bloc has essentially stalled as the composite index softened slightly to a 50.3 reading. Weakness persists in manufacturing where the sector remains mired in its deepest downturn in 6 years, though November's reading lifted to a 3-month high of 46.6 in a sign that activity is beginning to stabilise. While the services sector has remained resilient to this weakness throughout 2019, recent indications are that spillover impacts are in train as activity softened to its lowest level since the start of the year at a reading of 51.5. Germany narrowly avoided falling into a technical recession in Q3, though the largest economy in the bloc remains under the strain of trade tensions and external weakness with its composite PMI remaining in contraction at 49.2 in November. 

Also this week, the Account of the European Central Bank's policy meeting in late October was published. At its September meeting, the Governing Council delivered a comprehensive package of stimulus measures to revive an ailing inflation outlook prompted by an ongoing slowdown in the euro area economy. Thus, October's meeting was very much focused around taking a "wait and see" stance that will allow the Governing Council time to assess how the economy responds to this new stimulus. In the lead up to September's meeting, several members of the Governing Council had been in public opposition to various elements of the stimulus package, most notably the reintroduction of quantitative easing. At what was the former ECB President Mario Draghi's final meeting, the Account outlined that "a strong call was made for unity of the Governing Council", noting that while robust discussions were appropriate and necessary, "it was regarded as important to form a consensus" as it would enhance its commitment to its inflation-targeting regime. This is the task now in front of the new President Christine Lagarde, who in her first major speech in the role called on fiscal authorities to work in tandem with the ECB's accommodative monetary policy stance to drive the euro area's long-term growth potential.

— — —

The domestic perspective was informed this week by the minutes from the Reserve Bank of Australia's Board meeting held earlier this month. As was widely expected, the Board elected to hold the cash rate at 0.75% at that meeting on the basis that it wanted to "wait and assess" the impact of the three rate cuts it had already delivered in 2019 in June, July and October. Overall, the Board's assessment is that this easing is bolstering employment and income growth and is thus assisting with gradually returning inflation to target, while it has also noted an improvement in conditions in the established housing market and the "positive spillovers" this will generate for the broader economy. Less certain is what the extent of those spillovers is likely to be and how earlier rate cuts and tax relief will work their way through to household spending. Adding weight to the decision to remain on hold, the Board recognised that with interest rates at a record low level there was a negative confidence impact on savers, while it also discussed the thesis that further rate cuts "could have a different effect on confidence than in the past, when rates were at higher levels". Notwithstanding, the Board remains prepared to ease further and is closely monitoring developments from offshore as well as the state of the domestic labour market. In looking ahead, the Board anticipates that output growth will lift to trend (2.75%) next year, before firming to around a 3.0% pace in 2021, based on stimulus from low interest rates, tax cuts, rising house prices, a turnaround in mining investment and ongoing infrastructure spending. Regarding infrastructure, this week PM Morrison announced that $3.8bn of projects will be brought forward over the next 4 years, with the impact to be a $1.8bn boost in spending between now and the end of the next financial year.