Macro (Re)view (24/1) | Markets given reason for caution

Global events were the key focus for markets this week as policymakers and business leaders made their annual trip to Davos in the Swiss Alps for the World Economic Forum where trade agreements and responses to climate change headlined discussions. This came as the International Monetary Fund (IMF) saw tentative signs of stabilisation in the global economy from its slowdown over much of the past couple of years, with the downside risks to the outlook assessed to be receding somewhat following the broad-based easing by central banks in 2019, the US-China phase one trade agreement and a reduced likelihood of a hard Brexit. However, the IMF's revised forecasts for global growth of 2.9% in 2019 (down from 3.0%) and 3.3% in 2020 (down from 3.4%) is consistent with an outlook that is subdued and relatively precarious given the potential for trade and geopolitical tensions to re-emerge, and for unforeseen events, such as this week's outbreak of the coronavirus in China that forced authorities to lock down at least three cities and cancel Lunar New Year celebrations in Beijing, to weigh on activity and unsettle sentiment in markets. 

As it was an unusually quiet week for data in the US, attention turned to Davos as discussions regarding a US-Europe trade agreement began to ramp up. US President Trump met with European Commission President Ursula von der Leyen, with the US wanting to reduce barriers to entry and increase access for domestic-based firms to markets on the continent. In media appearances, President Trump warned that in the absence of a new agreement, previously-threatened auto tariffs (of potentially as high as 25%) would be implemented. Meanwhile, discussions between the US and France over the latter's planned introduction of a digital tax, which Washington believes unfairly targets US-based firms, found a more conciliatory tone following talks between President Trump and President Macron. To that end, France suspended the implementation of the digital tax that was due to start in April, while the US will hold off threatened tariffs on French champagne and other consumer goods for now. The main US data point was January's flash Markit PMI readings, with the composite index firming slightly from 52.7 to 53.1 to indicate economic activity was expanding a moderate pace early in 2020. Conditions in the services sector improved from 52.8 to 53.2, though there was an unexpected slowing in the manufacturing sector from 52.4 to 51.7.

On the policy front this week, the European Central Bank's meeting went by largely as expected, with the Governing Council keeping its monetary policy stance on hold. In the post-meeting press conference, ECB President Christine Lagarde outlined that the recent data flow had been in line with the Bank's expectation for a stabilisation of the euro area economy at a moderate pace of growth, with weakness in manufacturing continuing to drag on activity. Friday's flash Markit Eurozone PMI readings were broadly consistent with that assessment, with the composite index unchanged at 50.9, while the services sector was expanding modestly at 52.2 and manufacturing was still in contraction at 47.8 but conditions had improved to a 9-month high. There was a subtle change in the ECB's assessment of economic conditions relating to inflation, where it noted "there are some signs of a moderate increase in underlying inflation", whereas at its previous meeting in December it described the increase as "mild". Of most significance at this meeting, the ECB's strategic review was officially announced, which will examine how the Bank uses its monetary policy toolkit to achieve its inflation mandate, though it will also take into account broader considerations in terms of how it may affect financial stability, employment, and environmental sustainability. The review is expected to be concluded by the end of the year, with President Lagarde in media interviews at Davos pushing back against the notion widely touted in markets that the presence of the review made changes in the ECB's current monetary policy stance less likely. 

Then to Asia, the Bank of Japan (BoJ) held its latest meeting where it kept its monetary policy settings unchanged, as expected. The BoJ has become slightly more constructive in its view of the outlook, due to a stabilisation of the slowdown in the global economy, fiscal support and accommodative financial conditions, with its GDP growth forecasts upgraded for 2019 (from 0.6% to 0.8%), 2020 (from 0.7% to 0.9%) and 2021 (from 1.0% to 1.1%). However, its inflation forecasts were trimmed by 0.1ppt in each of 2019 (0.6%), 2020 (1.0%) and 2021 (1.4%), and with the risks to its growth and inflation prospects still assessed as being to the downside, the Bank maintained its guidance that "it will not hesitate to take additional easing measures" if required.  

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Developments in Australia this week significantly altered the near-term outlook for monetary policy, with market pricing for a Reserve Bank of Australia rate cut in February falling from a near 60% chance to around 20%, while several forecasters, including three from the major banks (Westpac, CBA and ANZ), have now delayed the timing of their calls for the next cut. This came after December's employment data (released on Thursday) was much stronger than expected (full review here), just as was the case in November. On net, employment increased by 28.9k in December; well clear of the 10.0k rise anticipated by markets, extending the strength from November where employment accelerated by 38.5k (revised from 39.9k). However, the compositional split was uneven, with part-time employment accounting for all of the increase (29.2k) as the full-time segment fell (-0.3k), while employment growth in Q4 at 43.4k was the softest quarterly outcome since Q1 2018. Instead, as our chart of the week (below) highlights, the focus turned to the national unemployment rate that fell unexpectedly from 5.2% to  5.1% — its lowest level in 9 months — following on from a 0.1ppt decline in November. While this will be welcomed by the RBA, it remains elevated relative to its estimate of full employment (around 4.5%), while underemployment, unchanged at 8.3% in December, continues to point to a labour market with considerable spare capacity thus restraining wages growth and inflation pressures.  

Chart of the week

Meanwhile, the Westpac Melbourne Institute's Index of Consumer Sentiment fell by 1.8% in January to a reading of 93.4, with Westpac's Chief Economist Bill Evans reporting that the nation's bushfire crisis had weighed further on already weak confidence. The economic outlook remains a headwind for consumers, with January's readings for both the "next 12 months" (-5.4%) and "next 5 years" (-3.7%) declining sharply this month. Weak confidence and concerns around the outlook appear to be weighing on spending intentions, which remain at well below-average levels, with the index for "time to buy a major household item" declining by 1.8% in January to be down by 4.1% through the year. Assessments of family finances on a year ago (+0.7%) and for the next 12 months (+0.9%) improved slightly in January, likely supported by the strong gains recorded by Australia's equity market early in the new year. In the housing market, consumers remain confident that the recent upswing in prices will continue at pace with the "House Price Expectations" index lifting by 8.1% in January to be up by 58% on a year earlier. The "time to buy a dwelling" index increased by 5.7% in the month to 118.8, though this remains slightly below average (120) and Westpac Economics' expectation was that this component had likely reached its top in this cycle given that buying intentions had slipped by 6.4% since August coming after house prices troughed in June.