Macro (Re)view (29/5) | Risks to the optimism

Optimism over the near-term outlook was a key theme this week reflected by a tilt in global equities towards the cyclical areas of the market previously left behind in the rally off the lows from late March, a step in the right direction regarding fiscal aid in Europe and signs that activity was improving as economies reopen. However, the risks around this more upbeat assessment of conditions remain significant and perhaps even underappreciated given that the reopening of economies is only in its very early stages, global cases of new viruses are still rising due to outbreaks in developing countries and geopolitical tensions are ratcheting up.      

In Australia this week the data flow included updates on construction activity and capital expenditure in the March quarter ahead of next week's national accounts. At this stage, GDP is likely to have contracted in Q1, though there will be more inputs available on Tuesday before assessments can be finalised (see here). In the data at hand, construction work done fell by 1.0% in the quarter, which was better than consensus (-1.5%) and an improvement from the 2.9% decline in Q4 (see here). In a surprise outcome, the magnitude of the decline in private sector activity (-0.6%qtr, -8.7%yr) was less severe in Q1 than in the public sector (-2.5%qtr, 1.1%yr). The other important aspect of the report was continued weakness in the residential construction cycle (-1.6%qtr, -12.4%yr), with activity having now fallen by almost 16% since its most recent peak in mid 2018.  

Capital expenditure by private sector firms fell by a further 1.6% in the March quarter — consensus and Q4's outcomes were much more pessimistic at -2.8% and -2.6% respectively — as the decline over the year deepened to -6.1% (see here). On a sectoral basis, mining sector capex advanced (4.2%qtr, 6.9%yr) against weakness from the non-mining side (-4.0%qtr, -10.8%yr) and this will become an increasingly key theme in the domestic economy over the year ahead. Indicating the impact on investment from the COVID-19 crisis had been immediate, firms lowered their outlook for capex in 2019/20 by 3.8% to $115.4bn. Looking ahead, capex intentions for the 2020/21 financial year were lowered by 8.8% to $90.9bn (see chart, below). This means that intentions have fallen by 7.9% compared to the same estimate a year ago, which is a complete reversal to what was forecast 3 months earlier that had capex on track to rise by 8.2% over the year. The concern is around non-mining investment that is projected to plunge by 16.9% over 2020/21 (services -18.4% and manufacturing -6.1%). Certainly, until this outlook improves progress on lowering unemployment will be constrained. The positive is that mining investment is set for an upward trajectory of 10.4% coming after 6 consecutive years of decline.

Chart of the week

In other domestic developments, the ABS's latest business and household COVID-19 surveys were released. For businesses, there continues to be a very significant impact on cash flow with 72% of firms reporting that revenue had fallen as a result of the pandemic. Serious consideration should also be given to the finding that 74% of businesses reported they were now operating under modified conditions (such as with a reduced workforce or shifting to online platforms). A structural change of this magnitude occurring as quickly as it has in this instance has the potential to weigh on output well past the easing of restrictions and highlights that the risks around the recovery are not confined to the demand side of the economy only. In the household survey, details around the labour market were a little less constructive than in the previous reading, indicating that another very weak outcome for employment will be reported in May. Lastly, in an appearance before a Senate Select Committee on COVID-19 during the week, RBA Governor Philip Lowe noted that the economy appeared to be tracking slightly ahead of its baseline outlook, though there were still "a lot of challenges coming down the track". In response, Governor Lowe reiterated the continued importance of fiscal support and highlighted that his view the Bank's policy settings were working well, though if needed its bond purchases could be stepped up again, while the prospect of negative rates was "extraordinarily unlikely". 

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Switching the focus offshore, tensions between the US and China continued to escalate after China's parliament voted in national security law to be imposed on Hong Kong. In a press conference on Friday, US President Trump flagged that his administration would move towards ending the special trading status Hong Kong has had with the US since 1992, though for the time being markets viewed these warnings as less severe than feared as equities advanced on the day and over the week. Meanwhile, Federal Reserve Chair Jerome Powell spoke of the risks that a second wave of the virus would pose to the economic recovery in terms of its impact on confidence and reiterated that the central bank would be "strongly committed to using our tools" to assist where it can in lowering borrowing costs and keeping credit lines flowing. In terms of data in the US this week, GDP was revised to show a slightly larger contraction of 1.3% quarter on quarter in Q1 (-5.0% in annualised terms), while more timely indicators for the month of April showed further deterioration as durable goods orders collapsed by 17.2%, personal spending plunged by 13.6% and initial jobless claims lifted by another 2.1 million in the past week, though there was some better news evident in the fall of continuing claims of unemployment benefits from 24.9 million to 21 million. The one result that surprised to the upside was on personal income, which soared by its most on record rising by 10.5% in April reflecting the impact federal assistance payments under the CARES Act to households. 

Across the Atlantic, sentiment was boosted by the European Commission's announcement to propose a €750bn fiscal package to provide recovery funding to the member states most impacted by the COVID-19 crisis. The proposal would involve a common bond issuance by the EU, with disbursement of €500bn in grants and €250bn in loans. The major sticking point has been the issue of whether recovery funding should be disbursed in either grants or loans, though this solution provides something of a comprise, acknowledging the resistance that a grants-only plan has been met with by nations including Austria, Denmark, Sweden and the Netherlands. The advantage of grants is that it will assist countries that entred the crisis with high debt levels, particularly as some of those are heavily reliant on the tourism sector that will be slow to reopen. At this stage, it is still a long way from a done deal as all 27 member nations will need to ratify the proposal, though it does already have a significant level of support from Paris, Berlin, Rome and Madrid. If agreed upon, the two largest beneficiaries stand to be Italy and Spain, receiving €81.8bn and €77.3bn respectively.  

Preview: Australian Q1 GDP

Australia's national accounts for the March quarter are due to be released by the ABS today at 11:30am (AEST). Our forecast is for GDP to have contracted by 0.2% in Q1. After slowing sharply between the second half of 2018 and the first half of 2019, momentum in the domestic economy improved in the December quarter as annual GDP growth firmed from 1.8% to 2.2%. However, that momentum was derailed by the emergence of the COVID-19 crisis in Australia. Government authorities responded initially by implementing travel restrictions for non-resident arrivals from early February and were progressively tightened through March leading to a closure of the international borders. Social distancing measures were introduced from mid to late March resulting in the shutdown of non-essential services and strict limits being placed on numbers for outdoor and indoor gatherings. These measures led to a significant deterioration in economic conditions as businesses responded by standing down or releasing employees, while retained workers had their hours reduced. Meanwhile, the focus of households turned to the impending lockdown as precautionary spending was driven up very strongly, supported also by areas of household goods and home entertainment. Export volumes were weakened by travel restrictions and iron ore shipments were disrupted by Tropical Cyclone Damien in Western Australia, while imports collapsed as the outlook for business investment deteriorated.  

As it stands | National Accounts — GDP

Output growth in the domestic economy matched the consensus forecast rising by 0.5% in the December quarter, while the annual pace firmed from 1.8% to 2.2% to be a little more than half a percentage point above its post-GFC low. With annual growth remaining at a sub-trend pace since the second half of 2018, the domestic economy approached the COVID-19 crisis in a relatively fragile position. The same can be said of the global economy with the OECD estimating that the growth momentum slowed to a 2.5% pace through the year to the December quarter from around 3.0% a year earlier due to trade tensions and geopolitical uncertainty weighing on activity.

In Australia, GDP growth in 2019 was driven by public demand and net exports as weakness in private demand persisted in response to subdued growth in household consumption, declining business investment and the downturn in the residential construction cycle. Ongoing drought conditions had been significantly impacting production in the agricultural sector for some time, while widespread bushfires had devasted regional communities across the nation over the final months of 2019 into early 2020.

From its mid-2018 peak of 3.1%, growth in household consumption had slowed to just 1.2%Y/Y by the end of Q4 to be at its weakest pace since the GFC as wages growth remained stuck in the slow lane, unable to be offset by both monetary and fiscal support in 2019 where the RBA lowered the cash rate by a total of 75 basis points and the Federal government provided increased tax relief to low- and middle-income earners. As concerns over the outlook intensified, consumer sentiment in this economy had been fragile, though it would likely have been much more pessimistic had it not been for a turnaround in the housing market over the second half of the year, most notably in Sydney and Melbourne. 

Residential construction activity was mired in its sharpest downturn in 7 years with both new construction and alterations rolling over in 2019 following sharp declines in dwelling approvals. Business investment contracted over 2019 (-1.2%) as mining investment continued to unwind ahead of a rebound in Q4, while in the non-mining sector investment had been expanding modestly until it was hit by a sharp 3.6% fall in the final quarter amid an increasingly uncertain outlook. Public spending that was focused on social assistance initiatives and defence was the leading contributor to GDP growth in 2019, while exports were also a key support driven by strength in resources and services.  

Key dynamics in Q1 | National Accounts — GDP Q1 forecast -0.2%

Household consumption — The profile of household spending was heavily focused on precautionary spending on essential supplies in food, pharmaceuticals, and liquor and household goods ahead of the April lockdown as discretionary consumption was shunned. Retail sales volumes were modest overall (0.7%qtr) as a record surge in food (6.4%) was moderated by significant contractions in clothing and footwear (-12.1%), cafes and restaurants (-8.4%) and department stores (-5.2%). Spending on household services is likely to have weakened sharply over March as restrictions were implemented. (Forecast: -0.2ppt in Q1).      

Dwelling investment — The residential construction cycle weakened further in early 2020 with activity contracting by 1.6% to be down by 12.4% through the year. This continued to be driven by the rollover in new home building, which retracted to its weakest level in more than 5 years after a 2.2% fall in Q1. Alteration work lifted by 2.3%, though this provides little offset. (Forecast: -0.1ppt in Q1).

Business investment — Weakness in private sector capital expenditure extended to a 5th straight quarter falling by 1.6% in Q1 and by 6.1% over the year. The emergence of the COVID-19 crisis saw business confidence and conditions collapse, with firms to delay or scale back investment plans over the quarters ahead. (Forecast: -0.2ppt in Q1).  

Public demand — Growth in underlying public demand was 1.4% in Q1, which was driven by a 1.8% lift on consumption spending against a broadly flat outcome from investment. This overall adds 0.3ppt to activity in Q1.  

Inventories — An unprecedented surge in demand for essential goods ahead of the nation's month of lockdown through April led to the sharpest run down on inventories (-1.2%) in a single quarter in more than 5 years. This looks to take 0.4ppt away from GDP in Q1.      

Net exports — A 0.5ppt contribution to GDP growth came through from net exports in Q1, though the details were weak. Export volumes contracted 3.5% (sharpest fall since Q1 2011) and imports collapsed by 6.2% (weakest since Q1 2009) as the strains from travel restrictions and economic uncertainty associated with COVID-19 hit.    

Australian Q1 CapEx -1.6%; 2020/21 investment plans $90.9bn

Weakness in capital expenditure by Australian firms was extended to a 5th consecutive quarter falling by 1.6% in Q1. The intentions component of the survey pointed to significant declines ahead centred in the non-mining sector due to the uncertainty associated with the COVID-19 crisis, though mining capex is projected to advance. 

CapEx — Q1 | By the numbers

• Total private sector capex spending fell by 1.6% over the March quarter to $27.964bn, though that was smaller than expected (-2.8%) after a 2.6% decline in Q4. In annual terms, the decline extended from -5.9% to -6.1%.

• Equipment, plant and machinery investment declined by 2.3% to $13.265bn, with the contraction over the year accelerating from -1.6% to -4.0%. 

• Buildings and structures capex was 1.1% lower in Q1 to $14.699bn, though a base effect trimmed the annual decline from -9.5% to -7.9%. 

• On intentions, the immediate impact of COVID-19-related uncertainty on business investment plans was clear. Estimate 6 of investment plans for the 2019/20 financial year was nominated at $115.43bn, which was 3.8% lower compared to estimate 5 provided by firms 3 months ago and some 5.6% weaker than it was a year earlier. 

• Meanwhile, firms' 2nd estimate of investment plans for 2020/21 was significantly weaker at $90.89bn; down by 8.8% on estimate 1 and 7.9% below estimate 2 for the 2019/20 financial year. 

CapEx — Q1 | The details

Australian firms cut capital expenditure for the 5th straight quarter with a 1.6% reduction coming through in the March quarter. This takes the level to 6.1% below where it was a year earlier, and unsurprisingly businesses indicated in this report that much more material falls are on the way. Consistent with recent NAB and ABS business surveys, with visibility over the outlook extremely limited and after sustaining significant disruption to trading conditions and sustaining cash flow impacts, firms outside of mining will be reluctant to invest for some time.

   

The sector details were mixed, with the overall theme being that mining investment was lifting as weakness in non-mining capex was gathering pace. Capex from the mining sector advanced by 4.2% in Q1 to $8.53bn as annual growth lifted sharply from 0.7% to 6.9%. These outturns were the strongest since the investment boom through the early 2010s. Non-mining capex continued to go backwards, and at a pace, falling by 4.0% in Q1 to $19.44bn to be down by 10.8% through the year.

  

This weakness centres on the services sector in which capex declined by 5.2% for a year to year decline of 12.8% — its sharpest rate of contraction since the recession of the 1990s.   

On intentions, firms now expect capex to come in at $115.43bn for 2019/20 according to estimate 6, which was down by 3.8% on the previous estimate put forward by firms to the ABS three months ago. That may appear to be a small decline, though we need to remember that estimate 6 incorporates 9 months of actual investment and a 3-month forecast. As such, it is unusual to see intentions falling this late in the estimates cycle, which highlights that the impact of the uncertainty of the crisis was immediate in terms of the shelving or delaying of investment plans for some firms.

The outlook for 2020/21 was weak at $90.89bn based on estimate 2 collated through April and May, which was 8.8% down of the first estimate taken three months earlier. On that basis, capex plans have fallen 7.9% below estimate 2 for the previous financial year, which is a seismic reversal from 3 months ago when estimate 1 for 2020/21 was pointing to an 8.2% rise over the year. That weakness is to be driven by the non-mining sector in which investment plans point to a contraction of 16.9% from year to year, and while mining investment plans are projected to advance by 10.4%, though that will not be enough to offset the overall drag on the economy. 

CapEx — Q1 | Insights

Weakness in business investment extended into 2020 ahead of significant declines with firms in the non-mining sector shelving or delaying plans due to the collapse in trading conditions and confidence and the overall uncertainty of the outlook in response to the COVID-19 crisis. For Q1 GDP, the contraction in buildings and structures (-1.1%) was less severe than in the December quarter and was consistent with yesterday's construction work done data. Equipment investment saw renewed weakness (-2.3%) with business investment to subtract noticeably from output growth in Q1.  

Preview: CapEx Q1

Australia's capital expenditure (capex) survey for the March quarter is due for release by the ABS at 11:30am (AEST) today. The survey will include the level of capex made through the first three months of the year as well as estimates of total capex expected to be made over the 2019/20 and 2020/21 financial years. It is this component around expectations that will be of significant interest given the high level of uncertainty over the outlook.  

As it stands | Capital Expenditure

Capex contracted for the fourth straight quarter with a 2.8% fall in Q4 to $28.5bn, accelerating the decline over the year from -1.6% to -5.8% (full review here). The decline in the quarter was centred on a 5.9% pullback in spending on buildings and structures to $14.8bn (-9.6%yr) as equipment, plant and machinery investment lifted by 0.8% to $13.6bn (-1.4%yr). 

On a sector by sector basis, mining investment softened after advances in the previous two quarters falling by 2.7% to $8.2bn (0.9%yr), while non-mining investment posted a fourth straight quarterly contraction with a 2.8% decline to $20.3bn (-8.3%yr). Within the non-mining segment, 'other selected industries' (mainly services) continued its run of weakness with a 1.9% decline to $18.1bn (-8.6%yr) while manufacturing plunged by 10.1% to $2.2bn (-5.4%yr) amid a global downturn in the sector prompted by trade tensions.

The 5th estimate of investment plans for 2019/20 had capex on track to rise modestly by 2.1% compared to a year earlier to $120.3bn. Meanwhile, estimate 1 for investment plans in the 2020/21 financial year was nominated at $100.2bn to up by 8.8% from the same estimate a year ago, albeit with considerable uncertainty attached.

Market expectations | Capital Expenditure

The consensus estimate according to Bloomberg is for capex to decline by a further 2.8% in the March quarter, with estimates ranging between -5.0% to +1.0%. The range of estimates informs us that the risks are to the downside in a quarter that was affected by the summer bushfires and the early stages of the COVID-19 crisis. 

Today's survey will also include the 6th estimate of firms' investment plans for 2019/20 (incorporating 9 months of 'actuals' and a 3-month outlook), though it is the 2nd estimate of capex intentions for the full 2020/21 financial year that is of much more significance in the circumstances. 

What to watch | Capital Expenditure

All the attention will be on the intentions component of the survey for a look through of how firms are adjusting their investment plans in response to COVID-19. Firms' responses for the 2nd estimates for capex in 2020/21 were collated by the ABS during April and May, which was in the midst of the nation's period of lockdown. The severity of the impact on firms was evident in the NAB's Business Surveys for March and April as trading conditions collapsed to their weakest since the 1990s recession and confidence plunged to record lows. In response, capex plans will have clearly been either been scaled back or delayed, particularly in an environment where cash flow is coming under severe strain. The split between investment plans between the mining and non-mining sectors will also be of interest.  

Australian construction activity -1.0% in Q1

Weakness in Australian construction activity rolled over into 2020 ahead of what will be much more significant headwinds from Q2 onwards due to disruptions and uncertainty associated with the COVID-19 crisis. Residential construction saw further weakness in Q1, as did engineering work, while public sector activity was a downside surprise.   

Construction Work Done — Q1 | By the numbers

• Total construction activity (private and public sectors) declined by 1.0% in the March quarter to $49.481bn against the consensus forecast for a 1.5% fall following on from a 2.9% contraction in Q4 (revised from -3.0%), which left the fall in activity over the year near unchanged at -6.5% from -6.6%.
• The headline results were;  
• Residential work -1.6%q/q to $17.245bn (-12.5%Y/Y)
• Non-residential work 0.0%q/q to $11.677bn (-0.3%Y/Y)
• Engineering work -1.1%q/q to $20.557bn (-4.4%Y/Y)

Construction Work Done — Q1 | The details 

Coming ahead of significant headwinds associated with the COVID-19 crisis, Australian construction activity declined a little further with a 1.0% contraction in the March quarter. The second half of 2018 marked the start of a downturn in the nation's construction cycle with activity now down by 12.5% over the period driven by weakness in residential activity and engineering work. 

Private sector construction activity declined for the 5th consecutive quarter, though the 0.6% fall in Q1 was the most modest contraction in that stretch, while the decline in annual terms eased slightly to -8.7%. Breaking this down further, building work fell by a relatively modest 0.9% in the quarter (-9.3%yr) compared to the sharp 4.2% fall in Q4 as commercial work moderated ongoing weakness from residential construction. Non-residential (or commercial) activity lifted by 0.5% in Q1, though it swung negative through the year to -2.2% from 5.1% indicating that the slowdown in approvals in this segment over the second half of 2019 (up 5% compared to +22% in the first half) was weighing on activity.

Residential construction activity contracted for the 7th straight quarter falling by 1.6% to be down by 12.4% over the year. The level of activity has fallen nearly 16% below its most recent peak in Q2 2018 and this has been a significant drag on the national economy, directly subtracting in the order of 0.8ppts from output growth over the period. This has followed a sharp reversal in dwelling approvals that have been trending lower for much of the past couple of years after rising strongly between Q3 2017 to mid-2018. In the March quarter, new home building declined by a further 2.2% (-14.3%yr), while alteration work, which accounts for a much smaller share of activity, lifted by 2.3% (2.0%yr). 

 

Engineering activity in the private sector was stable in Q1 (0.2%) after recording falls in 8 of the 9 preceding quarters that reflects mining investment rolling off as major projects moved through the construction phase. This left activity down sharply on a year earlier (-7.3%).

In the public sector, activity was surprisingly weak falling by 2.5% in Q1, which slowed annual growth from 2.0% to 1.1%. After running up strongly between 2015 and 2018 activity had pulled back between mid 2018 to mid 2019, though that had appeared to be stabilising after a robust second half of last year. Q1's weak result brings that assessment into question, though it would appear likely that fiscal support through infrastructure investment will become a focus for the federal and state governments to help re-start the economy in the post-lockdown period.  

Public engineering activity led the overall decline falling by 3.0% in the quarter as annual growth slowed to 0.3% from 1.7%. Meanwhile, public building contracted by 1.4% in Q1, though annual growth actually lifted from 2.5% to 3.1% skewed by a base effect.

A summary of the state-based detail is provided in the table, below, which incorporates both the private and public sectors. Construction activity declined in New South Wales, Queensland and Western Australia over the past year, while Victoria was stable and South Australia and Tasmania saw modest increases.   

Construction Work Done — Q1 | Insights

Today's result (-1.0%) came in close to the consensus forecast (-1.5%) as weakness in residential construction and engineering activity continued. Dwelling investment will continue to drag on the economy through 2020, particularly with visibility around population growth extremely limited due to uncertainty over overseas migration, while more insight will be provided on the engineering side in tomorrow's capital expenditure data. The main surprise in this report was the weak result from the public sector with infrastructure and building softening ahead of the pandemic.  

Preview: Construction work done Q1

The March quarter update on Australian construction activity is due to be published by the ABS at 11:30am (AEST) today. Following on from recent weakness, another soft outcome is expected to be posted in the first quarter of 2020 that was affected by the summer bushfires and the early phases of the COVID-19 crisis. 

As it stands | Construction Work Done

Australian construction activity has been contracting since the second half of 2018 driven by a downturn in the residential cycle and by the wind-down in work in the resources sector as major projects completed. The December quarter was particularly weak as construction work done fell by 3.0% on declines in residential, non-residential and engineering activity, which steepened the fall in annual terms from -5.6% to -7.4%. 

Private sector residential construction activity notched its sharpest quarterly contraction since Q3 2003 pulling back by 4.6% in the December quarter to be down by 12.6% over the year — its fastest pace of decline in 18½ years. This was driven by a 5.1% fall in new home building (-13.5%yr), while alteration work weakened by 1.2% (-5.6%yr). Amid a volatile profile in recent quarters, private non-residential work declined by 4.7% in Q4 slowing the annual pace from 10.8% to 3.7%, though this was well up from its most recent trough of -4.7% a year prior as earlier strength in approvals translated to activity. Reflecting the final stages of construction of major projects in the resources sector, private engineering work fell by a further 3.1% in Q4, increasing the annual decline from -7.7% to -13.3%. 

After an earlier slowdown, public sector work stabilised over the second half of 2019 with activity lifting modestly in the December quarter (0.7%q/q, 0.5%Y/Y) to consolidate an advance from the previous quarter. Engineering work followed up Q3's 2.9% rise with a 1.0% lift in the quarter while building work was flat after a robust 5.5% increase in the September quarter. 

Market expectations | Construction Work Done 

The median forecast for today's outcome according to Bloomberg is for construction activity to post a 1.5% decline in the quarter, with estimates ranging from -5.0% to +1.0%. 

What to watch | Construction Work Done

Private sector residential work is the area to watch in this report as it accounts for around 35% of total construction activity. With the residential construction cycle already in a sharp downturn ahead of the pandemic, this weakness is now expected to extend for longer than previously thought and remain a drag on GDP growth throughout 2020.

Macro (Re)view (22/5) | Hostilities ramp up

Geopolitical tensions between the US and China over the pandemic have been simmering in the background in recent weeks but the situation escalated following the latter's plans to introduce a bill at its National People's Congress (NPC) to impose new national security law in Hong Kong and subvert the local legislature in the process. Australia was not immune from these tensions as China announced tariffs on barley exports, while there were reports that some Chinese power companies had been advised by authorities to avoid purchasing domestically-produced coal. On domestic matters, tensions were playing out between the states over the timing of the release of border restrictions that are currently in place. Overall, the week's developments added another layer of uncertainty to the outlook at a time of fragility as economies across the globe look at reopening.

At Friday's NPC, China jettisoned its usual practice of announcing an annual GDP growth target due to the uncertainty brought on by the pandemic as the authorities outlined their plans to support the economy through this shock. Here, the focus will be on investment in infrastructure, with local governments to issue CNY3.75 billion in special bonds this year, as well as jobs with a target to create 9 million jobs in urban areas severely affected by shutdowns to lower the unemployment rate down to around 6%. The authorities said its fiscal deficit will widen to over 3.6% of GDP from 2.8% a year ago, although that estimate excludes the special bond issue and the initial reaction from the markets indicated that the measures had missed the mark. Staying in Asia, at an unscheduled meeting, the Bank of Japan announced a new funding facility of around 75 trillion yen that will incentivise banks to facilitate emergency loans to small and medium-sized businesses. This came after the Japanese economy contracted by 0.9% in the March quarter following on from a sharp 1.9% fall in Q4, with the nation being in the unfortunate position of having had typhoon Hagibis and a sales tax increase arrive just ahead of the pandemic.  

Over in the US, the focus once again was on the Federal Reserve where the issue of negative rates remains on the radar for markets. However, as far as the Fed goes their messaging on the issue was unchanged this week as a host of influential FOMC members reiterated that current policy settings were seen as appropriate and working effectively. The minutes from the FOMC's meeting held in late April were released this week and while they did not specifically address negative rates, insight was provided into the Committee's thinking around potential future policy changes. In particular, it noted that it could turn to a more explicit form of forward guidance, where it would either specify certain objectives (such as progress in lowering the unemployment rate or in meeting the inflation target) or provide a certain timeframe that would need to pass before consideration would be given to raising rates. Another possibility discussed was around stepping up its purchase of treasury securities to keep yields at the long end of the curve low. Most tellingly, however, was the option presented by "a few participants" to move towards a form of yield curve control that would aim to keep yields "at short- to medium-term maturities capped at specified levels for a period of time". On the banking sector, the Committee highlighted the importance of upcoming stress tests that would provide a gauge of the ability of the major financial institutions to withstand the economic downturn ahead, with "a number of participants" noting that regulators "should encourage banks to prepare for possible downside scenarios by further limiting payouts to shareholders".

In Europe, the main development over the past week was the agreement between German Chancellor Angela Merkel and French President Emmanuel Macron to present a plan for debt mutualisation to be voted on by EU leaders that would involve the membership issuing €500bn in common bonds to provide funding via grants to the nations most imperiled by the COVID-19 crisis. Germany had previously been resistant to such a plan, though the change in stance appears to have come in response to the threat of divisions within the EU widening. However, while it is a step in the right direction, those concerns are far from resolved with nations including Austria, Netherlands, Denmark and Sweden remaining insistent that support must be made via loans rather than grants. As far as economic conditions go, IHS Markit's flash PMI reading for the eurozone improved to 30.5 in May rising off a record low of 13.6 in the month prior. While the group still anticipates GDP growth in the bloc to contract by around 10% through the year to the June quarter, the survey provided a sign that the severity of the shutdown was on the path to moderating. The gain in the headline reading was matched by advances in conditions in both the services (from 12.0 to 28.7) and manufacturing sectors (from 18.1 to 35.4).

Turning to Australia, news came through that the Treasury and the ATO had uncovered reporting errors by around 1,000 businesses participating in the government's JobKeeper (wage subsidy) scheme, while its initial forecasts on the take up had also proven to be overly pessimistic. As a result, the Treasury has significantly revised its estimates of the coverage and cost of the policy. Whereas it had initially anticipated 6.5 million workers to be covered by JobKeeper that number has now fallen to 3.5 million workers, while the cost has almost halved from $130bn to $70bn. In last week's review, we highlighted the risks posed to the economy in ending fiscal support of this size on a cliff edge date. In the event, the government now potentially has $60bn in policy flexibility (3% of annual GDP), where for example it could consider either broadening access to the policy or lengthening its duration for the sectors that will still be in need of support after the September 27 finish date. There is a range of possible interpretations as to what the lower-than-forecast take up reflects, though the most plausible explanation would appear to be that fewer businesses either sustained or were expecting to sustain falls in revenue significant enough to meet the threshold for eligibility to the scheme. 

This additional policy flexibility is likely to be highly advantageous for the government at a time of extreme uncertainty. With the re-opening of the economy occurring in a sequential manner, it will become clear over time which are the sectors that will either require or be in need of more support. The minutes from the RBA's May Board meeting highlighted that its policy measures were "working broadly as expected", though in a similar tape to the message that has been coming from the major central banks across the globe in recent times, Governor Philip Lowe's noted in his remarks to the FINSIA Forum on Thursday that there is a "limit to what can be achieved with monetary policy". Governor Lowe also touched on one other key but intangible aspect to the recovery being confidence of people — that they can re-engage in normal activity without the fear that the virus will pose an undue health risk and that better economic times will be ahead. When confidence is the issue there are no easy fixes and the ABS's latest household survey on the impacts of COVID-19 highlighted some of the prevailing complexities in this area (see here). In the week's main data point, the preliminary estimate of retail sales in April pointed to the sharpest monthly decline on record of -17.9% as the impact of lockdowns hit the sector and came immediately after a rise of unprecedented strength (+8.5%) in March that was driven by stockpiling of food and other essentials. Such was the severity of the month to month swing, it eclipsed the volatility around the time of the introduction of the GST in 2000 (see chart below).    

Chart of the week

Hidden impacts of COVID-19

The latest ABS survey of Australian households following the COVID-19 outbreak highlighted the hidden impacts the crisis has had on sentiment and mindsets. What is first and foremost a health crisis has clearly led to significant financial and economic hardship, but there has also been another element around its impact on mindsets, and this survey focused on this area. Consumer sentiment is arguably the most important factor in determining how quickly households re-engage in economic activity as restrictions ease and that will, in turn, have major implications for the duration of the recovery. This survey was taken between April 29 and May 4, with the Bureau receiving responses from 1,022 households (response rate was 88.3%).

According to the survey, almost 1 in 2 (46%) of respondents said the pandemic had resulted in them now working from home. For those not working from home, the almost universal reason (89%) was due to the nature of the work (ie unable to be done from home). Details on employment arrangements read more constructive in this survey in terms of holding a job (+0.6ppt to 64.2%) and paid hours worked (+2.4ppt to 59.0%), though the ABS notes there is a high margin of error attached to these estimates so making broader extrapolations on the state of the labour market on that basis would be unwise.

Precautionary behaviour by Australians remains evident, highlighted by adherence to social distancing (94%) and the avoidance of public spaces (85%). This then extends into the home where 65% of respondents said they were diligent in disinfecting surfaces before using them. Compared to a month earlier, adhering to social distancing was little changed, though there had been a notable decline in stockpiling of essentials as households work through their inventories (see below). 

Source: ABS

This level of precaution becomes further evident when looking at the reasons respondents provided for getting out of the house. For both 18 to 64-year-olds (91%) and those aged 65 and over (77%) shopping for food was the main reason for their outing followed by exercise. There was a clear spread between these two purposes and all other reasons for outings (see below).     

  Source: ABS

So, the profile we have is a prevalence of working from home and precautionary behaviour in which outings are likely to have been limited to trips to the supermarket and for exercise. Linking this together, the survey then informs us that the feeling of loneliness has been common, more so for females (28%) than males (16%). Other stressors that this unfamiliar lifestyle has brought on include; 

• difficulty in maintaining a healthy lifestyle (19%) with around 1 in 5 eating more junk food than usual, 3 in 5 engaged in more screen time and a little more than 1 in 10 (14%) had increased alcohol consumption

• problems managing existing health, mental health or chronic conditions (10%), with around 1 in 10 having had a health appointment cancelled

• relationship difficulties (7%)  

Source: ABS

The survey then reports that 1 in 10 adult Australians has sought out advice during the crisis to help deal with some of the above or other issues such as employment or financial-related concerns. Overall, 12% of females had sought support compared to 8% for males. The most common form of support has come through a family member (71%), followed by a private or public organisation or service (such as Beyond Blue or Lifeline) (33%) and then a friend or work colleague (17%). For those that had sought out help 95% said they were able to obtain it either all or most of the time. However, there appears to be a particular issue here for Australians managing a mental health condition. With face to face appointments perhaps being avoided due to social distancing, more than 1 in 3 (33%) had turned to a Telehealth service for advice, which is much more prevalent than the 15% that had used such a service who were not dealing with a mental health condition.

Recent readings of consumer sentiment, either from the ANZ's weekly survey or the monthly Westpac-Melbourne Institute report, have pointed to sharp improvements off the lows from late March and early April, though it remains outright pessimistic overall. Today's ABS survey sheds light on some of the reasons why highlighting concerns around being isolated from friends and colleagues, reduced quality of lifestyle, and the need for support to help deal with these difficult times.