Improved risk sentiment played out in equities this week and set the tone across markets. The US dollar lost some of its recent strength, with yields at the front end of the curve declining on the idea the Fed may be set to pause on rate hikes towards the end of the northern summer, a view strengthened by inflation easing from its peak.
Headwinds slowing global growth
Growth in the world's major economies is losing momentum, with May's flash PMIs down from April's readings in the US, UK and euro area and broadly unchanged in Japan. Purchasing power continued to be dented by high inflation and input prices remained around record levels across the G4 as the Ukraine war and China's lockdowns added to supply disruptions. The likely reshoring of supply chains in response to these and other events over the Covid period was a key area of discussion in Davos this week at the World Economic Forum. Firms are anticipated over the coming years to recalibrate their focus from efficiency to resiliency in their supply chains.
S&P Global chart
Capacity constraints weighed on Q1 activity in Australia...
First quarter construction activity (-0.9%q/q) and business investment (-0.3%q/q) data in Australia disappointed to the downside of expectations this week, likely contributing to a subdued Q1 GDP outcome next Wednesday (previewed here). Construction work is being held back by supply constraints caused by labour and materials shortages, discussed in depth by the RBA's Luci Ellis in a speech this week. These issues are particularly pressing in residential construction where there remains a vast pipeline of houses that are yet to be constructed, though commercial construction, which had been picking up, has now lost some momentum as well. As these supply issues are resolved, construction work should regain momentum and support economic growth; however, cost escalations may see some of the work sitting in the pipeline being delayed.
A disappointing aspect of this week's data was the soft outcome on equipment investment by the non-mining sector (-0.1%), which is yet to regain the strong momentum it had built up ahead of the Delta lockdowns. More encouraging was the strong upgrade made to business investment plans for 2022/23, which were lifted by 11.8% to $131bn, its strongest level since 2014/15. There is some risk plans could be pared back as global growth slows, but these concerns are not new and businesses were submitting their investment plans as these headwinds were intensifying through April and May.
... but consumer spending remains strong
April retail sales were posted at a 0.9% rise in the month, a more moderate pace than the gains through the first quarter of around 1.7% but still a solid outcome. Annual growth ticked up from 9.4% to 9.6%. Rising retail inflation has partly driven these increses, though demand has also been robust, helped by a further easing of Covid restrictions, a tightening labour market and accumulated savings. Household consumption should drive Q1 GDP and confirm that demand has been resilient to the fall in consumer sentiment.
Also of note domestically this week was a speech by the RBA's Chris Kent, which emphasised rate hikes as the main tool in removing accommodative monetary policy. Although the runoff in the balance sheet will also play a role, Kent said it would be a "predictable and modest one". This is because the RBA has said it is not planning on sales of its bond holdings, implying a passive approach to QT.
Fed set for a predictable path
Following the Fed's 50bps rate hike in May, the central message coming out of that meeting was that there were likely to 50bps hikes coming in June and July. This was reaffirmed in the minutes from the May meeting that were published this week. The need for further hikes reflected the FOMC's assessment that the underlying conditions in the economy were robust, with the 1.5% contraction in Q1 GDP reflecting temporary drags from inventories and trade associated with the global supply chain pressures. That view was backed up robust personal consumption data, with real spending rising by 0.7% in April, its strongest increase since January, with gains in both goods (1%) and services (0.5%). However, falling real incomes due to high inflation is seeing households increasingly draw on accumulated savings, with the personal saving rate declining to 4.4% in April from 5% in March.
Assuming the FOMC hikes as expected over the next couple of meetings, the Atlanta Fed President Raphael Bostic raised the idea of then taking a pause post the Jackson Hole Symosium (25-27 August) where the theme is "Reassessing Constraints on the Economy and Policy". There was some encouraging news for the Fed on the inflation front, with its preferred core PCE deflator printing at 0.3%m/m for the 3rd consecutive month. These outcomes have seen the year-over-year pace ease to 4.9% in April compared to February's peak of 5.3%.
ECB to hike in July; exit negative rates in Q3
A blog post from ECB President Christine Lagarde effectively summed up the mood around the Governing Council was to end APP purchases "early in the third quarter" enabling the first rate hike to be announced at the late July meeting. That would lift the policy rate from -0.5% to -0.25%, and then the intention is to hike again in September, thus exiting from negative rates for the first time since 2014. President Lagarde outlined that the supply/demand imbalances in the global economy coming out of the Covid crisis, together with shocks such as the war in Ukraine and the return of lockdowns in China, had lifted measures of inflation expectations above the ECB's target and monetary policy needed to respond.
RBNZ ramps up its hawkishness
For the second meeting running, the RBNZ hiked rates by 50bps, the policy rate now standing at 2%. The summary of the meeting showed that the MPC agreed to keep "briskly lifting" rates to rein in inflation expectations and return inflation to its target band. The RBNZ has already delivered 175bps of hikes since October. The Bank's latest Monetary Policy Statement brought forward the timing and raised the projected peak for rates to 4% from 3.3% in the February Statement. The MPC's guidance is that as the economy returns to equilibrium, rates can be lowered to a more neutral level.
