A large repricing in US and European equities reflected the differing macro risks facing both economies from higher interest rates in the US and an energy crisis in the continent. The speech from Fed Chair Powell at the Jackson Hole symposium signaled a 'raise and hold' strategy will be the playbook from the FOMC as it looks to bring inflation back to target. A further surge in energy prices sees inflation risks in Europe rising while softer PMI readings showed weakening growth momentum.
Fed pivot on the backburner
The speech from Fed Chair Powell at Jackson Hole gave clear guidance that the FOMC will not be shirking the task in front of it to bring inflation back to its 2% target. Powell said the committee plans to raise rates to a "sufficiently restrictive" level and then keep them there until it is confident price stability has been restored, likely meaning a "sustained period" of weak growth and a softer labour market would follow. While that outlook is nothing new for markets, they have been reluctant to shift from the expectation that the Fed will pivot to rate cuts in 2023, though that will now need to come under review on the back of Powell's speech. The central argument from Powell was that the FOMC had taken lessons from previous periods of high inflation when monetary policy was eased prematurely and that it would place a high priority on repeating those missteps.
Being roughly half way through the inter-meeting period, Powell said there was still several key datapoints that would need to be taken into consideration when determining the size of the next rate hike. The door is ajar for a downshift to a 50bps hike following consecutive 75bps increases in June and July. Key to that is an easing in inflation pressures with its preferred core PCE deflator rising by 0.1% in July, its slowest month-on-month increase in 17 months, softening the year-on-year pace to 4.6% from 4.8%. Although one month doesn't make a trend it suggests September's hike will be a close call between 50bps and 75bps.
Slow start to Q3 in Australia
A light on week domestically limited to the release of a few largely second-tier indicators. Those indicators suggested economic activity had made a slow start to the third quarter, highlighted by the first sub-expansionary reading on the composite PMI in August (49.8) in 7 months. The gauge of services sector activity slowed to a 49.6 reading, potentially indicating a softening in demand due to consumers facing higher inflation and rising rates, though a spike in Covid cases during the winter may have been a contributing factor.
Manufacturing activity slowed but remains comfortably in expansionary territory (54.5) on the back of continued growth in new orders and employment. Input cost pressures for manufacturers remained elevated reflecting rising prices for materials, transport and energy. Job vacancies tracked by the National Skills Commission posted their first decline in 2022, falling by 3.8%m/m in July. This was consistent with the softening seen broadly in the labour market data in July. The interpretation I side with is hiring slowed around the end of the financial year and due to school holiday periods and the latest Covid wave. Vacancies remain very elevated at more than 2 per cent of the labour force, indicating the labour market should quickly regain momentum.
The data flow ramps up again next week with updates due for retail sales (29/8), building approvals (30/8), construction activity (31/8), private sector capex and housing finance (1/9).
ECB monitoring wage-price dynamics
The account of the ECB's July meeting detailed just how significantly the situation changed for the Governing Council in the space of a few weeks. The 25bps rate hike it had signaled at the June meeting became a 50bps hike by the time of the July meeting on the basis that a worsening inflation outlook warranted an accelerated exit from negative interest rates. According to a Reuters report, the more hawkish members now want a 75bps hike to be discussed at the September meeting. The move would be to counter second-round effects from high inflation feeding through to wage settings, though in the July account the Governing Council had seen little evidence of these risks emerging.