A rally across risk assets was blunted by strong US labour market data at the end of the week, backing up commentary from Fed officials that rates will continue to rise at pace. That rally was given impetus partly by the RBA pivoting to a 25bps hike after a sequence of 50s. There was no let up across the Tasman with the RBNZ hiking by another 50bps. Developments in energy markets remain key to the inflation outlook, a situation not helped by OPEC+ agreeing to a larger-than-expected output cut, though leaders in the UK and Europe are working on plans to cap wholesale gas prices to alleviate pressure on their economies over the winter months.
Fed set to hike by another 75bps...
The September nonfarm payrolls data provided another solid read on US labour market conditions, with markets pricing in another 75bps Fed rate hike in November off the back of the report. A host of Fed officials through the week backed up the signal in the dot plot that indicates rates are likely to be hiked to a peak of around 4.5%, some 150bps above the current fed funds rate. Although there has been speculation that financial stability concerns could impede the Fed's progress, Governor Waller pushed back on that assertion in a speech this week. Fed officials Mester, Daly and Bostic also sought to dismiss the idea that rate cuts could be on the cards in 2023 as the economy slows.
... as the US labour market remains solid
On the labour market, employment showed a lift of 263k on nonfarm payrolls in September, coming in slightly better than the 255k expected. While data on job openings posted a decline of 1.1 million in August, they remain very elevated at just over 10 million and the pace of hiring is running at a very robust 372k on a 3-month average for nonfarm payrolls. Strong employment combined with a small fall in labour force participation (to 62.3%) led to the unemployment rate declining from 3.7% to 3.5%, in line with its level immediately before the Covid crisis. Prospects for an easing in wage-price pressures received an encouraging signal as average hourly earnings growth moderated from 5.2% to 5.0%yr, remaining on a softening trajectory after hitting their recent high of 5.6% in March. The main constraint remains on the supply side, with prime-age (25-54yrs) participation (82.7%) still around 0.5ppt short of recovering from its pandemic-induced fall.
RBA pivots to a 25bps rate hike...
After delivering 225bps of rate hikes since April, with the past four increases coming at the frontloaded pace of 50bps per meeting, the RBA Board elected to slow the pace of tightening, lifting its key rates by 25bps to 2.6% on the cash rate and 2.5% for exchange settlements (reviewed here). The outlook described by Governor Philip Lowe in his post-meeting statement of inflation remaining above target over the next couple of years meant that the guidance for further rate hikes being expected remained intact. However, the Board is also trying to keep the economy "on an even keel" and is mindful of the risk of overtightening when the outlook for global growth has deteriorated and with the RBA's Financial Stability Review outlining the adjustment from households to higher rates was still largely yet to play out. In that respect, the RBA has turned slightly more cautious, leading markets to lower their expected peak in the cash rate to around 3.5% from around 4% last week.
... while the housing market showed more signs of cooling
The sensitivity of the housing market to rising interest rates was on display in the week's data points. Housing prices fell by 1.6% on CoreLogic's national index in September to be down by 4.1% over Q3, driven by the Sydney market (-6.1%qtr). Declining prices and tighter borrowing conditions are weighing on housing finance commitments, down by 3.4% in August (reviewed here). Notwithstanding this and capacity constraints in the construction sector, headline building approvals surprised to the upside of estimates in August (28.1%) as higher density approvals rebounded off a weak July reading and detached approvals kept up their notable resilience (reviewed here).
Meanwhile, retail sales have continued to advance, confirmed at a 0.6% rise in August's finalised report, indicating households continued to spend despite headwinds from weak sentiment and high inflation (reviewed here). The nation's trade surplus is well off its recent highs but was still elevated at $8.3bn in August as global demand for Australian commodities continued to underpin export earnings (review here). Import expenditure is up by more than 40% over the year, driven by a combination of robust domestic demand conditions, eased restrictions on offshore travel and the rising global inflationary backdrop.
ECB to press on, potentially with QT in the mix
The account of the ECB's September meeting indicated that the Governing Council is set to keep hiking rates at an accelerated pace, frontloading the removal of accommodative monetary policy. As part of this effort, there were signals that quantitive tightening (QT) is on the radar, with the account acknowledging the size of the ECB's balance sheet was providing "significant monetary policy accommodation" by compressing bond yields.
Should this be unwound, the ECB has its new Transmission Protection Mechanism in the toolkit to help keep a lid on Italian (and other peripheral nations) bond yields from widening too severely, though on the other hand if there are signs at the next Governing Council meeting that the commencement of QT is imminent, this could amplify the already elevated volatility in bond markets. Only last week, the Bank of England had to defer its plans for selling down its gilt holdings and is instead now buying bonds to restore orderly function in the market.
On rates, the account revealed the Governing Council's decision to hike by 75bps was not unanimous with "some members" arguing for a smaller 50bps increase in light of the rising risks of recession in Europe. Although the 75bps hike was not intended to signal this was the new normal hiking pace for the ECB at the moment, that is the course of action markets are anticipating at the next meeting at the back end of the month.
