Macro (Re)view (5/7) | US data boosts Fed rate-cut prospects

Equities saw solid gains this week, underpinned by US tech, with lower bond yields and a weaker dollar supporting risk sentiment. The UK general election went as the polls had predicted and was a non-event for markets. Politics remains in focus over the weekend with the second round of the French elections taking place, though with Le Pen's RN party looking unlikely to secure a majority a tail risk in market pricing has reduced. Comments from Fed Chair Powell at the ECB's Sintra Forum that US disinflation is back on track as well as soft labour market and activity data moved markets closer to pricing in a September rate cut. This comes ahead of next week's key CPI and PPI reports for June. 

Signs of a cooling US labour market upped dovish bets on a Fed rate cut in September to a 75% chance, with markets close to discounting two cuts by year-end. Although the June employment report showed nonfarm payrolls increased by a stronger-than-expected 206k (vs 190k forecast), this was weighed by downward revisions subtracting a net 111k from employment over April-May. As a result, the 3-month average for nonfarm payrolls has slowed to 177k, its lowest since the start of 2021. The headline unemployment rate now stands at its highest level since late 2021 after rising from 4% to 4.1% in June; however, that came alongside an increase in the labour force participation rate from 62.5% to 62.6%. Reflective of easing tightness in the labour market and slowing inflation, annual growth in average hourly earnings moderated to a 2-year low at 3.9% from 4.1% previously. Meanwhile, weak readings in the ISM surveys for services (48.8) and manufacturing activity (48.5) in June were indicative of slowing growth momentum. 

Opening the ECB's Sintra Forum, ECB President Lagarde spoke about steering monetary policy through the current cycle. Unique to this cycle, the ECB's tightening has seen a faster pace of disinflation than previous episodes, but the labour market has remained significantly more resilient. The ECB cut rates in June and the account from the meeting cast more light on the decision. Easing monetary policy reflected increased confidence that inflation was headed durably back to the 2% target. This approach was characterised as a 'judgement call' intended to guard against the risk of rates remaining too high for too long. The fact there were dissenting views and that the inflation data remains elevated suggests that the ECB's easing cycle will progress at a measured pace. Inflation data for June this week showed the headline pace easing from 2.6% to 2.5%yr (vs 2.5%) and the core series remaining at 2.9%yr (vs 2.8%). 

Turning to Australia, confidence in the existing monetary policy strategy to return inflation to target saw the RBA Board holding rates steady last month. This was a key message conveyed in the June meeting minutes. The Board remains wary that upside inflation risks could prompt further tightening - a scenario markets price as around a 50/50 chance - but the RBA is reluctant to hike, unless the Q2 CPI report (due 31 July) forces its hand. At the June meeting, a hike was considered on the basis that rates weren't 'sufficiently restrictive' to bring inflation back to target 'within a reasonable trameframe'; however, policymakers did not see evidence to draw that conclusion. Instead, the view was that rates were working to slow the economy in a manner consistent with inflation back at target in 2026 while also preserving the post-Covid employment gains. 

Data to hand this week was on the strong side of expectations but noisy at the same time. End of financial year discounting drove a 0.6% rise in retail sales for May, their strongest increase since the start of the year (see here). Gains were broad-based across food and discretionary categories for the month, but sales momentum remains weak amid cost-of-living pressures and higher interest rates. Dwelling approvals posted their strongest rise since last October up by 5.5% in May but remain at low levels (see here). The fundamentals of tight supply amid strong demand continue to drive housing prices higher, up nationally for the 17th month running in June (0.7%) according to CoreLogic. Lastly, the monthly goods surplus narrowed to $5.7bn in May, a continuation of the recent momentum (see here). Iron ore boosted exports (2.8%) to their strongest rise since last August only to be outpaced by a lift in imports (3.9%). 

Australia's trade surplus narrows to $5.7bn in May

The balance on Australia's goods account narrowed to a surplus of $5.7bn in May from a downwardly revised $6bn in April ($6.5bn prior), disappointing expectations for a $6.2bn figure. In positive news, exports (2.8%) saw their strongest rise in 9 months; however, this was outpaced by a 3.9% increase in imports.

The trade surplus for May at $5.7bn was little changed from April ($6bn) but well up from the recent low in March ($4.3bn). This saw the 3-month average for the trade surplus moderating to $5.4bn (from $5.7bn in April) - its lowest since December 2020 -  down substantially from its level at the end of 2023 ($9.6bn). An adjustment in commodity prices associated with weaker global growth has weighed on exports while import spending has trended higher amid resilient domestic demand and slower goods disinflation in Australia compared with peer economies.    

Exports in May lifted by 2.8% to $44bn (-7.8%yr), their first rise in 4 months and the strongest gain seen since August last year. This was driven largely by non-rural goods (3.7%), with iron ore exports posting a 6.3% rise that broke a run of declines between December and April, falling 17.4% over the period. Today's release reported that higher iron ore exports reflected the combination of a lift in prices and shipment volumes. Across the other commodities, other mineral fuels (mainly LNG exports) advanced by 1.7%m/m and coal exports were a touch softer (-0.2%m/m). 

By contrast, rural goods declined (-1.2%) to be down by 15.9% over the year and nearly 25% below their mid-2022 high. Cereal exports have been the major driver of this retracement (-51%yr) coming after prices surged following the disruptions to global wheat exports stemming from the war in Ukraine.    

Imports lifted by 3.9% month-on-month coming to $38.2bn, up modestly over the year (3.5%). Spending on imports in May was supported mainly by intermediate goods (6.6%) on the back of a surge in fuel imports (10.8%) as global oil prices advanced. Also driving imports in May were consumption goods (2.4%) and capital goods (0.5%), though both categories were coming off sizeable declines in the prior month of 5.3% and 6.4% respectively.  

Australian dwelling approvals rise 5.5% in May

Australian dwelling approvals lifted by a stronger-than-expected 5.5% in May (1.7% forecast), posting their sharpest increase since last October. Backward revisions lifted approvals over prior months to make this the fourth consecutive month-on-month rise for dwelling approvals. Nonetheless, dwelling approvals remain at low levels reflecting the interest-rate sensitivity of the home building sector as well as legacy issues from the pandemic that have held back construction activity.  

Dwelling approvals in May lifted by 5.5% to 14.2k, their fourth consecutive rise following revisions to prior months. These revisions also lifted the level of approvals, with the May figure coming in at a high since November last year. Approvals for the 3-months to May averaged 13.6k, marginally above the cycle lows of around 13k. 

Approvals for detached houses were up by 1.3% in the latest month and were 12.1% higher over the year, bringing the level in May (9.3k) to its highest since October 2022. House approvals have surged in Western Australia over the past year (65.7%) and have also risen in Queensland (14.2%), New South Wales (8.2%) and Victoria (4.8%). 

Turning to the higher-density segment, approvals posted a 14.2% rise - their sharpest increase in 12 months - reaching a total of 4.9k. The detailed data indicates that much of the strength from the May result related to high-rise units, with townhouses and low-rise projects also contributing. 

Alteration approvals fell sharply in May, down 9.3% on the month to around $1.05bn. This may reflect the impact of changes to national building codes (effective 1 May) that have increased regulatory requirements for construction, adding additional cost. Ahead of these changes, alteration approvals saw strong rises in March (8.3%) and April (3.4%). 

Australian retail sales 0.6% in May

Australian retail sales accelerated past estimates rising by 0.6% in May, their strongest outturn since the start of the year as end-of-financial year sales saw people returning to the shops. While the momentum in retail sales is weak averaging just a 0.1% gain for the 3 months to May, today's report indicates that households faced with cost-of-living pressures and higher interest rates are still responsive to discounting. 

The outcome for May retail sales (0.6%) surprised the market to the upside, doubling the expected increase and coming in above the top end of the range of forecasts (-0.4% to 0.5%). The ABS cited in its release the effect of end-of-financial-year promotions, with budget-conscious households capitalising on discounted prices. Annual growth in retail sales lifted from 1.2% to 1.7% but remains weak relative to the pace of population growth and inflationary effects. 

Broad-based growth was seen across the categories in May; food sales advanced by 0.7%, reversing a fall in April (-0.5%), with liquor sales a key driver behind the month-to-month swing. Discretionary spending was up by 0.4%, moderating slightly from the previous month (0.6%). Within this, the strongest gains came in household goods (1.1%) - its best outturn since January - and clothing and footwear (1.6%), rebounding after falling sharply over March-April. By contrast, the categories of disretionary spending that weakened were department stores (-0.9%) and cafes and restuarants (-0.2%), the latter unwinding from the boost generated by the AFL Gather Round and LIV Golf held in Adelaide during April. 

Overall, while this was a solid result for May, retail sales remain constrained by households cutting back amid cost-of-living and interest rate pressures. The effect of price discounting clearly resonated with consumers in that context. While households are now in line for tax relief via the stage 3 tax cuts in addition to government energy rebates, I am minded to think this is more likely to alleivate the pressures being faced in the first instance rather than providing an outright boost to demand.