The domestic and international debate took some interesting turns over the course of the last week. Beginning with the US non-farm payrolls report last Friday, through the Chinese data round over the weekend, a number of policy pertinent Australian domestic updates Tuesday through Thursday, and instructive central bank meetings in Asia and New Zealand, there was more than enough for markets to ponder.
Market pricing for the next Reserve Bank meeting on July 2 crested at around 60 per cent of a 25 basis points cut at the Sydney close ahead of payrolls. By the evening of Thursday it had settled back to around a one-in-three that the bank would choose to cut in July, while the August window, our favoured position, was three quarters priced.
Casting back to payrolls, the 175,000 outcome was middling, neither confirming nor denying robust recovery, or previously held positions on the tapering debate. While we remain in the sceptical camp as to the sustainability of the sort of activity outcomes the US has managed to produce in the year to date, the tapering question has developed a life of its own.
The feedback from Westpac's latest client visits in London, detailed in this space a week ago, indicated strongly that the consensus among Northern Hemisphere investors has moved decisively in the direction of taking tapering as a something of a fait accompli. That degree of certainty has been reflected in a broad variety of asset markets. One in particular – the Australian dollar – which is enduring its worst run in a considerable period of time – is feeding back directly into the short term monetary policy debate (of which more below).
The Chinese data for the month of May were not impressive. The recovery has been consistently challenged in the year to date by stop-start investment spending, an end to the inventory rebuilding phase and soft external demand, which took a material turn for the worse in May. The majority of the data flow has underwhelmed in each of the last three months. The positive exceptions from earlier in the year are showing signs of levelling out or decelerating.
The Reserve Bank seems to have downgraded its view of Chinese economic momentum in the wake of the first quarter GDP outcome, and will presumably not revisit that position in detail until the second quarter outcome becomes available. Notably, that will not be any earlier than the July 18. If the bank wanted assurance on the veracity of its global growth views before moving interest rates again, it might be prudent to await this update.
On the home front, important new information on business and consumer confidence, housing finance and the labour market came to hand this week. The NAB survey showed that the business conditions index rose 2pts to –4 in May, with a three month average of –5. Business confidence was unchanged at –1, versus the historic average of 5. From an investment point of view, the capacity utilisation index is more than one standard deviation below average. Business conditions are now below zero for each and every state, while mining conditions and confidence are now below those prevailing in the rest of the economy.
Westpac-MI Consumer Sentiment did somewhat better in May, with an unlooked for jump in the headline reading taking it back above the 100 threshold. Quarterly updates on the critical “best place for savings” questions also showed signs of improvement, with an increase in the proportion nominating real estate and a notable reduction in those nominating “pay down debt”.
Our composite index of risk aversion accordingly declined. There was, however, a sting in the tail. The unemployment expectations series moved adversely, implying a material reduction in job security. We have a large degree of faith in this series as a genuine reflection of household anxiety, and a robust leading indicator of labour market developments. The May Labour Force update (a 1100 increase in jobs, a slight decline in the unemployment rate – 5.56 per cent to 5.53 per cent – mostly due to lower participation, the employment to population ratio fell 0.1 percentage points to 61.6 per cent, while hours worked declined by 0.7 per cent) was a bland document from the point of view of the near term policy outlook. The West Australian labour market has come off the boil, with employment growth decelerating sharply. A theme across all of the Australian data is that the resource states are cooling rapidly.
The April housing finance approvals release was tasked with building upon the positive reading from March. They rose 0.8 per cent in April following a downwardly revised 4.8 per cent rise in March. While in our minds finance approvals remain broadly consistent with a recovery, the strength and breadth of the upturn remains underwhelming.
Construction-related loan approvals were soft in April, but with through the year growth of 17.9 per cent, are a genuine bright spot, although the growth rate is inflated by a very weak base of comparison. First home buyers remain the stand out weak spot. Lending to this segment is still down 10.8 per centyr and at very low levels by historical standards. Whilst FHBs remain on the sidelines, the scale of the upswing will be limited.
On the exchange rate, the Australian dollar regained some composure on Thursday evening, but on balance its performance in the June quarter (-8 per cent against the US dollar in the quarter to date, the trade weighted index down 10 per cent from its April peak) in the face of Fed tapering expectations takes some pressure off the Reserve Bank at the margin.
Even so, the case for further interest rate cuts need not be currency-centric. We should not get to the point where the probabilities for a move at the near meeting fluctuates blow by blow with spot Australian dollar. The Reserve Bank is interested in the relativity between the real exchange rate and the terms of trade, and the views expressed in the governor’s statement in May – “The exchange rate has depreciated since the previous board meeting, although, as the board has noted for some time, it remains high considering the decline in export prices that has taken place over the past year and a half” – indicates that it has not suddenly narrowed its frame of reference. One can deduce from that statement that the bank would need to see a deeper and more sustained move in the currency before it ceased to be a concern for demand, and ultimately, inflation that is too low.
In conclusion, developments over the course of the last week do not, on balance, argue that the risks around the short term monetary outlook have altered substantially. Our confidence in our standing position that the August window is more likely to see a cut delivered vis-a-vis July, has increased a smidgin. New information on Australian CPI and Chinese GDP, both due in the middle weeks of July, will be extremely valuable inputs to the bank’s deliberations, and the opportunity to outline the thinking behind a move in the August SOMP, also has its attractions. The counterpoint is that the underlying frailty revealed in the first quarter national accounts could easily be considered grounds for easing in and of themselves, in advance of CPI. We note in that context that front-running inflation updates is far more common during easing cycles than when policy is being tightened.
We await next week’s minutes for greater clarity on the board’s June deliberations, to gauge if the relative weights we are applying to the various moving pieces are appropriate.
Huw McKay is a senior economist at Westpac.