Westpac Market Outlook September 2022
Our latest thinking on Australia, markets and the global economy.
Read full report 'Westpac Market Outlook September 2022' (PDF 423KB)
The last month has been another volatile one for markets which have taken their cues from further aggressive monetary tightening and more determined inflation-fighting rhetoric from major central banks. The tone was set by Fed Chair Powell’s Jackson Hole speech in late August where he made the FOMC’s singular focus on reducing inflation clear, and its willingness to impose more costs on an already slowing economy if necessary. Indeed, a worse than expected August CPI report, released just as we go to press, has triggered a significant upward revision to our fed funds rate forecasts with a 4.125% rate now expected by year end (see here for more). The ECB has also stiffened its inflation-fighting rhetoric, delivering a 75bp rate hike at its September meeting.
The shift has triggered a material risk-off move, markets also whipped around by a range of other factors including developments in Ukraine and the energy crisis in Europe, and China’s challenges with COVID and a weak residential construction sector. Bonds, equities, currencies and commodities have all traded fairly big ranges in recent weeks. Heightened volatility now looks set to continue through to year-end. Accordingly we have lowered our near term AUD profile – a convincing ‘risk on’ move unlikely to gain traction while inflation fears dominate. We now see the currency holding around USD0.69 and a flatter USD profile, the eventual AUD rally coming through in 2023 in the form of a 5¢ rise over the year. Commodity prices will also retrace although the picture here is more complex, underinvestment also suggesting many prices will be better supported over the medium term.
Aside from some slowing evident in the US, most of the real economy effects of this rapid monetary re-tightening have yet to appear. That will change as we head into year-end with the major developed economies set for an abrupt slowing. However, the current messaging from central banks suggests it will take a significant further rise in rates and clear evidence that inflation is subsiding before growth considerations come more into frame. That should still happen in 2023 but exactly when is uncertain.
Australia: The Australian economy grew by 0.9% in the June quarter, a solid outcome driven by strong household spending on discretionary services, a reopening effect and supported by earlier stimulus. We confirm our downbeat view on prospects for 2023, with output growth forecast to be a well below trend 1%, slowing sharply from an expected 3.4% this year. By 2023, the full impact of the RBA’s 325bp increase in interest rates will be felt, along with the adverse effects of ongoing high inflation and with the reopening effect having long since faded. Consumer spending is expected to be a tepid 1.2% in 2023, while home-building activity will likely contract associated with a sharp pull-back in property prices.
Commodities: Fading fears of Ukrainian crisis supply disruptions and rising fears that central banks will raise rates more aggressively to squeeze out inflation have increased the risk of a recession in 2023 driving a correction in commodity prices. However, a rising cost base and increasing uncertainty about energy demand given strengthening global efforts to meet net zero emissions targets, has seen investment lag behind prices.
Global FX markets: Data clearly highlighting the abating of inflationary pressures and little-to-no growth momentum in the US economy has been quickly discounted this month with market participants instead focused on the inflationary-fighting rhetoric of policymakers and the possibility of event risks. We have flattened out our US dollar profile through to year end accordingly. However, we still expect economic fundamentals to reassert in 2023 and beyond.
New Zealand: The Reserve Bank of New Zealand is continuing to hike the cash rate at a rapid pace and economic growth is set to shift down a gear in coming months. We are not forecasting a recession. However, growth is set to remain subdued for some time until the level of demand comes back into line with the economy’s productive capacity.
United States: The Inflation Reduction Act of 2022 has the capacity to materially reduce US CO2 emissions to 2030 and beyond. But to do so will require a household sector that is both able and willing to spend on discretionary purchases. For both the economic and environmental health of the US, it is critical that the FOMC remove the risk of inflation without causing a deep or lengthy recession.
China: China’s residential construction sector has been hit hard by both structural reform and cyclical weakness, not to mention confidence effects associated with lockdowns associated with the government’s ‘COVID-zero’ policy approach. However, underlying demand for new construction and housing more broadly remains strong. With authorities now intent on resolving the liquidity and solvency concerns of the sector, growth will return, sustainably so.
Europe: The sudden momentum shift in the Russia-Ukraine conflict and heightened anxiety around Europe’s energy security are stark reminders that the balance of risks can swing rapidly in and out of favour. That said, the region’s unexpected economic resilience heading into Q3 supports the ECB’s unwavering focus on inflation and inflation expectations, necessitating further rate hikes into year-end.
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