Cliff Notes: costs heap pressure on the consumer and business
Key insights from the week that was.
Updates on the consumer, housing and investment kept Australian market participants busy this week. While new information for the US argued for greater caution from policy makers.
Domestically, the week began with a sour update on the Australian consumer, October’s retail sales printing its first negative result of the year at -0.2%. The limited detail showed the weakness was broadly-based, with declines in nominal spending across almost all store-types and states. That retail prices are rising at a pace of 2%qtr suggests the underlying decline in real spending volumes this month was much larger than the nominal headline figure, likely in the -0.5% to -1.0% range. Rising interest rates are clearly beginning to impact retail spending, and with the RBA expected to tighten policy into early-2023, the pressure on consumer demand will build in the period ahead.
Developments on housing were also downbeat. CoreLogic’s home price index, covering the eight major capital cities, fell by another 1.1% in November. Price declines remain broadly-based across the major eastern states, with most segments by price tier, region and type of dwelling continuing to move lower. That dwelling approvals tumbled another 6.0% lower in October provided additional perspective on the scale of housing’s downturn, with private detached houses and private sector units respectively down -2.2% and -11.3%. Given the extensive set of headwinds facing the construction sector and broader housing market, further significant declines are expected ahead, hitting GDP as well as the demand for housing credit.
Lastly for the consumer, some evidence of a deceleration in inflation was seen in October. The ABS’ new monthly CPI came in at 0.2% against our expectation for a 0.6% rise, with food, housing, auto fuel and holiday travel all materially weaker than anticipated. Note though that key components of the CPI are not sampled every month; as an example, electricity costs are assessed in the end month of the quarter. Moreover, the October release would not have captured the impact of that month’s flooding. Still, the October release points to the circa 8%yr pace we have forecast for Q4 being the peak for this cycle.
In the lead-up to next week’s Q3 GDP report, the ABS also released two partial indicators of investment.
Construction work done staged a rebound in Q3 as expected, rising 2.2% to reverse Q2’s -2.0% (initially -3.8%). The ABS however noted that this outcome should be regarded as a preliminary estimate with a below-average 70% response rate to the survey. The gains for construction were broad based in the quarter. Though housing’s 1.3% increase came despite a 5.0% decline in renovations, and the overall level of construction remains 0.5% below mid-2021. Supply delays, difficulties in sourcing labour and inclement weather continue to limit the sector’s ability to work through its project pipeline. Higher costs are also a consequence, up 2.8% in Q3 and 10.8% versus a year ago – the most rapid pace of cost escalation since 1989.
CAPEX spending subsequently disappointed, falling 0.6% owing to a dip in mining sector activity (-5.1% versus +1.4% for non-mining) which is likely to prove temporary given investment in the sector rose 11% over the 12 months to June 2022 and as expectations remain constructive. For mining, the update on 2022/23 investment intentions points to a 11% increase in spending; meanwhile, a near-17% gain is projected for non-mining, resulting in a 15% forecast for investment growth overall. Clearly businesses are responding to tight capacity and rising demand, though tax incentives and rapid price growth are also buoying these nominal estimates. With the economy set to slow dramatically in 2023 and remain below-trend in 2024, we are likely to see increased caution come 2023/24.
Following the downside surprise for retail sales, renovation work and equipment investment, we have revised down our forecast for Q3 GDP from 1.1% to 0.8%.
Over in the US this week, both the data and tone of central bank speak pointed to a need for caution over the outlook. Ahead of tonight’s nonfarm payrolls release, November’s 127k rise in ADP private payrolls was well below expectations at close to half October’s gain. For October, the JOLTS survey also pointed a loss of momentum for employment, with job openings and the hiring rate both falling. In our view, annual growth in both indicators is now below average, signalling a trend deceleration in net job creation and, likely, wage growth. Quantitative and qualitative views on business activity also deteriorated in November. Most notably, the ISM manufacturing index followed the S&P Global measure and fell to a contractionary reading of 49.0, signalling that big manufacturers at the core of the US economy are now also coming under pressure. More broadly, the latest Beige Book from the Federal Reserve pointed to stagnation across the economy, with growth assessed to only be “flat or up slightly”.
Given these outcomes, it is not surprising that FOMC Chair Powell, while still determined to defeat the threat of inflation, was a little more circumspect on the outlook this week, making clear that the FOMC planned to downshift their pace of tightening at the December meeting, from 75bps to 50bps. Helpfully, in the speech and Q&A, Chair Powell provided some benchmarks for employment growth and wage inflation, referring to 100k in monthly job gains as the pace required to match population growth – with any outcome lower than this level increasing slack in the labour market – and a need for wages growth to be 1.5-2.0ppts below its recent pace to be consistent with inflation returning to the 2.0%yr target in the medium-term.
The ADP and business surveys point to employment growth decelerating to or below the 100k level very soon; while wages growth also looks to be converging to the 3.5-4.0%yr range that the FOMC is arguably looking for, with annualised ECI private sector compensation growth in Q3 around 4.5% compared to 6.0% in Q2 and hourly earnings growth having averaged 0.3% per month the past 3 months – a sub-4.0% annual pace. If labour market momentum does slow as these partials suggest, the FOMC would be justified in halting the hiking cycle at 4.625% in February. However, if more momentum is seen in nonfarm payrolls and/or financial conditions ease quickly, the FOMC may look to continue slowly tightening towards mid-2023 to make sure inflation risks are guarded against.
Finally to China. The path out of COVID-zero remained in focus this week with new cases near record highs. Giving the market confidence, the actions of the Government were deliberate and controlled, with health authorities announcing a drive to increase the vaccination rate amongst the elderly, and Beijing allowing some of its residents to isolate at home. Current restrictions in cities with high caseloads were also narrowed, highlighting the intent of both central and local authorities to progressively free the domestic economy from the constraints of COVID-zero. Uncertainty will remain for some time, but both consumer activity and sentiment should see a material lift during the first half of 2023.
When assessing the outlook for China, it is also important to recognise the drive they are undertaking to revolutionise their power grid with renewable power, benefitting industry through improved access to power and by minimising cost pressures. The scaling up of renewable power is also allowing for the rapid take-up of electric vehicles, aiding both economic activity and their environment. Furthermore, leading in the green transition is giving Chinese industry a strong incentive to scale up their production of finished goods and parts required for society’s electrification, with potential markets spanning the globe. However, with regards to export opportunities, we must also remain cognisant of the threat of geopolitics.
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