Cliff Notes: The new year brings optimism over inflation
Key insights from the week that was.
This week’s data was broadly supportive of confidence, with the risks around inflation and therefore the policy outlook thought to have improved into the new year.
Beginning in Australia, the Westpac-MI Consumer Sentiment survey reported another improvement in confidence, the headline index up 5.0% in January to be up 8.1% over the last two months. However, at 84.3, confidence among households is still in deeply pessimistic territory comparable to other major recessions. The lack of an RBA Board meeting in January looks to have provided households some temporary relief from the tightening cycle, highlighted by a 10.7% lift in sentiment among mortgage holders.
Although the survey’s sub-indexes showed an improvement in households’ expectations around the economic outlook and finances, households’ spending intentions for major items remained little changed and acutely pessimistic given the persistence of cost-of-living pressures. As detailed in our CPI preview, Westpac expects inflation to peak in Q4 2022 at 7.4%yr after a 1.5% quarterly lift in consumer prices before gradually easing over the course of 2023. Still, with more interest rate rises anticipated in coming months, consumer confidence will likely remain in a fragile state.
The December labour force survey provided the largest domestic surprise of the week. Against a market consensus of an around-trend 30k gain in employment, 14.6k jobs were instead lost in the month. This follows multiple months of robust prints for employment growth, averaging around 40k between August and November. Illness remains the key factor limiting employment and hours worked, as evinced by the fact that 50% more people worked reduced hours than is typically seen in December. This is also likely why the participation rate declined by 0.2ppts to 66.6%, resulting in the unemployment rate holding at 3.5%.
It was also interesting to note though that the proportion of workers taking annual leave was below the pre-pandemic average in December despite 2022/23 being the first summer of unrestricted travel since the pandemic. This was also partly reflected in Australia’s overseas arrivals and departures data wherein we estimate that departures, despite posting a 345.6k lift in original terms, underperformed once seasonally adjusted. Progress in short-term visitor flows has been a key positive of late, with the excess of arrivals over departures averaging roughly 65k/mth so far in FY23, pointing to some upside risk to the Government’s net overseas migration forecast of 235k.
In New Zealand meanwhile, we saw evidence of the impact of higher rates and inflation on consumer spending and the housing market. In December, retail card spending materially disappointed expectations, falling 2.5% following a 0.3% rise in November. House prices also continued their decline, taking the cumulative loss-to-date to 15% -- Westpac believes on its way to a trough reading of -21%. Unsurprisingly, given the much-higher marginal cost of debt, house sales are now down 39% versus a year ago. This week, Westpac NZ economics released a detailed view on the impact of higher rates on household finances and wealth. Ahead of next week’s Q4 CPI, their preview was also released.
Arguably though, the data release of the week came from offshore, with Chinese GDP and the associated partials witnessing to the turmoil created by the December end of COVID-zero but also the underlying strength of their economy. Instead of contracting, GDP stalled in the December quarter as households’ panic buying of necessities offset a significant fall in services consumption. Fixed asset investment meanwhile remained resilient, both to the 10% decline in residential construction through 2022 and COVID-zero’s end, with total investment up 5% for the year. Most notable for the outlook is the strength of high-tech investment in both manufacturing and services, up 22% and 12% respectively in 2022.
Not only is this a way to offset the cost to the economy of the structural decline and ageing of their population, but also to produce the increased productivity and profitability necessary to fund a doubling in per capita GDP by 2035 as Chinese authorities intend. We continue to expect China’s economy to grow at an average rate of 5% or more through 2022-2024, and for this rate of growth to prove sustainable into the medium term. There may however be consequences for geopolitical relations, with US authorities showing through 2022 a desire to restrict China’s rise, both in the global economy and industry.
Still in Asia, the Bank of Japan kept policy unchanged at its January meeting, having surprised by adjusting their stance the month prior. The January decision highlights the doubts the BoJ have over the sustainability of inflation at-or-above target into the medium term despite the extraordinary inflation the developed-world is currently experiencing. Arguably, these doubts could grow hence, with the global fight against inflation proving successful – best evinced by the US. With the evolving global backdrop and having held firm in January, it is difficult to see the BoJ making another change before Governor Kuroda steps down in April, keeping the historic divergence in rates between Japan and the rest of the developed world intact.
Then to the US. The limited commentary we have seen from FOMC members to date in 2023 has, by and large, suggested the Committee remains on track to raise the fed funds rate to a peak around 5% at March or May – Westpac continues to expect two more 25bp moves to a 4.875% peak in March. However, increasingly it is becoming clear that activity in the economy is deteriorating more than the FOMC expected. Retail sales was an example this week.
More to the point for the FOMC though, the inflation detail is now showing very clear signs of rapid disinflation. From a peak of 7.6% annualised at June, the three-month change in ‘sticky’ prices as measured by the Atlanta Federal Reserve has fallen to 5.5%. Excluding shelter, the deceleration has been more than twice as large, from 7.7% to 2.9% annualised. ‘Flexible’ price growth on a core basis has dropped from +8.7% to -6.8% annualised over the same period. These are very large and sustained moves which put US headline inflation on a path back near the FOMC’s 2.0% annualised target in the second half of the year.
It is not surprising then the market is pricing in rate cuts by the FOMC in the second half of the year and that the 10-year yield has declined almost 50bps through January. With the US labour market to only weaken slowly, and given the FOMC’s resolve over inflation, we believe a 2024 start date for rate cuts is more probable, although we then forecast a hefty 200bps of cuts to end-2024.
While Europe and the UK have seen much less of an improvement in printed inflation, upside risks are subsiding and there is growing belief that through 2023 a marked reduction in price pressures will occur. So, through January, a more cautious tone has been struck by officials on the policy outlook. Most notably, ECB Chief Economist Lane put the focus squarely on the tightening to date when speaking in January, with interest rates now seen as “ballpark neutral” – as an aside, Westpac believes they are best considered contractionary, particularly if market spreads and the limited risk tolerance of banks is taken into consideration. To that end, we anticipate the ECB’s tightening cycle will conclude at roughly the same time as the FOMC’s, but at a much lower level of rates. For EUR/USD and the US dollar more broadly, relative growth opportunities should then take centre stage, with Euro and Asia gaining favour as this transition occurs.
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