Key insights from the week that was.
Ahead of this week’s primary Australian release, Q2 GDP, the RBA left the cash rate unchanged at 1.00% at its September meeting as expected. In the decision statement, the Board kept its options open on the timing of the next cut by leaving “if needed” in the final paragraph. From the statement, while the labour market remains front of mind for the Board, other factors are also being assessed closely. Of these, uncertainties around the global economy and weak domestic consumer spending are crucial.
The latter was a key reason why GDP growth was soft in Q2, disappointing the RBA’s expectation. Notably, annual GDP growth of 1.4% at Q2 is the weakest annual growth rate since the GFC; and, given population growth of 1.6%yr, means GDP has contracted in per capita terms over the past year. Breaking down growth by sector: not only was consumption growth weak at just 0.4%, but residential construction and business investment declined, respectively –4.4% and –0.4%. Had it not been for net exports’ 0.6ppt contribution (as the first current account surplus since 1975 was reported) and further strength in public demand, the economy would have stalled in Q2.
The household income detail of the Q2 GDP report further emphasises that there is considerable downside risk ahead for the consumer. While nominal labour incomes grew robustly in the quarter and over the year (1.2%; 5.0%yr), non-labour income declined in the three months to June owing to weak small business/ farm profitability and a decline in insurance payouts. A further 2.3% increase in income tax payments (after strong rises in 2018) resulted in real household disposable income falling 0.3% in Q2 and being up just 0.6%yr.
A decline in retail sales in July (–0.1%; 2.4%yr) also signalled a lingering reticence on the part of the consumer to spend coming into Q3. The poor July outcome came as a result of broad-based weakness across store types and by state. The substantial tax windfall to be delivered to households through the second half of 2019, and the benefit of lower interest rates, will have to overcome considerable headwinds if spending is to lift as the RBA and Government hopes. One negative that does look to be abating is the shock to housing wealth from declining house prices. As at August, post-election optimism, low rates and thin turnover are combining to see robust house price gains, particularly in Sydney and Melbourne.
Overall, we continue to expect the RBA to cut the cash rate in October and February, taking it to 0.50%. A further point to watch on the RBA ahead is that Treasurer Frydenberg is reportedly in discussions to strengthen the RBA’s inflation target, “to ensure that we continue to see inflation where the Reserve Bank and the government want it to be”.
Lastly on Australia, the latest update on Australia’s financial account showed that we are continuing to attract strong interest from foreign investors, particularly those looking to take a material stake in companies/ assets (i.e. direct investment). Though inflows of funds for portfolio equity investment has been light of late, demand for Australian corporate and government debt instruments remains strong. On investment outflows, Australian firms remain reluctant to expand their operations abroad, but our superannuation assets continue to be deployed internationally.
Offshore, the market began the week fixated on the risks emanating from global manufacturing, with China’s NBS PMI disappointing, and the US ISM manufacturing survey following suit. Very clearly, President Trump’s tariffs are having a material negative impact on the US as well as China. Based on the orders components of the surveys, there is more downside to come and risks are heavily skewed – particularly if US employment growth slows in line with the ISM measures, as has been seen historically.
Some optimism on political matters buoyed markets later in the week, as Hong Kong’s CEO Lam withdrew the contentious extradition bill and the US and China agreed to (once again) restart high-level trade talks in October. In our opinion, uncertainty on these matters, particularly the latter, remains highly elevated. We believe that the damage from the trade dispute has already been done, and hence remain of the view that the FOMC should cut the fed funds rate pro-actively in September, October and December 2019. Note that this week’s main events for the US are still to come: the latest employment report is due tonight; and FOMC Chair Powell will also appear on a panel.
Finally, a quick word on Brexit. Prime Minister Johnson suffered two defeats this week. First the opposition and Conservative ‘rebels’ were successful in their attempt to support the Benn bill that will effectively force PM Johnson to ask Europe for yet another extension of the Brexit process, this time to 31 January. Second, PM Johnson failed in his attempt to get parliament to agree to a snap election in mid-October as the Labour party abstained. For Labour, the priority is to pass the Benn bill into law. Only then will a general election be considered. But even then, Labour’s tactics remain unclear. On that note, we cannot stress enough that the outlook remains highly uncertain.