MLC August 2019 Update
- Central banks have engaged in a policy reversal in response to weaker economic growth and the uncertainties associated with the US-China trade conflict.
- US inflation has inched higher, but core CPI measures and sluggish wages growth still point to spare capacity in the labour market.
- The UK’s new prime minister Boris Johnson will enter Brexit talks with the EU, but Europe’s negotiators are unwilling to agree to the removal of the Irish backstop.
- Fears of further economic fallout from the trade conflict were partially allayed following positive growth in Chinese exports in July.
- The Australian economy is benefiting from the rise in commodity prices, but the Australian dollar remains under pressure due to the diverging interest rate differential.
Markets enjoyed a short-lived reprieve from the US-China trade conflict in July, but economic data points to a further slowing in the global economy. The US Federal Reserve’s recent rate cut appears justified given the re-emergence of trade tensions, with the US administration threatening 10% tariffs on the remaining $300 billion of Chinese goods.
The US Fed has finally completed one of the most significant policy reversals in recent history. After lifting the funds rate towards 2.50% in late 2018 and signalling that there was some way to go with tightening (the FOMC dot plot pointed to a peak of 3.40% in 2021), July’s FOMC meeting saw members vote to lower the funds rate to a range of 2.00–2.25%. The pivot in policy over the past six to nine months has been in response to a combination of a slowing US economy, weaker global growth, uncertainties associated with the ongoing trade war, and consistent undershooting in inflation.
The IFO Institute’s leading index showed that the mood among managers has weakened to its lowest level in nearly five years. The IHS Markit Global Business Outlook fell to its lowest level since 2012 in June, with new orders weakening sharply and business optimism at the lowest level on record. The survey sees the trade war causing a marked fall in optimism among US and Chinese companies.
Chinese data over the past month has been mixed but generally in line with expectations. GDP growth in the June quarter slowed to 6.2%—the lowest level since 1992— and the July manufacturing PMI readings are both holding below the critical 50 level, while the service sector PMI fell to 53.7 from 54.2. Industrial production lifted to 6.3% year-on-year in June from 5.0%, and retail sales growth jumped to 9.8% from 8.6%.
The Jibun Bank of Japan Composite PMI paints a picture of continued softness in the manufacturing sector and resilience in the service sector. The surveys are suggesting growth in the June quarter of an annualised rate of around 0.3%, down from the 2.1% seen in the March quarter. The slowdown reflects subdued domestic consumption and struggling exports.
The minutes from the RBA’s July meeting noted that low wages growth and spare capacity in the labour market meant there was room for the bank to cut rates. The underemployment rate in May was 8.6%, barely below the level seen in 2014 when the unemployment rate was more than 1.0% higher at 6.5%. The participation rate is now at a record 66.0%, up from 64.5% in 2014. Perhaps the RBA has been too focused on the employment growth data, which has surpassed expectations over recent years, and has risen 2.6% in trend terms over the past year to June. Meanwhile, GDP growth is just 1.8% p.a., suggesting productivity growth is negative.