The world’s biggest economies showed signs in November of continued growth around trend or a little better while major equity markets extended the falls recorded in October implying a weaker global economic growth outlook. This disconnect between evidence of strong growth and growth prospects and equity markets’ concerns about potentially weaker growth ahead relates to market views that a range of issues can undermine growth. These issues include increasing global international trade tensions; potential debt crises; and the risk that the US Federal Reserve (Fed) hikes rates too aggressively. While there are risks to the global economic growth outlook, the risk still seems comparatively small that strong global economic growth will be derailed in the near term.
In the US, the second reading of Q3 GDP growth is due this week and looks set to confirm annualised growth at 3.5% underpinned by consumer spending growing around 4% annualised as reported in the advance GDP reading. More importantly, consumer spending still looks strong early in Q4. October retail sales rose by 0.8% m-o-m (0.7% excluding automobile sales). Factors that point to consumer spending continuing to improve beyond October are high consumer sentiment and consumer confidence readings in October, strong wages growth (average hourly earnings up 3.1% y-o-y in October, a decade high) and strong employment growth (non-farm payrolls up 250,000 in October) plus the lowest unemployment rate (3.7% in both September and October) since 1969.
Strong household income and spending growth should continue to support US economic growth in the face of patches of softness in housing activity and business investment spending. Importantly, most business purchasing manager reports are holding up in territory consistent with strong expansion. The October ISM manufacturing report showed a general index reading of 57.7, down from 59.8 in September, but still a strong report. The ISM non-manufacturing report covering more than 90% of the US economy moderated slightly in October to a still strong reading of 60.3 from 61.6 in September.
One fear in the US equity market (although not yet in the US bond market) is that the Fed may continue to view a combination above trend economic growth and low spare capacity as a potential higher inflation threat causing it to hike rates eventually beyond neutral setting. Yet there is no evidence that the Fed is doing anything more than slowly returning the Funds rate to a neutral setting. Essentially the Fed is watching US economic data to ensure that the economy can cope with higher interest rates. The Fed is not using monetary policy to restrain US economic growth at this point for the simple reason that it has no cause to do so because higher inflation is not a significant threat. While CPI inflation has lifted to 2.5% y-o-y in October, most of the Fed’s preferred measures on inflation remain below 2%. While wages are rising faster, labour productivity in the US is strong too helping to place a lid on US inflation. At this stage, the Fed is likely to hike the Funds rate to 2.25 to 2.50% range at its mid-December policy meeting it also has cause to herald a slower pace of rate hikes in 2019.
In China, GDP growth slipped to 6.5% y-o-y in Q3 from 6.7% in Q2. The latest monthly readings for October point to growth still tracking close to 6.5% in Q4. The trade war with the US will hit China’s growth rate eventually but in the near-term the pulling forward of exports to escape higher US tariffs is driving faster growth. Exports accelerated to 15.6% y-o-y in October from 14.5% in September, while imports lifted to 21.4% y-o-y from 14.3% in September. The main domestic spending and production data in October were mixed-strength. Fixed asset investment spending improved to 5.7% y-o-y in October from 5.4% in September and industrial production improved too lifting to 5.9% y-o-y from 5.8% in September. In contrast, retail sales growth slipped to 8.6% y-o-y from 9.2% in September. the style of rebalancing in drivers of economic growth that the authorities want to see occur. China is developing spending initiatives that are likely to boost fixed asset investment spending but these alone are unlikely to prove sufficient to fill the void as export trade weakens. Much will depend on whether retail sales can be boosted and the early signs are not encouraging. At this stage, China’s GDP growth rate looks set to fade to 6% in 2019 barring an unexpected reduction in hostilities in its trade war with the US.
In Europe, annual GDP growth weakened to 1.7% y-o-y in Q3 from 2.2% in Q2. The quarter-on-quarter growth was only 0.2% and while most European countries recorded positive growth in the quarter one of the two exceptions was Germany -0.2% q-o-q a result driven by weak consumer spending. The soft European growth result in Q3 is expected to be temporary. Europe’s labour market continues to tighten with the unemployment rate at a post global financial crisis low point in September of 8.1%. Wages are starting to lift in some countries too. The ECB in the minutes of its latest policy meeting views slower growth as temporary and sees some inflation pressure building in Europe. The ECB is sticking with its plan to end quantitative easing at the end of December and is still looking to start hiking interest rates in the second half of 2019.
In Australia, economic growth lifted pace quite sharply in the first half of 2018, notwithstanding comparatively soft activity in the housing sector. GDP rose by 0.9% q-o-q in Q2 after an upwardly revised 1.1% gain in Q1. At this stage Q3 GDP (due for release early in December) is tracking around a 0.8% q-o-q gain which would lift annual GDP growth to 3.5% y-o-y from 3.4% in Q2. At the heart of Australia’s improving growth story is the strength of the labour market. The unemployment rate fell to a six-year low point of 5.0% in September and October. In New South Wales and Victoria, the unemployment rates are down to 10-year low points of respectively 4.4% and 4.5%. While wages growth is still rising only slowly (up to 2.3% y-o-y in Q3 from 2.1% in Q2), pockets of more rapid wages growth are developing and are likely to spread. Strong labour market conditions are encouraging the household sector to spend even in the face of weak housing and high household debt.
The export sector is another area of strength in the economy assisted by relatively fast rising export prices and a comparatively soft Australian dollar exchange rate. Australia recorded a record $A3 billion trade surplus in September. Business investment spending is also improving slowly. Rising government spending is providing strong contribution to growth too.
Housing activity continues to weaken and will detract from GDP growth over the next year at least. House prices have further to fall in Australia’s two biggest cities, Melbourne and Sydney, but the price falls are starting to improve housing affordability and are setting the groundwork for an owner-occupier led lift in housing demand starting potentially in 2020.
The RBA upgraded forecasts of GDP growth and inflation in the November quarterly Monetary Policy Statement but is keeping its cash rate at the emergency low 1.50% rate established more than two years ago when Australian economic growth and inflation were much lower than they are currently. We expect the RBA to upgrade again its growth and inflation forecasts in the next quarterly Monetary Policy Statement in February 2019, a prelude to a first cash rate hike in the first half of 2019.