Financial markets turned very gloomy about global and local economic growth prospects in the last couple of months of 2018. Markets focused much more on the factors that might tip key economies such as the US and China either in to recession or on to a much slower growth path. The Australian economy was expected to suffer a growth set-back, possibly even recession, with home-grown growth crimping factors such as a heavily debt-burdened household sector facing a worsening housing market adding to the negative impact of weaker growth in its key international trading partners. These concerns flourished despite evidence in economic data that growth continued to hold up reasonably well and momentum alone would ensure that any major pull-back in economic activity was unlikely in the near-term.
As 2018 turned to 2019 financial market concerns about potentially weaker economic growth prospects remain but they appear to have moderated a touch. Two major concerns prominent in late 2018 were the risk of policy error by the US Federal Reserve (Fed) pushing interest rates too high and the risk that the escalating tariff trade war between the US and China would lower growth in both countries and elsewhere.
In terms of a possible policy error by the Fed pushing interest too high the Fed seems to be shifting its guidance to the markets from a singular need to respond to a US economy growing strongly enough to generate increasing inflation pressure to a need to monitor not just the economic numbers but also the messages from movements in financial markets. The change in Fed guidance implies that the near mechanical one-a-quarter 25bps hikes in the funds rate through 2018 may become noticeably fewer hikes in 2019 and possibly a lengthy pause before the next Fed rate move.
The risk of the Fed making a policy mistake and pushing the Funds rate up to a point that promotes much weaker US economic growth is less pronounced than it was late in 2018.
In terms of the escalating US-China trade war risk to global economic growth the news has taken a more hopeful turn over the past month or so. The move in December by the US Administration to extend the 1st January deadline by three months before imposing higher tariffs on a range of imports from China has allowed talks to start on a possible trade deal. The talks could still fail, but the current position is an improvement compared with where matters stood late last year – a long and escalating trade war with no end in sight.
What are still quite modest and tentative easing of concerns about Fed policy and the trade war have been reinforced by more evidence that key economies continue to grow quite strongly and encouragingly with very little sign of inflation pressure that might force major central banks to reduce the large pool of liquidity helping to keep the global economy afloat.
In the US, the labour market remains very strong with non-farm payrolls up 312,000 in December. Average hourly earnings in December were up 3.2% y-o-y, a decade high and leaving the household sector in a strong position to keep spending freely. At this stage, the US Q4 GDP report due later in January is likely to show annualised growth at 3% or more and well-supported by consumer spending.
In China, key December economic readings as well as Q4 GDP are due this week. Any set-back to growth is expected to be minor – consensus forecast 6.4% y-o-y from 6.5% in Q3 2018. Lower inflation in China with the December CPI coming in at 1.9% y-o-y from 2.2% y-o-y in November and producer prices fading more quickly to 0.9% y-o-y in December from 2.7% y-o-y in November provide the Peoples’ Bank of China with flexibility to go even further than the significant monetary policy easing it announced a week ago – two 50bps cuts, one on the 15th January and another on 25th January, to the Reserve Ratio Requirements for large banks. Policy easing initiatives raise the possibility (one unrecognized at this stage by financial markets) that China’s economic growth rate could lift later in 2019.
In Australia too, the economic news early in 2019 has been positive for the most part. Job vacancies rose another 1.3% q-o-q in Q4 to 241,600 a record high and up 13.9% compared with Q4 2017. The very high level of job vacancies provides good reason to expect more strong monthly employment figures over coming months in turn providing strong support for household spending. Based on October retail sales, +0.3% m-o-m, and November retail sales released last week and up 0.4% m-o-m, household spending probably rose strongly in Q4.
The weak spot in the Australian growth story remains housing. Lower house prices are starting to cut the supply of new homes. The number of new home building approvals fell by 9.1% m-o-m in November to 15,465, down 32.8% compared with November 2017 and the lowest monthly reading in more than six years. On these latest numbers new housing supply is falling below the number required to meet the demand from Australia’s rising population. In short, while the downturn in new home building activity is bad news for growth in the near-term it also sets in train conditions that will help promote a bottoming out of house prices over the next year or so. There are some tentative signs the bottoming out of house prices could occur even sooner. The number of housing finance commitments rose by 2.2% in October a first sign perhaps of better conditions ahead.
Whether it is a lessening of feared threats to global economic growth or continuing evidence that most economies are still growing relatively well, financial markets have reason to be less gloomy early in 2019