Most leading economic indicators and rising central banks’ official interest rates point towards global recession, but the latest still firm household spending and labour market data in the US, Europe and Australia are still showing resilience. Annual inflation readings showed more signs of topping out in November in the US and Europe while Australia seems to be closing in on peak annual inflation. Central banks are starting to talk about hiking official interest rates in smaller increments although most still announced large hikes in November. The path still looks a long one towards returning annual inflation to central banks’ targets indicating that once official interest rates peak, the stay at the peak may be longer than it has been in the past – around three months on average for the US.
In the US, leading economic indicators weakened further in November. Housing indicators were weak mostly. The November National Association of Homebuilders’ index fell to a cycle low 33 from 38 in October, a far cry from the 70+ readings a year ago. October building permits, housing starts and existing home sales fell respectively m-o-m by 2.4%; 4.2%; and 5.9%. Exceptions to the weakness in the housing figures were September pending home sales, up 0.8% m-o-m and October new home sales, up 7.5%.
The October ISM purchasing managers’ reports for the manufacturing and non-manufacturing sectors slipped to respectively 50.2 (September 50.9) and 54.4 (September 56.7). The November readings out in early December are likely to see at least one slip below the 50 expansion/contraction line, although readings in the low-to-mid 40s in the past have been harbingers of recession.
Coincident and lagging US economic indicators remained firm in November. Revised Q3 GDP growth was unchanged from the first reading and was up 2.6% annualized. September personal income, up 0.4% m-o-m, and spending, up 0.6%, were both firm as too were October retail sales, up 1.3% m-o-m. The US labour market remained tight in October, notwithstanding a lift in the unemployment rate to 3.7% from 3.5% in September. Non-farm payroll growth was stronger than expected, up 261,000 in October, while average hourly earnings rose by 0.4% m-o-m, 4.7% y-o-y.
The Federal Reserve needs the US unemployment rate to rise above 4% to allow annual growth in average hourly earnings to settle back to 3.5% y-o-y to be confident that annual inflation will fall back towards 2% y-o-y over the next few years. While the October CPI reading was lower than expected at +0.4% m-o-m, +7.7% y-o-y there is no hope of annual inflation receding to 2% over coming years without weaker labour market conditions. The Fed remains in the tricky position of goading weaker economic conditions with higher interest rates while trying to avoid recession, a combination rarely achieved in the past. At this stage, the Fed still needs to deliver several more rate hikes and it is unlikely that the peak Funds Rate will be below 5%.
In China, economic data released in November remained weak beset by the continuing downturn in the property, the lockdowns used to control Omicron outbreaks and softening global demand for China’s exports. October exports, -0.3% y-o-y, and imports, -0.7% y-o-y were both weaker than expected. October fixed asset investment spending moderated to +5.8% y-o-y from +5.9% in September and October industrial production to +5.2% y-o-y from +6.3% y-o-y in September. The greatest damage from sporadic and unpredictable covid-containment lockdowns showed in retail sales, -0.5% y-o-y in October from +2.5% y-o-y in September. Rare signs of opposition to President Xi and his policies showed in civil protests in some cities. China’s economic growth rate will continue to languish while current lockdown policies persist. An ill wind on the economic growth front is delivering inflation that is very low by international standards. China’s annual CPI inflation rate fell to 2.1% y-o-y in October from 2.8% in September while producer price inflation fell below zero to -1.3% y-o-y from +0.9% y-o-y in September.
Europe continues to teeter on the edge of recession, but is not quite there yet. A milder than usual autumn so far in Western Europe is providing hope that energy supply shortages and price hikes may not be as great as widely feared in the approaching winter. European Q3 GDP growth lifted 0.2% q-o-q, 2.1% y-o-y. Leading European economic indicators point towards recession with the November manufacturing and service sectors PMIs at respectively, 47.3 and 48.6. September retail sales rose 0.3% m-o-m and the unemployment rate is still hugging the cycle low point at 6.6%. CPI inflation at 10.6% y-o-y in October was probably at its peak for this cycle but is unlikely to recede fast given that producer prices are up over 40% y-o-y. The ECB is indicating that fighting high inflation is the key policy aim, even at the risk of adding to the risk of recession. In the UK, where economic growth has turned negative, the Bank of England has no choice but to continue hiking interest rates to contain double-digit annual inflation.
Australia is an example of the split between soft leading economic indicators and surprisingly strong coincident and lagging indicators threatening to keep inflation too high for too long. Housing activity at the leading edge continued to weaken in November under pressure from higher borrowing interest rates. House prices are falling at the fastest pace in 40 years. In September, the value of housing finance commitments was down by 8.2% m-o-m and down by 18.5% y-o-y. September home building approvals were down by 5.8% m-o-m and were down by 13.0% y-o-y. As more fixed-rate home loans written in 2020 and 2021 come up for renewal over coming months and the RBA hikes the cash rate at least two more times, housing activity looks set to weaken further.
There is little sign yet of the weakness in housing feeding through to softer retail spending. The opposite is true with retail sales up 0.6% m-o-m in both August and September. While much of Australia’s high inflation problem is supply-shock driven, overly-strong demand is making a contribution too. At this stage, the Q3 GDP report due next week, is likely to show at least 0.5% q-o-q real GDP growth with domestic demand the main support and running closer to 1.0% q-o-q. q.
Australian labour market conditions remain strong. Employment rose 32,200 in October (over the year ending October employment is up 762,000 or 5.9% y-o-y!). The unemployment rate fell to 3.4% in October, the lowest reading since 1974. The Q3 wage price index rose a little more than expected and was up 1.0% q-o-q lifting annual wage growth to 3.1% y-o-y from 2.6% in Q2. We see a high probability that annual wage growth will accelerate above 3.5% y-o-y, the pace the RBA sees as consistent with returning inflation to 2-3% target range, by mid-2023.
Readings released in November of demand in the Australian economy and the strength of the labour market have all been a touch higher than would be consistent the latest RBA economic forecasts released in the RBA’s Monetary Policy Statement early in the month. Those forecasts were sufficient for the RBA to herald that further rate hikes would be needed over coming months. Although the RBA has managed to go against the grain of big rate hikes still being delivered overseas by hiking 25bps in both October and November, Australian data reports covering strength of demand in the economy and labour market strength point at the very least to the need to continue hiking rates. At this stage, we are penciling in another 25bps rate hike to 3.10% next week and a further 25bps hike to 3.35% at the first RBA policy meeting of 2023 in early February. The risk is that more rate hikes may be needed beyond February.