News

Summary: Melbourne Institute inflation index plummets; annual rate just north of zero; bond yields, cash rates rise anyway.

Despite the RBA’s desire for a higher inflation rate, ostensibly to combat recessions, attempts to accelerate inflation through record-low interest rates have failed to date. In the current environment, the RBA would be satisfied just to avoid deflation. The RBA’s stated objective is to achieve an inflation rate of between 2% and 3%, “on average, over time.” Since the GFC, Australia’s inflation rate has been trending lower and lower and it has been below the RBA’s target band for some years now.

The Melbourne Institute’s latest Inflation Gauge index dropped by 1.2% through May. The large fall follows a 0.1% decline in April and a 0.2% increase in March. On an annual basis, the index increased by just 0.1%, a big fall from April’s comparable rate of 1.2%.Commonwealth Government bond yields moved modestly higher, ignoring lower US Treasury yields in overnight trading. By the end of the day, the 3-year ACGB yield remained unchanged at 0.27%, the 10-year yield had crept up 1bp to 0.89% while the 20-year yield finished 3bps higher at 1.52%.

In the cash futures market, expectations of a rate cut softened a touch. By the end of the day, July contracts implied a rate cut down to zero as a 54% chance, down from the previous day’s 57%. August contracts implied a 48% chance of such a move in that month, unchanged from the previous day. Contract prices of months in the remainder of 2020 and through to late-2021 implied probabilities ranging between 33% and 52%.

Summary: No growth in private sector credit in April; business lending stalls; owner-occupier lending maintained; investor lending goes backwards faster; negative lending growth expected in 2021/22.

The pace of lending to the non-bank private sector by financial institutions in Australia has been trending down since October 2015. Private sector credit growth appeared to have stabilised in the September quarter of 2018 but the annual growth rate then continued to deteriorate through to the end of 2019. The early months of 2020 provided some positive signs but the most recent numbers do not look promising.

According to the latest RBA figures, private sector credit growth was zero in April. The result was well below the +0.6% increase which had been expected and considerably below March’s +1.1% increase. The annual growth rate slipped from March’s revised annual rate of 3.7% to 3.6%.

The flat result came about from a reduction in personal debt and investor housing loans in conjunction with a steady rise in owner-occupier loans. Business lending barely rose over the month.

After the March figures were released a month ago, ANZ economist Hayden Dimes had noted the increase had been driven by a jump in business credit which had not been that large since 1988. This month, business credit growth also played a significant role, just not in the same direction. “Credit growth slowed sharply in April as business credit growth came off. This sharp reversion in business credit growth likely means the precautionary shoring up of balance sheets seen in February and March is over.”

Local Treasury bonds yields moved modestly higher, just as US Treasury yields had in overnight trading. By the end of the Australian trading day, the 3-year Treasury bond yield remained unchanged at 0.27%, the 10-year yield had ticked up 1bp to 0.88% and the 20-year yield finished 2bps higher at 1.49%.

In the cash futures market, expectations of a rate cut softened. At the close of business, June contracts implied a rate cut down to zero as a 47% chance, down from the previous day’s 49%. July contracts implied a 57% chance of such a move, down from 59%. Contract prices of months in the remainder of 2020 and through to mid-2021 implied similar probabilities, ranging between 35% and 48%.

The traditional driver of loan growth rates, the owner-occupier segment, grew by 0.5% over the month, the same rate as in April. The sector’s 12-month growth rate ticked up to 5.3% in April from March’s rate of 5.2%.

Summary: Eurozone composite sentiment index improves slightly; manufacturers remain pessimistic about demand; not all major economies’ indices improve; implies GDP smaller contraction.

The European Commission’s Economic Sentiment Indicator (ESI) is a composite index comprised of five differently-weighted sectoral confidence indicators.  It is heavily weighted towards confidence surveys from the business sector; the consumer confidence sub-index only accounts for 20% of the ESI. However, it has a good relationship with euro-area GDP, although not as a leading indicator.

The ESI recorded a reading of 67.5 in May, below the market’s expected figure of 72.5 but up a little from April’s revised reading of 64.9. The average reading since 1985 has been just under 98.

Overall sentiment in the euro-zone improved as three of the five confidence sub-indices showed gains. The Industry, Consumer and Retail sub-indices increased while the Services and Construction sub-indices deteriorated. On a geographical basis, the ESI rose in Germany and Spain but slipped in France.

“The improvement in industry confidence was led by improved production expectations,” said ANZ economist Kishti Sen. However, he noted “manufacturers remain pessimistic about demand…”

German and French bond yields either remained stable or finished lower, despite the improved figures and new plans by the European Commission for a €750 billion recovery fund. By the end of the day, the German 10-year bund yield remained unchanged at -0.42% while the French 10-year OAT yield had lost 4bps to -0.06%.

Summary: Private capital expenditures down but better than expected; weakest since 2009; investment cuts on par with early-1990s recession.

Australia’s capital expenditure (capex) slump was thought to be coming to an end as investment in the mining sector reverted back to its long-term mean after a spike early in the decade. Total investment had begun to grow again, driven by investment in the services sector. However, contractions in recent quarters have become the norm.

According to the latest ABS figures, seasonally-adjusted private sector capex in the March quarter fell by 1.6%. This latest figure was well above the 2.8% contraction which had been expected and also above the December quarter’s revised rate of -2.6%. However, on a year-on-year basis, total capex still contracted by 6.1% after recording an annual rate of -5.9% in the previous quarter.

ANZ senior economist Catherine Birch said, “This was a smaller fall than expected, with rises in mining and manufacturing capex offsetting a decline in other industries.”

There was little reaction to the report in the Commonwealth Government bond market. By the end of the Australian trading day, the 3-year Treasury bond yield had ticked up 1bp to 0.27%, the 10-year yield remained unchanged at 0.87% while the 20-year yield slipped 1bp to 1.47%.

Prices of cash futures contracts moved to reflect a slight softening of rate-cut expectations but only among 2021 contracts. By the end of the day, June contracts implied a rate cut down to zero as a 49% chance, unchanged from the previous day. July contracts implied a 59% chance of such a move, also unchanged. Contract prices of months later in 2020 and through to mid-2021 implied probabilities ranging between 41% and 53%.

Summary: Construction spending contracts at slower pace in March quarter; non-residential building flat; residential and engineering spending falls smaller than in December quarter; March quarter GDP growth likely to be negative.

Construction expenditure increased substantially in Australia in the early part of last decade following a more-steady expansion through the 2000s. A large portion of the increase came from the commissioning of new liquid natural gas projects and the expansion of existing mining projects to exploit a tripling in price of Australia’s mining exports in the previous decade. The return to “normal” investment levels is still continuing.

According to the latest construction figures published by the ABS, total construction in the March quarter fell by 1.0%. The decline is slightly smaller than the 1.5% contraction which had been expected and it was an improvement on the previous quarter’s -2.9% after revisions. On an annual basis, the growth rate slightly improved from December’s revised figure of -6.6% to -6.5%.

Westpac senior economist Andrew Hanlan said “the mix of construction activity was a little different than expected, with public works a downside surprise, revealing that activity eased back following a robust rebound over the second half of 2019.”Commonwealth Government bond yields finished the day a touch lower, ignoring higher US Treasury yields in overnight trading. By the end of the day, 3-year, 10-year and 20-year ACGB yields had each slipped 1bp to 0.26%, 0.87% and 1.48% respectively.

Prices of cash futures contracts moved to reflect a slight hardening of rate-cut expectations. By the end of the day, June contracts implied a rate cut down to zero as a 49% chance, up from the previous day’s 47%. July contracts implied a 59% chance of such a move, unchanged from the previous day. Contract prices of months later in 2020 and through to mid-2021 implied probabilities ranging between 41% and 53%.

Summary: US consumer confidence stable; present conditions slip further; bond yields increase despite firmer expectations of Fed cut; uneven recovery path, potential second wave to maintain consumer uncertainty.

US consumer confidence collapsed in late 2007 as the US housing bubble burst and the US economy went into recession. By 2016, it had clawed its way back to neutral and then went from strength to strength until late 2018. Measures of consumer confidence then oscillated within a fairly narrow band at historically high levels until they collapsed again through March and April.

The latest Conference Board survey held during the first half of May indicates US consumer confidence has stabilised at a below-average level after it nosedived in April. May’s Consumer Confidence Index registered 86.6, broadly in line with the median consensus figure of 87 and just above April’s final figure of 85.7. Compared to consumers’ views held at the time of the April survey, their views of present conditions slipped a little while their views of future conditions improved modestly.

Lynn Franco, a senior director at the Conference Board said, “Short-term expectations moderately increased as the gradual re-opening of the economy helped improve consumers’ spirits.”

Longer-term US Treasury bond yields increased as a “risk on” attitude was taken. By the end of the day, the yield on 2-year Treasury bonds was unchanged at 0.17% while the 10-year yield had gained 4bps to 0.70% and the 30-year yield had increased by 7bps to 1.44%.

However, in terms of US Fed policy, expectations of a reduction in the federal funds rate over the next 12 months firmed somewhat. OIS contracts from April 2021 onwards implied a zero effective federal funds rate whereas they had implied a zero rate in September 2021 at the end of the previous day.

Summary: ifo business climate index bounces; expectations index back to March level; “many German companies” still pessimistic

As with other surveys which produce an index, the ifo Institute’s business climate index is a composite index which combines German companies’ views of current conditions with their outlook for the next six months. It has similarities to consumer sentiment indices in the US and the business surveys in the EU.

According to the latest figures released by ifo, its business climate index bounced to 79.5 in May. The reading was just above the expected reading of 78.3 and 5.3 points above April’s final reading of 74.2. The average reading since January 2005 is just above 97.

Its expectations index rebounded back to just above March’s reading. It increased from April’s final figure of 69.4 to 80.1 in May, above the expected figure of 75.0.

Following a recession in 2009/2010, the indices largely ignored the European debt-crisis of 2010-2012 which flowed from it, remaining at average to elevated levels through to early-2020. Their relationship with each other and to euro-zone GDP growth is shown below.

French and German 10-year bond yields both added a few basis points over the day. By the close of business, yields on 10-year German bunds and French OATs had both gained 3bps to -0.45% and -0.01% respectively.

Clemens Fuest, President of the ifo Institute, described sentiment at German companies as having “recovered somewhat” even as conditions had deteriorated further in May. However, he noted the latest expectations reading still implies “many companies are still pessimistic”, although he added “the gradual easing of the lockdown offers a glimmer of hope.”

Summary: US leading index falls markedly again; fall less than previous change; suggests US in recession; points to tough June & September quarters.

The Conference Board Leading Economic Index (LEI) is a composite index composed of ten sub-indices which are thought to be sensitive to changes in the US economy. The Conference Board describes it as an index which attempts to signal growth peaks and troughs; turning points in the index have historically occurred prior to changes in aggregate economic activity. The reading from March signalled “a deep US recession”; April’s reading has continued in that vein.

The latest reading of the LEI indicates it fell by 4.4% in April. The result was better than the 5.7% fall which had been expected and not as bad as March’s revised figure of -7.4% after it was revised down from -6.7%. On an annual basis, the LEI growth rate slowed from March’s revised figure of -7.5% to -11.7% in April.

“The sharp declines in the LEI and CEI suggest that the US economy is now in recession territory,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. CEI refers to The Conference Board’s Coincident Economic Index which is a measure of current conditions.

Changes over time can be large but once they are standardised, a clearer relationship with GDP emerges. The latest reading implies a year-on-year growth rate of -2.3% at the beginning of the December 2020 quarter.

Summary: Households slightly less pessimistic in May; still well below long-term average; euro-zone bond yields slightly lower

EU consumer confidence plunged during the GFC and again in 2011/12 during the European debt crisis. Since early 2014, it has been at average or above-average levels, rising to a cyclical peak at the beginning of 2018.  Even after it dropped back significantly in late 2018, the index remained at a level which corresponds to significant optimism among households until a substantial drop took place in April 2020. The latest reading indicates households have become slightly less pessimistic.

The May survey conducted by the European Commission indicated household confidence has made a small recovery, albeit to still-depressed level. The EC’s Consumer Confidence index recorded a figure of -18.8, just above the -19.0 which had been expected and a small gain from April’s final figure of -22.0. The average reading since the beginning of 1985 has been -11.6.

The report had little effect on major European bond markets. At the end of the day, yields on German 10-year bunds remained unchanged at -0.49% while French 10-year OATs had shed 2bps to -0.04%.

Summary:  Leading index fall worse than March drop; implies GDP growth to fall to ~-2.5% later this year; index growth rate likely to recover as restrictions removed.

Westpac and the Melbourne Institute describe their Leading Index as a composite measure which attempts to estimate the likely pace of Australian economic activity over the next three to six months. After reaching a peak in early 2018, the index trended lower through 2018, 2019 and the early months of 2020. A sharp drop came as expected in March as various sectors of the economy were mothballed and restrictions on individuals’ movements came into force. Westpac’s chief economist hinted at that time April’s reading would probably be worse.

The latest reading of the six month annualised growth rate of the indicator has fallen from March’s revised figure of –2.34% to -5.16% in April. After a brief improvement at the end of 2019, the index deteriorated in both January and February before a (smaller) plunge in March.

Westpac chief economist Bill Evans said, “The signal points to a broad-based economic contraction.” He noted it was “the weakest reading since the GFC” and comparable to readings seen prior to all previous recessions going back to 1960. What’s more, he said the speed of the index’s fall was “unprecedented”.

Index figures represent rates relative to trend-GDP growth, which is generally thought to be around 2.75% per annum. The index is said to lead GDP by three to six months, so theoretically the current reading represents an annualised GDP growth rate of around -2.50% sometime in the second or third quarters of 2020.

Long-term Commonwealth Government bond yields finished lower, largely in line with falls in US markets overnight, while the 3 year yield remained just above the RBA’s 0.25% target rate. By the end of the day, the 3-year ACGB yield remained unchanged at 0.26% but the 10-year yield had lost 3bps to 0.94% and the 20-year yield finished 4bp lower at 1.53%.