Asia Shows its Strength as US Growth Prospects Dwindle

In Australia, the RBA was the focus of market participants’ attention. Outside the country, the RBNZ reaffirmed its hawkish resolve, while U.S. data weakened noticeably.

The RBA decided to leave the key interest rate unchanged at 3.60% in April, a decision that was in line with Westpac’s forecast. In line with the decision, the Governor’s statement included a subtle change to the guidance, indicating that further tightening “may be required” in March, rather than “will be required.” While this certainly still qualifies as a tightening bias, after 350 rate hikes in the past decade, the central bank board is increasingly concerned about the need to assess the full spectrum of risk.

In our view, the evolution of underlying inflationary pressures is critical to the near-term stance of monetary policy. Westpac projects that inflation will average 6.6% for the year in the first quarter, an outcome that the RBA is likely to find uncomfortably high against the backdrop of a historically tight labour market, thus warranting a policy response. As a result, we continue to expect a final 25 basis point rate hike in May, taking the policy rate to a peak of 3.85%, where we believe it will remain until the end of 2023. If economic momentum continues to slow and inflation risks subside, a series of rate cuts may be implemented in 2024 and 2025 to bring policy back toward neutrality and facilitate a recovery in economic growth.

Turning to domestic data, housing market data released this week was generally mixed. Most notably, the CoreLogic home value index seems to point to some stabilization in home prices, which rose 0.8% in March after falling only 0.1% in February. The pace of monthly declines in residential mortgage approvals continued to moderate in February; however, broadly speaking, this indicator continues to point to a further significant slowdown in residential loan growth as interest rate headwinds increase. Meanwhile, monthly housing permit updates remain hostage to their own seasonality: following the extreme volatility in high-rise permits and now emerging issues related to processing delays, February’s modest 4.0% increase appears to mask a fundamental slowdown in the trend, as evidenced by the 30% decline in permits over the past year. All in all, we maintain our view that increasing headwinds, particularly with regard to interest rates and the general economic outlook, will continue to weigh heavily on the housing sector this year, but we are wary of the possibility of a sustained stabilization.

The decision by the Reserve Bank of New Zealand (RBNZ) to raise interest rates by 50 basis points this week surprised the market, as the consensus was 25 basis points. The tone of the statement was also aggressive, as the RBNZ is concerned about the potential impact of post-cyclone reconstruction on inflation given the already strained state of the economy. As our New Zealand team, led by Chief Economist Kelly Eckhold, explained, the RBNZ appears to be focused on quickly achieving the absolute level of policy it believes is needed to bring inflation back to target. The RBNZ also indicated that the recent

decline in wholesale funding costs could lower borrowing costs across the economy; the 50 basis point move was then seen as a way to “maintain current lending rates for businesses and households.” This situation highlights the tension that is building between monetary policy in New Zealand and the rest of the developed world, where policy is seen at or near peak levels. Our New Zealand economics team now anticipates a 25 basis point hike to 5.50% in May and expects the RBNZ to maintain a tighter stance thereafter, pending further information.

As for the U.S., three data releases stood out this week: the ISM and JOLT labour market data.

Both the ISM manufacturing PMI and the ISM services PMI surprised sharply to the downside in March, with the manufacturing contraction accelerating (the overall index was 46.3) and the services index nearly stalling at 51.2. It is also significant that new orders in manufacturing were particularly weak (the index fell to 44.3), while new orders in services fell sharply (the orders index fell 10 points to 52.2).

These results point not only to continued economic weakness, but also to clear risks related to employment, which is expected to decline in the manufacturing sector and to be only marginally positive in the services sector. A sharp drop in JOLTS job openings in February was further evidence of the building downside risks to employment. The number of available jobs fell to 9,931k in February, down from 10,563k in January and the 2022 peak of 12,027k. While highly volatile and often off the mark as a lead for nonfarm payrolls (due Friday night), ADP private payrolls was also soft in March.

We have long highlighted the risks for the US economy from tighter policy and the shock to household finances from high inflation. These concerns led us to remain of the view that the US is likely to experience a lengthy period of stagnation, with an output gap in the order of 3.0% by end-2024. As discussed last week, given recent developments in the US banking sector, the risks to this view are skewing to the downside. Most significant is the potential for US GDP growth to get stuck at a rate below potential beyond 2024. This is why we see need for the FOMC to act aggressively on policy in 2024, once inflation risks have abated; but also why it is necessary banking sector regulatory reform occur with haste to restore confidence amongst both borrowers and lenders. If the latter is delayed, the benefit of 2024’s monetary easing could be offset.