Something's got to give... Something's got to give... Something's got to give...

Something's got to give...

Macro
Strats-Eleanor-88x88
Eleanor Creagh

Australian Market Strategist

Summary:  The latest RBA targets contain little margin for error, with ongoing housing market difficulties, the slowdown in China, and a global growth slowdown all acting as severe headwinds.


The latest comments from the Reserve Bank of Australia reveal a stubborn optimism and imply an insistence that the next move in the cash rate is likely to be higher. But financial markets are not buying the RBA’s stoic narrative and are pricing in a greater than 50% chance of a rate cut in 2019.

According to the RBA’s November Statement of Monetary Policy, 2019 should bring a strengthening labour market with declining unemployment and GDP growth north of 3%, thus pushing inflation into its target range of 2-3%.
RBA Economic Outlook, November Statement of Monetary Policy
RBA Economic Outlook, November Statement of Monetary Policy (source: RBA)
For these targets to be met, a lot must go right and there is little margin for error. However, there are plenty of reasons for the market to be sceptical of the RBA’s forecasts. Declines in property prices continue to gain momentum as credit conditions have tightened and we see no reason for price falls to abate in 2019. In fact looking at leading indicators like auction clearance rates and housing finance the declines could be set to accelerate this year as the psychology of price momentum which fed expectations of future gains does a complete 180.

The housing market will continue to slide with Sydney and Melbourne seeing accelerated falls. Sydney property prices are already down 12% from their July 2017 peak and with banks' continued credit constriction and the economy decelerating, these falls are likely to intensify.

In the year ahead, we could see another 15% of declines, We are seeing 12% falls in Sydney house prices while unemployment is holding up; once the economic slowdown becomes more evident and unemployment rises, confidence will fall further and prices could overshoot to the downside. 
Housing prices
This coupled with the slowdown in China and global deceleration in economic growth presents downside risks to the Australian economy in 2019. The multiplier effects of house price declines on the economy are yet to be felt, and as declines continue they will intensify. The housing slowdown will feed back to the real economy through the negative wealth effect and weigh on overleveraged households’ consumption.

With the current savings ratio near decade lows, consumers will no longer be able to hold up spending habits as asset prices continue to fall. There were glimmers of this dynamic in the Q3 2018 GDP report where household spending growth slowed from 0.9% in Q2 to 0.3% in Q3, contributing to overall GDP growth slowing to 2.8% annually. Without a pickup in growth in Q4 2018 of over 1% (highly unlikely), the existing RBA Q4 2018 forecast of 3.25% will not be met

The grim news doesn’t stop there. According to Moody’s, delinquencies for Australian auto loan asset-backed securities have surpassed financial crisis levels, reflecting the current challenging environment. Adding to the picture of consumer weakness is a 9% drop in motorcycle sales in 2018  and 3% decline in new car sales in 2018, with a 15% decline in December compared to the same month a year earlier. The largest declines were seen in NSW and Victoria which corresponds with the epicentre of property market declines. 
Australian Delinquencies (Autos ABS)
Dwelling construction is also slowing and as consumption drops off it is likely business investment also takes a hit, further weighing on GDP growth this year. The NAB business conditions survey results earlier this week further confirmed the deteriorating outlook and loss of momentum in the domestic economy, with conditions slumping the most since the 2008 crisis. Poor business sentiment was coupled with declining capex intentions which dropped to +7 in December from +15. Capital expenditures are an important forward-looking leading indicator and if this decline is sustained, it signals lower potential growth is just around the corner. 

So where does the RBA garner so much optimism? Employment remains a bright spot, and the RBA is banking on a strong labour market supporting income growth to offset the negative wealth effect. The unemployment rate fell to 5% in December and is now sitting at cycle lows. The decent rise in employment in December shows that the housing downturn isn’t having a major impact on the labour market yet. But it must be remembered unemployment is one of the most popular lagging indicators, so the data only give us a rear mirror view on the health of the labour market.

Something's got to give... the dichotomy between the labour market and economic environment will not persist. In 2019, economic growth will rebound or the labour market will deteriorate, and our bet is on the latter. Annual jobs growth has slowed from 3.5% at the start of last year to just 2.2% in December and it will weaken further as the housing downturn weighs. ANZ job advertisements have fallen steadily since early last year along with other leading indicators. As the housing market slide continues it is only a matter of time before building and construction jobs lessen in NSW and Victoria where house price declines have been centred. With this backdrop in mind expect the unemployment rate to edge higher as economic activity decelerates.

The economic outlook is clearly deteriorating, and the housing downturn will continue to weigh on the economy throughout 2019. The RBA will have to strike a more cautious tone on the outlook for the Australian economy in its February meeting. At the very least, we should recognise the downside risks and uncertainties looming for both the global and domestic economies.

We expect the RBA to lower its forecast for GDP growth in 2019 from 3.5% to 3.0% when the SoMP is released in February. Although while employment remains at a cycle low, the central bank is unlikely to fully capitulate on policy guidance in February, given the optimism that has prevailed for so long. 
 

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.