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WE were running with a dual-track market last week.
Initially, a procession of Fed officials made some ground in convincing the market that the chances of significant rate cuts in the back end of 2023 was a pretty unlikely scenario.
At the same time there seemed to be some bipartisan movement with regard to agreement on lifting the debt ceiling.
Then on Friday Fed Chair Powell raised the possibility of a June pause in rate hikes — and the Republican negotiators walked from discussions over the debt ceiling.
Overall last week, bonds were down, equities gained and commodities held up.
US ten-year government bond yields rose 21bps to 3.68%. The S&P 500 was up 1.71% and the S&P/ASX 300 rose 0.47%.
US reporting season has produced a much better outcome than anticipated seven weeks ago while Australia also saw a couple of good results to round out the mini reporting season.
US Fed speak
There were mixed messages from Fed members over the course of last week.
On Friday Fed Chair Jay Powell had the final word.
He took a dovish tone, flagging that rates may not need to rise as much as previously thought, given the potential effect from a slowdown in bank lending.
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“Developments there, on the other hand, are contributing to tighter credit conditions and are likely to weigh on economic growth, hiring and inflation,” he said.
“Until very recently, it has been clear that further policy firming would be required. As policy has become more restrictive, the risks of doing too much versus doing too little are becoming more balanced” and “given how far we have come, we can look at the data and evolving outlook and make careful assessments.”
May’s RBA Board meeting minutes showed that they considered hiking by 25bp or leaving rates on hold.
The decision to hike, though ‘finely balanced,’ was based on data confirming that the labour market remained tight and a hike was needed to guard against upside risks to the outlook for inflation.
Looking forward, members “agreed that further increases in interest rates may still be required, but that this would depend on how the economy and inflation evolve”.
Labour and wages data
The surprising strength in February and March’s employment data reversed in April.
The unemployment rate rose from 3.5% to 3.7% and 4,300 jobs were lost, rather than an additional 25,000 created as per consensus expectations.
The three and six month moving averages for employment growth are slowing, painting a picture of a still tight labour market, but giving some degree of comfort around the trend.
Hourly wage rates (ex-bonuses) in Australia rose 0.84% quarter-on-quarter and 3.66% year-on-year in Q1 of 2023.
This is broadly in line with expectations and represents the strongest growth in Public and Private wages for about a decade.
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The RBA’s forecast in the May Statement on Monetary Policy was 3.6% year-on-year.
A lack of productivity gains means that unit labour costs are well above the RBA’s 2-3% inflation target.
Wage increases including bonuses and commissions rose a stronger 3.9% year-on-year, and 4.1% year-on-year for the private sector.
There is a strong chance we start to see public sector wage pressures begin to build from here.
Signs continue to be mixed in the US economy.
On the downside, the Citigroup Economic Surprise Index — which looks at the difference between economic forecasts and actual result — turned negative after a positive start to the year.
The EVRISI Trucking Survey — which has the highest correlation to real GDP of any single sector survey — is currently in recession territory.
That said, the May NAHB index of homebuilders’ activity and sentiment rose to 50 from 45, above the consensus expectation of 45.
The absolute level is still very depressed, but this index has now risen for 5 straight months. Homebuyers are being pushed into buying new homes, given the dearth of existing homes to purchase.
The share of new homes in the total home sales data has moved from 10% to 13%, hence the homebuilders are doing better than the mortgage demand data would indicate.
April new housing starts rose 2.2%, while building permits fell 1.5%.
The rise in April starts is more or less evenly split between single- and multi-family units. The small decline in April building permits, meanwhile, is entirely due to a 7.7% slump in the multi-family component, which is volatile on a month-to-month basis but has been pretty flat for a year.
In contrast, single-family dwelling permits rose by 3.1%. This is the third straight increase, reflecting lower construction costs and lack of existing home sales.
The bigger picture here is that residential construction is now stabilising, after being a huge drag on fixed investment in 2022. Single-family starts fell at an 8.8% annualised rate in the first quarter, following declines of 52% and 21% in Q3 and Q4 2022, respectively.
April retail sales rose 0.4%, below the consensus of 0.8%. Sales ex-autos were up 0.4%, in line with the consensus.
The April rebound in total retail sales follows two straight months of decline, but still leaves spending comfortably below its recent January peak.
April industrial production rose 0.5%, in contrast to consensus expectations of no change.
Manufacturing output rose 1.0%, significantly higher than the consensus expectation of 0.1%. Manufacturing output ex-autos rose at a much more modest 0.4%.
The ~10% spike in vehicle manufacturing is unlikely to be sustained, given production levels are above pre-Covid highs.
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The upshot is that the chance of a large rebound in manufacturing activity in the US for the remainder of CY23 looks unlikely.
US Results Season
The blended earnings growth rate for Q1 S&P 500 EPS currently stands at -2.2%, compared to the -6.7% expected at the end of March.
Of the 95% of S&P 500 companies that have reported for Q1, 78% have beaten consensus EPS expectations, better than the 73% one-year average and the five-year average of 77%.
In aggregate, companies are reporting earnings that are 6.5% above expectations, better than the 2.8% one-year average positive surprise rate but below the five-year average of 8.4%.
Drawing on more than 25 years of experience investing in top-performing Australian companies and a background in accounting, Jim manages our Long/Short Fund and co-manages our Imputation Fund. He is a Chartered Accountant with membership of the Australian Institute of Chartered Accountants.
Pendal Focus Australian Share Fund is managed by Crispin Murray. The fund has beaten its benchmark in 14 years of its 18-year history (after fees), across a range of market conditions. Find out more about Pendal Focus Australian Share Fund here.
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