Moderation Down Under?

Conclusion: Growth is setup to slow meaningfully in Australia over the intermediate term due to a confluence of two main factors: waning Chinese/Asian demand and a deteriorating consumer sector.

Admittedly, we don’t write about Australia much and that is a direct result of consensus understanding the Aussie trade – long the Aussie dollar as a play on growing Chinese demand for raw materials and long Australian equities as a play on the dollar-down/commodities-up reflation trade.

Looking “down under” now, we continue to receive confirmation that the two tailwinds that have supported the Aussie dollar’s +7.1% YTD gain and recent equity market strength are eroding, as: 

  1. Chinese growth looks to continue to slow into 1H10 as the government continues to aggressively fight inflation with rate hikes, reserve requirement hikes, margin hikes, price controls and supply rationing.
  2. The U.S. dollar looks to continue strengthening from here, which dampens reflationary pressure in the commodity markets. We don’t buy any of the bullish HOPE associated with EU bailouts, etc. As such, we contend Sovereign Debt Dichotomy is alive and kicking for intermediate-term TREND. 

Within the Australian economy specifically, growth appears to be moderating as both internal and external demand wanes. Australian YoY GDP growth slowed sequentially by (-47bps) from 2Q10 to 3Q10, coming in a +2.65% in the latest reading. A slight positive to the report was that inflation as measured by YoY CPI also slowed in 3Q10, which suggests the prudent rate hikes of RBA Governor Glenn Stevens have warded off the inflationary pressure that continues to plague many other Asia-Pacific nations for now.

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One side effect of slowing growth and four interest rate hikes YTD is weakness in the consumer sector, which is highlighted by Australian October Retail Sales growth exhibiting the sharpest MoM decline since July 2009 at (-1.1%). While we aren’t necessarily lamenting the Aussie consumer for refusing to lever up and spend beyond their means like we continue to do in the U.S., we are calling out slowing growth for what it is.

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The consumer spending decline is driven by a confluence of two factors: 1) weakness in the Australian labor market; and 2) higher mortgage rates constraining consumer finances.

Australia’s Unemployment Rate ticked up +24bps in October to a YTD high of 5.39%. Further, Australian Job Adds growth decelerated in the month to +29.7k from +49.6k in September; the slowdown was driven by an decrease in full-time employment (-14.1k), though that was more than offset by an increase in part-time employment (+43.8k). At any rate, replacing full-time hires with part-time labor is usually indicative of softness in the labor market and the economy at large. Further, wages and benefits for part-times employees typically lag those of full-time staff.

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Higher mortgage rates also remain a headwind for the Australian consumer going forward, which is evidenced by Australian Consumer Confidence falling in November to the lowest level since June (110.7; down -5.3% MoM). A gauge of family finances dropped (-10.2%) MoM, which is particularly supportive of the view that the rate hikes are constraining consumer spending (more than 2/3rds of Aussies own homes and ~90% of Australian homeowners have variable-rate mortgages; also, household debt is greater than 150% of pretax income). 

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Exacerbating this credit headwind is the fact that Australia’s largest mortgage lenders have been increasing mortgage rates even beyond the scope of policy rate hikes. Both ANZ Bank and Commonwealth Bank of Australia have increased variable-rate mortgage rates by an average of 168% of the latest 25bps policy rate hike. Treasury Secretary Wayne Swan recently called the moves a “cynical cash grab”, yet no official action has been taken to provide relief for the Australian consumer’s shrinking discretionary budget.

Given this setup, it’s no surprise to see that Australia’s Household Savings Rate ticked up 130bps QoQ to 10.2% of disposable income in 3Q10, which lends further support that  confidence in household finances is deteriorating.

Moving to the manufacturing sector, we see continued weakness there as well; PMI contracted for a third straight month, falling in November to 47.6 from 49.4 in October, with the employment subcomponent index falling 4.3 points to 45.9. Capacity Utilization also fell (from a two-year high, albeit) to 74.6% vs. 77.4% in October.

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These numbers are indicative of the weak external demand highlighted above from slowing growth abroad. Compounding this slowdown in mining and manufacturing is the fact that Australian budget deficit will come in wider than initially anticipated due to Aussie dollar’s strength (exporters’ revenue missed government projections). The total shortfall for FY11 will be ~A$800 million larger at A$41.5 billion and the deficit for FY12 is likely to come in at A$12.3 billion, up from the initial projection of A$10.4 billion.

This latest miss has recently-elected Prime Minster Julia Gillard weighing spending cuts in order to honor her election promise of a balanced budget within three years time. At this point, the Australian economy is on the tipping point of a meaningful slowdown in growth, so the potential for increased fiscal conservatism may exacerbate the slowdown over the intermediate term.

From a quantitative perspective, Australia’s S&P ASX All Ordinaries Index is bullish from an intermediate-term TREND perspective and ever-so-slightly bullish from an immediate-term TRADE perspective after having closed up +1.8% overnight.

Darius Dale

Analyst

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