Stocks Down 1.4%, Aussie Dollar Hits 2-Year Low

Consumer prosperity and robust exports are the defining features of Australia's economy in the second quarter of this year.

On September 7th, the Bureau of Statistics released the Gross Domestic Product (GDP) data for the second quarter, which seemed to indicate a favorable economic situation.

The second quarter marked the first time since March 2020 that Australia's borders were fully open, with a quarterly GDP growth of 0.9%. Although this is higher than the 0.7% growth in the first quarter, it was slightly below the market's median forecast of 1.0%. This brought the GDP growth for the fiscal year 2021-22 to 3.6%, the highest level since 2012 and slightly above the Reuters forecast of 3.5%.

However, following the release of these figures, the Australian Securities Exchange (ASX) 200 index, which had already plummeted in the morning session, did not recover its losses. It only slightly rebounded before turning down again, closing 1.42% lower at 6,729.3 points.

The Australian dollar's exchange rate against the US dollar also fell to the 0.67 level, a two-year low. The Reserve Bank of Australia's fifth interest rate hike yesterday could not support the Australian dollar. Compared to the exchange rate of 0.74 in August last year, the Australian dollar has depreciated by 9%.

Recently, a popular saying in the global financial market is "Good news is bad news," which was clearly exemplified in today's Australian market.

Why would the stock market and the Australian dollar exchange rate decline despite ongoing economic growth? Can Australia maintain such growth momentum in the fiscal year 2023? How will the current economic situation affect the Reserve Bank of Australia's interest rate hikes?

To assess Australia's economic growth prospects, one must first examine the current drivers of economic growth.

Looking at the contribution to GDP growth, exports and consumption are clearly the leading "two engines."Driven by a significant increase in disposable spending, the contribution of household final consumption expenditure to GDP growth reached 1.1 percentage points; export growth (5.5%) was strong, far exceeding import growth (0.7%), resulting in a trade surplus contribution of 1.0 percentage point.

However, due to the continuous relaxation of restrictions in Australia since the beginning of this year, and the reduction of substantial health expenditures by state governments, this has led to a reduction in the contribution of government spending by 0.2 percentage points.

In terms of investment, the private sector showed signs of fatigue, with a 1.5% decline in the second quarter, where investment in non-residential construction (-5%) and machinery and equipment (-4%) both saw significant declines. However, public sector investment grew by 5.9%, which contributed 0.2 percentage points to the overall GDP.

If consumption and exports can continue to strengthen in the coming year, Australia's economy will also maintain its growth rate.

But the reality is not so optimistic.

Consumption: The effect of interest rate hikes will gradually emerge

The full lifting of various restrictions and the opening of Australia's borders obviously have a significant driving effect on consumption. Household expenditure grew by 2.2% in the second quarter, with a full-year growth of 6%.

Among them, the growth rate of service expenditure reached 3.6%, exceeding the pre-pandemic level for the first time. Since Australia completely lifted various restrictions, dining out (+8.8%), transportation services (+37.3%), and entertainment (+3.6%) have been the main contributors to growth.

The statistics bureau stated that although household tourism expenditure has increased, it is still only two-thirds of the pre-pandemic level, and there is still room for growth in the future.

In addition, non-essential consumption also continues to grow. Looking at the retail situation in the second quarter (+1.2%), dining out consumption has grown rapidly, and clothing, shoes, hats, and personal goods also maintain a relatively high growth rate.However, this growth may not be sustainable. There are two main reasons:

Firstly, household savings are continuously decreasing. The high household savings rate of 23.7% in 2020 no longer exists, and the savings rate in the second quarter continues to drop rapidly to 8.7%, which is only slightly higher than the pre-pandemic level. It can be expected that as expenditures continue to increase, the proportion of household savings in the second half of the year is likely to return to the normal level of 2019.

Secondly, the impact of interest rate hikes has not been reflected in the second quarter. Although the Reserve Bank of Australia (RBA) raised the official interest rate for the first time in this cycle in May, many people's mortgage interest rates will not officially adjust until August, meaning that the increased mortgage payments were not included in the family expenditures for the second quarter.

The downward trend in housing prices will hit people's confidence in consumption, and the rise in interest rates will further increase the financial burden on households. These impacts will become more apparent after the third quarter.

Therefore, although Australians' consumption is still strong at present, it may weaken by the end of this year or the beginning of next year.

Trade: Iron ore steps down, coal "reigns supreme"

Consumption may not be able to maintain growth, what about exports?

This year, the global commodity prices have surged, which is indeed more favorable for a country like Australia that has "mines at home."

In the second quarter of 2022, the trade surplus reached a new high of 43.1 billion Australian dollars. The increase in net exports helped Australia's current account to achieve a surplus for the 13th consecutive quarter in the second quarter, with the amount increasing by 15.55 billion Australian dollars, reaching 18.3 billion Australian dollars.

Looking at the categories, iron ore, which was the "absolute main force" in exports last year, is no longer in the limelight. The continuous decline in prices has led to a total export amount that is almost being caught up by the second-largest export commodity.That is to say: coal.

Coal prices have surged significantly in the fiscal year of 2021-22, especially after entering 2022, where the increase can be described as "exaggerated." Currently, the price has doubled compared to the beginning of the year. This has led to the total export value for the 2022 fiscal year exceeding 100 billion Australian dollars for the first time.

It is only a matter of time before coal exports surpass iron ore exports.

Queensland Hay Point coal loading facilities

At the same time, Australian agricultural exports have also recovered, with a 5.9% increase in the second quarter, mainly driven by a significant rise in grain prices following the Russia-Ukraine conflict and an increase in beef demand.

Compared to consumption, Australia's exports should still be able to maintain growth in the short term.

Coal: Due to the suspension of gas supplies to Europe through the Nord Stream 1 pipeline, many European countries have restarted coal-fired power plants to ensure domestic energy usage. This has also led to a more than 20% increase in coal prices within a month. As the winter in the Northern Hemisphere approaches, the demand for coal will only increase.

Agricultural products: The Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) forecasts that Australia's agricultural exports in 2022-23 are expected to exceed 70 billion Australian dollars, with the main revenue coming from wheat (11.7 billion Australian dollars), beef (10.2 billion Australian dollars), and cotton (7 billion Australian dollars).

However, it is worth noting that the decline in demand from China may continue to lead to a downward trend in iron ore prices and total export value, offsetting the growth in coal and agricultural exports.

The Reserve Bank of Australia slows down interest rate hikes, while the Federal Reserve is more aggressive.Boman Australia Wealth's Chief Investment Officer, Wei Ruihao, believes that Australia's current economic data performance is relatively neutral. Although there is still a certain growth momentum, the growth rate is likely to slow down. Of course, compared with the United States' GDP negative growth for two consecutive quarters, the situation is much better, and there is still a long way to go before economic recession.

He judges that for a period of time in the future, the economy will be in a state of low-speed growth, which is mainly determined by the still high inflation and relatively fast interest rate hikes.

From the perspective of monetary policy, the GDP data this time may to some extent dispel some central banks' concerns about interest rate hikes leading to economic recession, that is, to support them to continue to raise interest rates.

Such interest rate hike expectations obviously put pressure on Australia's overall asset prices, whether it is the real estate market or the stock market will continue to bear pressure.

It should be pointed out that for the final interest rate hike "end point" of the Reserve Bank of Australia, the importance of GDP figures is obviously not as important as the inflation rate (CPI) in the third quarter of Australia. Investors need to pay more attention to the inflation data announced on October 26 (that is, before the Reserve Bank of Australia's November interest rate meeting), which is the core factor determining whether the Reserve Bank of Australia will slow down the pace of interest rate hikes.

The recent decline of the Australian dollar is more related to the performance of the US market. Due to the stronger interest rate hike expectations of the Federal Reserve, the US dollar index has continued to rise recently, with an annual increase of 15%, which has further devalued other currencies including the Australian dollar.