Tuesday, November 17, 2015

Growth and monetary policy in Japan and the Eurozone

Third quarter growth was weaker than expected in both Japan and the Eurozone.  Further monetary easing appears inevitable in both cases.  This will, in turn, have implications for the extent to which the Fed can take its foot of the monetary policy accelerator.

Eurozone GDP expanded 0.3% in the third quarter of 2015, below the consensus expectation of +0.4%.  Annual growth came in at +1.6%, up from +1.5% in the second quarter.  France and Germany both posted growth of +0.3% over the quarter with Italy disappointing at +0.2%.  Spain continues to expand more rapidly with a +0.8% increase over the quarter, though off a lower base.

Breakdowns of growth into its core demand components are not yet available but partial data for the quarter suggest the detail will show reasonably solid consumption growth offset by weakness in capital spending and net exports.

We see little scope for growth to accelerate from the current 1.6% annual pace in the near-term.  As we’ve said all year, the likely pace of growth is unlikely to prove sufficiently fast to put any sustained upward pressure on inflation.  While core Eurozone inflation is off its lows, it remains stuck at around 1.0%, well shy of the ECB’s 2.0% target.

ECB President Mario Draghi recently stated that “signs of a sustained turnaround in core inflation have somewhat weakened” and that the bank’s monetary policy stance will be re-evaluated at its December meeting.  That along with the downside risks to growth in the Eurozone key trading partners seems to make further easing a done deal.

Turning to Japan, the economy entered its second (technical) recession in 18 months.  The first came in the aftermath of the consumption tax increase last year, making this more recent downturn more worrying in that it highlights the fundamental weakness of the economy. 

GDP contracted at an annualised rate of -0.8% in the September quarter, well below the market consensus of -0.2%.  The biggest disappointment was the drop in capital spending which contracted at an annual rate of 5.0% over the quarter.  Strong capital spending growth observed in the in the first quarter of the year has now been completely unwound.  That’s inconsistent with recently upbeat capital spending intentions from various business surveys with concerns about the domestic economy and more recently China resulting in those intentions being delayed.

Consumer spending was solid at an annualised pace of +2.1% and net exports were positive, the first positive contribution in three quarters.  Weaker inventories was the major downside surprise, although that provides some scope for a recovery in production further down the track.

Looking ahead we think capital spending will remain soft and exports appear likely to slow.  Furthermore the positive impact from the last supplementary budget is now beginning to fade.  That leaves consumer spending as the determining factor of the pace of growth from here.  So it seems inevitable here too that the central bank will be forced to step up its monetary easing.

One of our “Themes for 2015” was the emergence of divergent monetary policy settings amongst the G4, with the US and the UK the first to tighten with more easing likely in the Euro zone and Japan.  While expectations of UK tightening are now pushed out well into 2016, our base case is the Fed hikes in December.  That means we can stop fretting about the timing of lift-off and start worrying about what really matters – the pace and extent of the tightening – which we expect to be gradual.  One of the key limiting factors on US interest rate increases will be the strong likelihood of further easing in Europe and Japan and upside implications for the USD. 

Monday, November 9, 2015

October jobs growth supports December "lift-off"

After a couple of soft months US jobs growth bounced back with a vengeance in October.  Non-farm payrolls rose +271k over the month, well ahead of average market expectations of +180k.   Adding to the strength in the result the unemployment rate dipped lower to 5.0% and wage growth blipped higher.

This result sees jobs growth back to a solid upward trend, supporting our view that solid consumer spending will continue to be the back-bone of above-trend GDP growth in the period ahead.  That tips the scales further in favour of a December “lift-off” for interest rates.  Indeed market-based probability of a hike in December now sits at 68%.

Average hourly earnings were up +0.4% in the month for an annual increase of 2.5%.  The unemployment rate is now within the Fed’s central tendency for full-employment and the broader U6 measure of labour market is slack is now at 9.8%, its lowest level in five-and-a-half years.

The Federal Open Market Committee will see this for what it is – an unambiguously strong result.  We know the Committee, either rightly or wrongly, operates within a Phillips Curve framework.  So a combination of diminished labour market slack and rising wages will have them itching to tighten.  Barring any data-disasters between now and mid-December, a rate increase before Christmas is looking like a done deal.

Wednesday, November 4, 2015

NZ Labour market data supports December rate cut

Ask me what New Zealand data is prone to the most surprise and I will always answer “the labour market”.  Today’s release of September quarter Household Labour Force Survey (HLFS) data did not disappoint.  The unemployment rate came in bang on expectations at 6.0%, but for all the wrong reasons.

The rise in the unemployment rate from 5.9% in June was MEANT to be the result of lower growth in employment offset by faster growth in the supply of labour.  Instead it was the combination of a 0.4% fall in employment, offset by a decline in the labour participation rate (and therefore a decline in the labour force).  The participation rate fell from 69.3% in June to 68.6% in September.

What should we read into this result?  For a start the number that’s hardest to believe is the 0.7 percentage point decline in the participation rate given the strong population growth we are experiencing through net migration.  Furthermore, we’re not convinced that employment actually did fall over the quarter, though some of the surprise is mitigated by the fact that the decline came through in part-time employment. That suggests to me we will more than likely see some degree of bounce-back next quarter.

The annual rate of employment growth slowed to 1.5% which is probably more believable, although we thought it would be early next year before jobs growth slowed to that extent.  Jobs growth in the Quarterly Employment Survey came in at 1.7% for the year which does add some corroboration to the result.

Wages data added to the soft tone with the private sector Labour Cost Index up 0.4% over the quarter for an annual increase of 1.7%, slightly lower than we were expecting.

It could well be that we are in for another bout of volatility in the HLFS.  While that’s not particularly helpful, we do see today’s result as consistent with the view that growth in the economy has slowed recently and that there’s room for a further rate cut in December.

Thursday, October 29, 2015

RBNZ leaves options open and FOMC keeps December "live"

After three successive cuts in the Official Cash Rate since June, the Reserve Bank of New Zealand (RBNZ) left interest rates unchanged today.  However they signaled “some further reduction on the OCR seems likely”, though this will depend on the emerging flow of economic data.

The Banks reading of economic developments is much the same as ours: global growth is below average with concerns about future prospects centered on China and East Asia.  At the same time global inflation remains low.  Dairy price weakness continues to weigh on domestic farm incomes and it remains to be seen how sustainable the more recent increase in prices will prove to be.  House price inflation remains a financial stability risk and while residential building is accelerating, it will take some time to correct the supply shortfall.

On a brighter note the Bank notes the recent robust growth in the services sector and construction driven by strong net migration, tourism and low interest rates.

The Bank expects inflation to return to “well within” the 1-3% target band by early 2016.  We concur.  That’s in response to the weaker exchange rate and as the earlier impact of lower petrol prices fall out of the annual calculation.  However they also note the more recent appreciation in the exchange rate which, if sustained, would require a lower interest rates path than would otherwise be the case.

I still think there’s another 25bp cut in the OCR on the cards and that this will be delivered at the December Monetary Policy Statement.  That’s based on an expectation the recent strength in exchange rate will prove to be more sustained than desirable.  But if we take anything from today's Statement its that a December cut is not a done deal.

Earlier this morning the US Federal Reserve left interest rates unchanged and, if anything, surprised markets by keeping “live” the prospect of an interest rate hike in December.

As you know we’ve been reluctant to completely dismiss the chances of a rate hike this year – though acknowledged this would require some stronger labour market data, better news on global growth (particularly China) and less general angst in financial markets.

Indeed today’s Statement appeared less concerned about global developments with the Committee removing the reference in the September Statement that those developments could restrain retrain economic activity somewhat and put further downward pressure on inflation in the near term.

So December “lift-off” is still on the table, though as with the RBNZ, their next move will depend on the data before the meeting in mid- December.  Markets are now pricing in a slightly less than 50% chance of a rate hike at that meeting which is probably about right.  But some stronger domestic data suggesting the likely low print for Q3 GDP (our forecast 1.2% saar) is just a blip will see that probability move to over 50%.