A thorough read of the minutes of the April
30 / May1st meeting of the Federal Open Market Committee (FOMC) shows a
Committee not in any mood to risk an early or premature end to the asset purchase
program. Markets have focussed on Ben
Bernanke’s comments during his Congressional testimony that suggested the FOMC
could potentially reduce the quantum of asset purchases “in the next few
meetings”. The important qualification
was that this would only happen if the outlook for the economy continues to
improve along with the level of confidence in the sustainability of that
improvement.
The assessment of the current state of, and
outlook for, the economy in the Minutes bore no surprises. The meeting participants recognised the costs
of fiscal drag in constraining aggregate demand, the improvement in the housing
market (though off a low base) and that progress was being made in the labour market. However, the Committee also noted that the recent
decline in the unemployment rate is overestimating the reduction in slack in
the labour market given the decline in the participation rate.
I have made the point before that it is
unlikely a reduction in the unemployment rate that has been in large part due
to people opting out of the labour market meets the FOMCs conditions for a substantial
improvement in labour market conditions.
While there are structural reasons why the participation rate should be
trending lower, I think at least some part of the recent decline is
cyclical. If that were to be reversed
continued modest jobs growth could be accompanied by a stabilisation or even
increase in the unemployment rate. Time
will tell. The Committee also noted the
recent soft inflation readings. Core Personal
Consumption Expenditure (PCE) was 1.1% in the year to March.
Much has been made in the media that “one
participant” preferred to begin decreasing the rate of asset purchases
immediately, but has missed the point that “another participant” wanted to add
more stimulus at that meeting. The
important point is: “Most participants emphasized that it was important for the
Committee to be prepared to adjust the pace of its purchases up or down as
needed to align the degree of policy accommodation with changes in the outlook
for the labor market and inflation as well as the extent of progress toward the
Committee’s economic objectives.” While
that was in response to the weaker data at that point, especially the initial read
of March payrolls data, it also seems to me the Committee didn’t want markets
to get too far ahead of themselves in anticipating an end to the asset purchase
program.
My read of the minutes, Bernanke’s
testimony to Congress and other recent speeches from FOMC members (Bullard,
Dudley) is that the Committee is not going to be in any rush to do anything
other than continuing to ease. In his
testimony Bernanke made the important point that a premature tightening of
monetary policy could lead interest rates to rise temporarily but could also
carry a substantial risk of slowing or ending the economic recovery and causing
inflation to fall further.
Given our outlook for the economy we
believe the next move in US monetary policy is a tapering in the pace of asset
purchases. However, they will need to be
conscious of not starting to taper too early.
As soon as they start the process markets will anticipate the eventual
cessation of the program and eventual tightening, even though the Fed will
still be easing at that point. We
continue to expect the earliest we will see a reduction in the pace of asset
purchase will be the end of this year, although recent inflation data is probably
more indicative of a 2014 start to that process. The good news is that when the tapering
begins, it will be because the FOMC sees a fundamental improvement in the outlook
for the US economy.
Japanese GDP growth for the first quarter
of 2013 surprised on the upside, posting an annualised increase of 3.5% (0.9%
q/q). The result was ahead of market
expectations of an annualised increase of +2.7%. It was all the more impressive for the fact
that the higher than expected growth came off a higher base following an upward
revision to growth in the fourth quarter of 2012 to an annualised +1.0%.
The growth was reasonably broad-based over
the quarter. Consumption was the star performer,
but exports contributed with their first quarterly increase in a year. Housing investment also remained strong. The only laggard was business investment
which is to be expected given the lags between a boost to confidence and the
implementation of investment plans.
The question is where to from here? There are a number of reasons to believe the
recent strength will be maintained, at least in the near term. Consumer confidence is strong on the back of
recent equity market gains which will support consumption growth and underpin
further gains in the housing market. A
significant public works program following the supplementary budget announced
in February will also support activity in the period ahead. And of course the recent depreciation in the
Yen combined with higher global growth in the latter part of the year
(particularly in America) will provide further support for exports. Business investment is likely to show some
strength as profitability improves on the back of stronger demand and the
depreciation in the Yen.
Remember there are three components of
Abenomics: an increase in fiscal stimulus focussing on public works, an
aggressive monetary easing by the Bank of Japan and structural reforms to boost
productivity. So far we have seen action
on the first two which is delivering gains.
However, from my perspective, it’s progress on the third leg of the
trifecta that’s necessary to make higher growth sustainable.
I think it’s a bit like Europe where the
ECB has created a window of opportunity for politicians to get on with the job
of fiscal consolidation and structural economic reform; in Japan fiscal and
monetary stimulus is creating a window of opportunity for the Government to get
on with the hardest part of the reform agenda.
We need to see policy reform in goods markets, the regulatory
environment (particularly the regulation of network industries) and the labour
market also needs some work to address rigidities.
An important part of the necessary
structural reform is dealing with the related issues of tax reform and unsustainable
fiscal settings. Japan needs a long-term
fiscal plan (where have we heard that before?).
Here’s where a better economic environment is creating room to move. An increase in consumption tax is scheduled
to take effect in two steps from April 2014.
At that point the tax increases from 5% to 8% and then again to 10% in
April 2015.
When the tax increase was announced it was
qualified with the implementation being conditional on the state of the economy
at the time. This recent economic strength
and its likely continuation this year means the consumption tax increases are
more likely. They will take an economic
toll and inevitably add volatility to the growth profile over the next couple
of years as people pre-spend prior to the tax increases, followed by a soft
patch. But they are a step in the right tax-reform
direction.
We see annual average growth of 1.6% (2.9%
q4/q4) in calendar 2013 followed by 1.4% (0.5% q4/q4) in 2014. After that we see growth slipping back to
trend growth of around 1.0-1.5% per annum.
I need to see a more ambitious reform agenda getting too excited about
the medium term outlook.
Budget
2013 marks another milestone of the pathway back to fiscal sustainability. Solid economic growth continues to underpin a
return to surplus in the 2014/15 fiscal year.
This is one year earlier than Australia (not that we’re at all
competitive). Net debt is projected to peak at 28.7% of GDP in fiscal 2014/15,
confirming New Zealand as having one of the strongest fiscal positions in the
developed world.
Fiscal
projections in the 2013 Budget are underpinned by average growth of 2.5% over
the forecast period. Growth is forecast
at 2.4% in the year to March 2014, lower than the 2.9% expected in the Half-Year
Economic and Fiscal Update (HYEFU). The
drought is the primary reason for the downward revision, taking an estimated
0.7% off growth this year. Growth is
then expected to rebound to 3.0% in 2015. These forecasts are slightly lower than ours (2.8% and 3.2%
respectively) and are therefore on the moderately conservative side in our
view. Growth is expected to drift lower in the years following.
Other
economic forecasts are broadly in line with our view. Inflation is expected to be lower than
previously forecast in the near term on the back of the high exchange
rate. Treasury is also forecasting a
gradual decline in the unemployment rate (which will now be from a lower
starting point following the release of March quarter HLFS data). They are also forecasting deterioration in
the current account deficit which is also in line with our own view.
Crown
revenues are forecast to rise over the projection period on the back of solid
economic growth. And after two “zero”
new spending budgets the improved fiscal outlook has allowed the Government a
bit more latitude on spending. They have
allowed themselves $900m in new spending in Budget 2013, which along with
continued reprioritisation of existing spending and higher revenue has enabled
new initiatives in health, education and social services.
A
further boost to investment in innovation is welcome via increased funding to
Callaghan Innovation for R&D grants.
That’s important support for the innovation system and I continue to
favour the use of targeted grants to support our aspiring innovators.
Other
significant initiatives include a reduction in ACC levies and a further commitment
of $2.1 billion to the Canterbury rebuild.
Operating
balance (excluding gains and losses or OBEGAL) is estimated at -2.9% of GDP in
the current fiscal year (-3.4% of GDP in the HYEFU), a deficit of -0.9% in
2013/14 (-0.9%) and a surplus of 0.0% ($75 million) in 2014/15 (0.0%, $66
million). Net core crown debt continues
to rise to a peak of 28.7% of GDP in 2014/15, and then begins to decline. Gross debt peaks at 38.5% of GDP in 2013/14.
Historical
efforts to reduce New Zealand’s debt levels have stood us in good stead. Our low level of debt combined with a
credible plan to get back to fiscal sustainability after the Global Financial
Crisis (and in our unique case the Canterbury earthquakes) is the key
difference between us and much of the rest of the developed world. By comparison gross debt as a percentage of
GDP is 95% in Europe, 108% in America and 245% in Japan. In the Australian Budget yesterday we saw the
benefit of low and prudent debt levels when the market took the deterioration
in the Australian crown accounts in their stride.
The
fiscal impulse is expected to be somewhat less of a headwind than estimated in
the last Budget. Fiscal drag is now
expected to be at its worst in 2015 at -1.2% of GDP. That compares with a previous “peak” of -2.0%
in 2014. Further out fiscal drag is now
forecast to be slightly greater than previously forecast. That being the case it remains a
critical reason why we expect only a moderate increase in interest rates over
the next tightening cycle.
Concerns
about fiscal drag also need to be tempered by the fact the government is also
running a significant investment program.
Following the partial sale of Mighty River Power the Government has
boosted the Future Investment Fund by $1.5 billion, taking the Fund to $2.1
billion. This will be used to fund
investment in schools, hospital, rail and irrigation. The Government announced today that Meridian
Energy will be the next asset up for partial sale, market conditions permitting.
The
housing market was a key focus in the Budget.
Housing represents one of the biggest risks to New Zealand’s financial
stability. Improvements in household
debt levels since 2006 have already started to turn for the worse again. The
most significant issues facing the housing market in New Zealand are supply-side
in nature. The Government announced
today they will be introducing legislation to enable a streamlining of new
housing developments in areas where housing is least affordable. That’s a positive and helpful step in the
right direction.
However
it’s inevitable that demand management will also have to play a role. The Minister of Finance announced today that
he and the Reserve Bank Governor have signed a Memorandum of Understanding
defining the operating guidelines for the use of macro-prudential tools to
assist in the management of the credit cycle.
The tools are as proposed in the Reserve Banks’ recent consultation
process and will be a welcome addition to their tool box. However, it remains to be seen what impact
they will have, especially given the housing cycle upturn is well advanced. International evidence on the efficacy of such
tools is, at best, mixed. We continue to
see them as complementary to the traditional demand management tool of interest
rates and therefore continue to see the Reserve Bank embarking on a tightening
cycle from later this year.
New
Zealand is in good fiscal shape. To be
fair there are things I’d like to see the Government do differently, but they
are mostly at the margin. In general, the
Government is managing a credible pathway to fiscal sustainability that looks
increasingly robust. At the same time
they are managing to invest in growth enhancing infrastructure, public services
and the rebuild of Canterbury. Rating agencies should be well pleased.
After
being disappointed with March quarter GDP growth in China we have been
anxiously waiting for April data for a read on the start to the second quarter
of the year. On balance the data makes
me more comfortable with the story of a modest cyclical upturn, but there are
still areas of weakness.
The
release of April activity data began last week with trade and money and credit
aggregates. Credit increased Rmb 793
billion over the month with total social financing rising by Rmb 1.75
trillion. The data shows continued
healthy demand for credit with non-bank lending particularly strong. M2 money supply is running strongly at an annual
pace of 16.1% over the year, well ahead of the target growth of 13% for the
year and supporting the story of an improvement in the nominal economy.
April
exports and imports both exceeded expectations over the month, rising 14.7% and
16.8% respectively. Some China-watchers
are questioning the validity of the export data given other export indicators
such as port put-through and PMI export orders suggest somewhat weaker
growth. Import data suggests some
strength in domestic demand. Implied
commodity volume growth supports further growth in infrastructure investment.
Annual
growth in industrial production rose from 8.9% in March to 9.3% in April,
although the monthly change was negative.
The annual rate rose by virtue of a larger monthly negative number
dropping out of the annual calculation from last year. Nominal retail sales growth nudged higher
from 12.6% in March to 12.8% in April.
The
disappointment came in the growth in Fixed Asset Investment which fell to 20.1%
in April, down from 20.7% in March. The
weakness was largely due to a decline in the annual rate of infrastructure
investment, although the import story above supports some degree of pick-up is
likely in the period ahead.
I’m
still hanging onto my 8.2% GDP forecast for the year. While the activity data is undeniably soft in
some areas, the credit data in particular gives me confidence there is still
some upward momentum in the economy.
However, we may now have to wait until later in the year for the
improvement to show through in the GDP numbers.
A stronger US economy later this year will also assist export growth.
I
don't think there is enough in this data to spur a policy response from the
authorities. Although non-food inflation
printed at a benign 1.6% in April, we continue to expect inflation to trend up
to around 3% this year. That’s
significant in light of the lower 3.5% inflation target for this year. That, along with clear attempts already by
the authorities to contain the recovery in the housing market seems to preclude
interest rate reductions. But neither do
we expect a tightening in monetary conditions until next year.
