Monday, November 17, 2014

Japan GDP - truly awful

I’m going to be out of the office later this week so thought I should get a post done before I head off.  That only left me to decide what to write about.  Then Japan GDP came out.  Problem solved.

What a truly awful number.  Japan’s third quarter GDP contracted at an annual pace of -1.6%.  Remember this was the quarter activity was meant to bounce back following the June quarter fallout from the consumption tax increase when GDP contracted at a -7.3% annualised pace.  Average market expectations were for an increase of 2.2%.

The detail of the result didn’t provide any silver linings.  Inventories contracted more than expected over the quarter but they were always going to be negative following the big positive contribution in the June quarter.

The real disappointment was the weak increase in consumer spending of +1.5% (annualised).  That followed a whopping -18.6% contraction in the June quarter.  I’ve been at the pessimistic end of Japan growth all year, especially with respect to how the economy would come through the tax increase, but even I’m disappointed in that result.

It seems highly likely the second tax hike scheduled for late next year will now be postponed.  That raises another important question beyond the obvious of the near-term growth outlook: how is Japan to achieve any semblance of fiscal sustainability?

Raising revenue is proving too damaging to the economy.  Cutting spending would have the same effect.  You know what I’m going to say next.  So far meaningful structural reform has proven to be too difficult politically.  Time to get on with the job.

Thursday, November 13, 2014

US wages, inflation and monetary policy

The recent spike higher in the US Employment Cost Index (ECI) has received a bit of attention recently.  With markets attuned to any nascent display of inflation the rise in the annual rate of increase from 1.8% in the year to March this year to 2.2% in the year to September has not gone unnoticed.

A couple of points.  Firstly, the ECI is a broader measure of worker compensation as it also captures the cost of benefits.  Benefit costs are rising at an annual rate of 2.4% - faster than wage growth which, while higher also than six months ago, is running at an annual rate of 2.1%.

Secondly it appears the recent rise in the wages component of the ECI just brings it back into line with average hourly earnings, the annual rate of increase in which has been tracking a little over 2% in the past few months.  In that respect there is little new news in the ECI to get excited about.
But as I’ve said on numerous occasions before; it’s ultimately unit labour costs (ULCs) that matter most to the inflation outlook.  ULC are clearly trending higher’ although admittedly it requires a 24-month moving average to find a nice fit with core inflation.


The upshot is that wage growth is off its lows and ULCs are trending higher.  Core inflation remains subdued and may indeed continue to be subdued for a while yet.  Core inflation excludes direct commodity price effects by excluding food and energy prices but second round effects of lower oil prices in particular are likely to keep core inflation pressures subdued in the near term.  The higher USD will also keep inflation subdued.

But monetary policy must retain a medium term focus. The ECI is just the latest in a number of indicators that suggest continued monetary policy normalisation is warranted in America.  We continue to expect the FOMC will leave interest rates unchanged into next year with the first interest rate increase likely in mid-2015.

Monday, November 3, 2014

More easing from the Bank of Japan

The Bank of Japan (BoJ) faced an important credibility test last week.  On Friday they released their semi-annual outlook report on the econony in which they had no option but to lower both their growth and inflation forecasts.  But in announcing new easing measures they were able to leave their growth forecasts at the optimistic end of market expectations and retain some hope their 2% inflation target would be met.

In their previous forecasts the BoJ was projecting annual growth of 1.0% in fiscal year (FY) 2014.  That had become increasingly unrealistic as the economy was hit harder by the consumption tax increase in April.  Market consensus growth for that period is now around 0.2% with our forecast at 0.0%.  With lower growth and weaker commodity (i.e. oil) prices their inflation forecasts had also taken on an aura of make-believe about them.

In announcing new easing measures the BoJ has been able to keep their growth forecasts at the optimistic end of expectations by dropping it to 0.5%.  That’s the BoJ’s assumed rate of trend growth.  Lowering their forecast below trend would have made forecasting rising inflation an even more challenging communications exercise.

Their inflation forecasts are only slightly reduced.  The Bank is now expecting annual inflation (excluding consumption tax increases) of 1.7% in FY 2015 (down from 1.9%) and 2.1% in FY2016 (unchanged).  Furthermore the timeframe for achieving their 2.0% target is now open-ended.

As for the easing itself – it was a mix of both qualitative and quantitative.  The key feature was the increased pace of expansion of the monetary base by ¥10-20 trillion to ¥80 trillion per annum.  It is probably no coincidence this was announced the same day the Government Pension Investment Fund announced a new target asset incorporating a reduced allocation to domestic bonds and higher allocations to domestic and global equities.  In addition to the expanded purchases of JGBs, the BoJ also announced increased purchases of both ETFs and REITs.

Will this work?  You know what I’m going to say.  Without a commitment to considerable productivity enhancing structural reform, the growth and inflation outlook in Japan is likely to remain very challenging.  At least I’m consistent!! 

Friday, October 31, 2014

Solid Q3 growth in America

September quarter US GDP growth came in in at a respectable annualised rate 3.5%.  That was slightly higher than average market expectations.  Furthermore, the detail of the result was suggestive of solid momentum in the US economy.

Personal consumption growth was held back over the quarter by soft growth in services.  That appears to have been the result of a mild summer and the resultant impact on utilities spending however consumption of durable goods posted a robust 7.2% annualised increase.

Private investment growth was held back by a negative contribution from inventories.  Residential investment looked soft with an annualised increase of 1.8% but disappointment needs to be tempered by observing that followed an 8.8% increase in the prior quarter. But growth in investment equipment came in at 7.2%.  All good.

Net exports was due a positive bounce after two negative quarters and didn’t disappoint with a 1.3% percentage point contribution to the overall result.  Expect that to revert to a negative contribution next quarter.

To look through the noise in any GDP result the best number to focus on is real final sales.  That came in at an annualized 4.2% in the quarter, up from 3.2% in the June quarter and the strongest result since the increase of the same magnitude in fourth quarter of 2010.  To me that’s indicative of an economy that’s building growth momentum.  This result lifts our annual average GDP growth forecast for 2014 slightly to 2.3% (from 2.2%) and supports our expectation of around 3.0% growth in 2015 and 2016.

There are no monetary policy implications in this result other than to give the FOMC increased confidence that growth in the economy is on a firm footing and that further normalisation of monetary conditions will be appropriate in time.