Friday, April 27, 2012

Around the World by Central Bank

The Fed
The Fed left monetary conditions unchanged this week with the FOMC continuing to signal no change in monetary condition until late 2014.  They continue to leave the door open to further monetary easing.  However, the economic forecasts accompanying the statement showed the FOMC has a somewhat more upbeat view with a downward revision to their unemployment forecasts and an upward revision to both GDP growth and inflation.  While this is not yet sufficient for the Fed to start withdrawing stimulus, it does help confirm the odds of QE3 are lower than they were.  Whether the Fed goes down the path of QE3 remains highly dependent on how the data plays out over the period ahead, with most attention focusing on the labour market.  The labour market provides the FOMC with reasons both for (elevated unemployment, slow jobs recovery) and against (zero productivity, rising unit labour costs) further monetary accommodation.   

Banco Central do Brasil
As was suggested in the minutes of the previous Copom meeting when the committee cut the Selic rate 75bps to 9.75%, interest rates were cut again this week.  The Selic rate was slashed another 75bps to 9.0%.  That’s nearly down to the historic low of 8.75% reached during the Global Financial Crisis.  Those minutes also suggested 9.0% would be the likely low, but the minutes from this meeting suggest further interest rate reductions are on the cards.  If the primary aim is to reduce the exchange rate, the Bank is having some success.  The Real is down just under 20% from its peak in July last year.  We continue to worry, however, that the Bank may be creating a bigger headache for itself further down the track.  While growth has been slowing, we expect that to be picking up in the second half of the year on the back of both stimulatory monetary and fiscal settings.  Capacity constraints are already tight (unemployment at 25-year lows), leading us to expect that inflation will be heading higher in 2013.

Reserve Bank of India
India made its first cut in interest rates this cycle this week, cutting its key policy discount rate 50bps to 8.0%. This move followed two cuts this year to the cash reserve ratio in response to tightening credit conditions.  We agree with the RBI’s assessment that scope for lower interest rates remains limited.  As we have mentioned before, India is the emerging economy where recent high commodity prices have had greatest spill-over into more generalised inflation.  Furthermore, the RBI recognises that part of the recent slowdown in GDP growth is a move to a lower post-GFC trend growth rate, indicating there is limited spare capacity.

Reserve Bank of Australia
The RBA meets next week, but the preconditions for an easing would appear to have been met.  At its last meeting the RBA signalled a rate cut was on the cards so long as March quarter inflation data behaved.  That data was released this week and it came in well below expectations:  the CPI rose +0.1% in the quarter versus a market expectation of +0.6%, thanks largely to a 60% fall in banana prices.  More importantly, core inflation also came in below expectations.  The AMP Capital team in Sydney tells us the RBA should cut rates by 50bp next week.

Reserve Bank of New Zealand
The RBNZ had a scheduled OCR review this week rather than a full Monetary Policy Statement.  As was universally expected they left rates unchanged, but they took the opportunity to try and talk the NZD down again.  As we mentioned in the post below, the recent strength of the New Zealand dollar has had a significant disinflationary impact.  The challenge for the Bank is that domestic inflationary pressures are by no means dead and buried.  Indeed there was sufficient evidence in the CPI result to support the view of a tightening from later this year.  The Bank is clearly frustrated by the continued strength in the currency and appears ready to change its indicated monetary policy course (a bias to tighten) should that be warranted.  We too believe the NZD should be lower, especially on the back of recent falls in commodity prices and the fact that the current account deficit is on a deteriorating trend back towards 6% of GDP.  At the moment we are happy with our view of a December OCR tightening with the OCR moving up to 4.5% over 2013.

Stop Press: Bank of Japan
The BoJ has just announced a ¥10 trillion extension to its asset purchase program.  Such a move had been widely anticipated by markets following signs the Japanese economy was slowing again after an initial burst of earthquake reconstruction activity.   Industrial production rose 1% in March, below average expectations of 2.3%.

Thursday, April 19, 2012

NZ Inflation and Monetary Policy

New Zealand March quarter consumer price inflation came in around market expectations at 0.5% for the quarter and 1.6% for the year. This was lower, however, than the Reserve Bank of New Zealand (RBNZ) expectations of +0.7% and +1.8% respectively.

There is no doubt that inflation pressures are currently contained. This latest result follows the much lower than expected -0.3% quarterly out-turn in December. Furthermore, annual inflation appears likely to move even lower in the following quarter. Our forecast of 0.6% for June quarter inflation would see the annual CPI move lower again to 1.3% for the year to June.

Over the quarter excise increases (alcohol and tobacco) and rentals (Christchurch) were the major upward influences. The strength of the exchange rate has been the dominant downward factor over recent quarters with tradeables inflation recording declines over the last two quarters (-0.9% in December and -0.4% in March). The annual rate now stands at +0.3% for the year to March. By way of comparison, annual non-tradeable inflation (the best estimate of purely domestic inflationary pressures) is up 2.5% in the year to March.



Recent low inflation results, along with lower than expected December quarter GDP growth, has justified the RBNZ (and market) progressively shifting out expectations of when it will be appropriate for monetary policy to start becoming less stimulatory. We agree with the RBNZ’s bias to tighten: we believe that inevitability can only be delayed for so long.

By later this year, we expect there will be signs of capacity constraints building. Indeed, capacity utilisation is already running ahead of its long-term average. We continue to watch indicators of skills shortages in the labour market, as we believe that will be the area in which inflationary pressures emerge first. Also the downward impact of the high exchange rate on inflation will continue to moderate over the next quarter or so (assuming it doesn’t move significantly higher) and could soon have the opposite impact of contributing to higher inflation as the NZD inevitably (in our view) falls.

We continue to expect the RBNZ to start tightening later this year with the OCR likely to move from 2.5% to 3.0% in December. We think the neutral official cash rate is now around 4.5%, helped by the fact that fiscal policy looks likely to be contractionary in the period ahead. That’s considerably lower than it was pre-GFC (6%), but a not insignificant 2 percentage points away from where the OCR is today. By the time less stimulatory monetary conditions are required, the Bank will need to get on with the job. We think the OCR will be at 4.5% by late 2013.

Monday, April 16, 2012

China GDP

China GDP came in at 8.1% in the year to March 2012, down from 8.9% in the year to December 2011 and its lowest level since 2009. The result was lower than the market was expecting, but higher than our forecast. We had expected a result under 8%.

We continue to believe this marks the low point in the current cycle. Recent partial data supports that view. The official manufacturing PMI has strengthened in recent months (although the HSBC-Markit index which has different coverage is lower). We expect industrial production growth will begin to move higher in the current June quarter.

More significantly, growth in both the money supply and loans accelerated in the March month indicating that monetary easing measures to date (a lower reserve ratio requirement) are already having an impact.





The makeup of recent data has also been positive from a rebalancing perspective. It’s significant that China managed to post growth in excess of 8% over a period in which exports were weak and investment growth has been slowing. Consumption growth is holding up well with retail sales rising an annual 15.2% (nominal) or 11.3% (real) in March.

Consumption growth is expected to remain relatively robust on the back of strong wage growth and fiscal policy settings that are increasingly supportive of a rebalancing of the economy towards consumption. Urban disposable incomes rose a nominal year-on-year 14% in March.

More easing is likely in the months ahead. That's despite the rise in inflation in the year to March. The CPI rose from 3.2% in February to 3.6% in March. That's still well below the 6.5% recorded in the year to July last year and the official target of 4% for 2012. However, we are increasingly of the view that easing will be in the form of fiscal measures rather than cuts to interest rates. Further reductions in the reserve ratio are likely which will support the recent recovery in loans growth.

Those expected easing measures along with a modest recovery in Europe in the second half of the year (which will help exports) has us continuing to expect China GDP growth of 8.5% this year.

Friday, April 13, 2012

Spain and US Jobs

Two bits of not-so-good news this week: the worse than expected US March month jobs report and a re-emergence of European sovereign debt angst. The latter is the more critical of the two.

March US payrolls data was worse than expected, but it comes after three months of generally better data. We don’t read too much into monthly data which can tend to be volatile from month-to-month. This result hasn’t changed our view of modest debt constrained growth in the US this year and a continued gradual decline in the unemployment rate.

However, it does reinforce our caution in not jumping to revise up our growth forecasts for this year on the back of recently better data. Rather, we are taking the view that the generally stronger data is providing a better balance of risks around our expectation of 2% GDP growth this year.

The other consideration for markets is the likelihood, or not, of further monetary accommodation from the Federal Reserve in the form of a third round of quantitative easing. The best way to describe the situation right now is that QE3 remains less likely than it was at the start of the year, but more likely than it was last week. The probability of the Fed going down that path will continue to wax and wane with the data, but we continue to hold the line that more QE is not the answer to more fundamental economic growth issues in the US.

In Europe, yields on Spanish (promise to not use analogies with “rain”, “drain” or “pain”) and Italian debt have moved higher over the last few days. While we didn’t think for a second that the recent period of relative calm would last forever, we had hoped for a few more months of respite before European sovereign debt angst re-emerged.

The catalyst has been Spain’s recent revision of its budget deficit target for 2012. This was originally set at -4.4%. The Government wanted to revise that down to -5.8% of GDP, but negotiations with “the troika” saw a compromise at -5.3% of GDP. The deficit target for 2013 remains at 3.0% of GDP.

Forecasts for Spain GDP growth in 2012 are now -1.7%. The concern from markets is that if the deficit target starts to slip again, there will be deeper cuts to spending, a deeper recession and a downward spiral that completely loses the necessary balance between fiscal consolidation and building stronger economic growth. We are not great believers in the concept of expansionary austerity.

Spain needs a credible long-term deficit reduction plan and structural reforms to address poor growth dynamics, especially with regard to the labour market and productivity. Spain’s unemployment rate is 23% and youth unemployment is 50%. The IMF estimates Spain’s output gap is 3%. That suggests the current unemployment rate isn’t significantly higher than the structural rate of unemployment. That suggests some urgency for structural reform.

What Spain needs most is the political will to institute credible reform and time for those reforms to take effect. The same is true of Italy. Both countries are suffering from a liquidity problem, rather than a solvency problem. But a liquidity problem can become a solvency problem if left unchecked.

The good news is that compared with 2011, systemic risks in Europe are lower than they were. The LTRO (tranches 1 and 2) means that the banking sector is better funded. At the same time, the firewall continues to be built but still isn’t sufficient to cover the possible needs of both Spain AND Italy. The ECB can also reinstitute the SMP if needed.

Also the global economy is in better shape than it was at this time last year. US data is, on balance, stronger than it has been. And while China is slowing, we think it is close, if not at, the bottom of the current cycle. Recent March month loans and money supply data support that story.

Thursday, April 5, 2012

Lies, damn lies and statistics

This week’s release of US Federal Open Market Committee (FOMC) minutes have seen markets scale back expectations of a third round of quantitative easing (QE3). The minutes were more upbeat than they have been recently with the staff at the Federal Reserve bumping up their forecasts for both GDP and inflation. The more interesting point is they have reduced their estimate of the output gap, which means reduced scope for further easing.

There are a couple of quirks in some of the recent data that are quite fascinating. The first is one we have mentioned before: the fact that jobs growth in the payroll data has been lower than that in the household labour force survey (HLFS). It’s the latter that feeds into the calculation of the unemployment rate.

Previously we’ve put this down to the fact that the payrolls data from firms has not kept up with the significant change occurring in the US economy – the Schumpeter-esqe “creative destruction” - that has been expedited by the deep GFC recession. The payrolls data has not kept up with firms that have disappeared and, more importantly, the new ones that have started up. It’s interesting that the trend recently has been for monthly payroll out-turns to be revised progressively upwards.

Another statistical quirk has been the fact that Gross Domestic Product (GDP) has been growing at a slower rate that Gross Domestic Income (GDI). Both are perfectly valid measures of economic output with GDP adding up all the expenditure in the economy including consumption and investment, with GDI adding up the income including wages and salaries and profits of firms. While both measures vary from quarter to quarter, they should both be the same over longer time periods. Over the last six-month of 2011 the gap has started to open up again with GDI running higher.




Putting both quirks together, you get a picture of an unemployment rate that has fallen faster than the growth in official GDP would suggest. We tend towards the view that the HLFS jobs data and the unemployment rate are a good reflection of the labour market and that GDI is therefore likely to currently be a better estimate of growth than GDP.

How do you best reconcile the gap if you are the Federal Reserve? The answer is in the minutes: in its latest staff forecasts the Federal Reserve has “reduced its estimate of the level of potential output, yielding a measure of the current output gap that was a little narrower and better aligned with the staff’s estimate of labor market slack”. With regard to inflation, Fed staff have increased their forecasts on the back of higher oil and other commodity prices, but also to reflect “the somewhat narrower margin of economic slack in the March forecast”.

We continue to believe there is no imminent risk of the FOMC changing its forward guidance with regard to the current accommodative stance of monetary policy, but we agree with the interpretation of the minutes that further accommodation is less likely.

Wednesday, April 4, 2012

Manufacturing data consistent with our view of the world

The regular monthly flurry of manufacturing PMI indices from around the world hasn't changed our view of what's going on in the world. They are broadly consistent with our story of subdued recovery in America, mild recession in Europe and soft landing in China.

In America the PMI rose to 53.4 in March from 52.4 in February. The strength in production (58.3) and employment (56.1) were especially pleasing. The employment index is at its highest level since June last year and is consistent with other recent employment data. The export index came back a bit but is still reasonably robust at 54.

There is nothing in this result to shift us from our expectation of 2% GDP growth in the US this year. We see the recent better activity data as improving the balance of risks around that forecast.

In Europe the March index fell to 47.7 from 49.0 in February. Our view on Europe is that while we think they have avoided a deep recession, the mild recession that began with the contraction in December quarter GDP will continue to mid-year. This result is consistent with other weak data such as the recent rise in the unemployment rate to 10.8%.

The surprise result was the strength in the China official PMI index which rose to 53.1 in March from 51.0 in February. At least part of this rise appears likely to be due to seasonal factors.

The rise in the official index is inconsistent with the previously released HSBC index which recorded a level of 48.3, under the 50 benchmark. The indices have different coverage with the HSBC index capturing smaller factories while the official index captures the larger SOEs. It is not unusual for these indices to diverge.

The stronger read of the official index supports the soft landing story and that the March quarter may be the weak point in the cycle. However, we are not reading too much into one surprise reading, especially with other contradictory data. We continue to believe that further easing in monetary and fiscal settings will be required before we can be confident of a turnaround in growth prospects in China.

Monday, April 2, 2012

Take it easy Brazil

When the Banco Central Do Brasil began cutting the benchmark Selic rate last year, we urged a bit of caution. As it has turned out, they have cut interest rates more aggressively than we thought, largely in response to the faster than anticipated slowdown in GDP growth, especially over the last 12-months.

Since August 2011 the Selic rate has been cut from 12.5% to 9.75% currently. The minutes from the latest monetary policy committee meeting (Copom) suggest interest rate cuts are nearly done. That’s entirely appropriate given ongoing structural issues that suggest inflation is far from dead and buried.



When we argued for caution on monetary policy, our point was that Brazil wasn’t suffering from weak domestic demand. The real problem is the strong exchange rate (excuse the pun) which has damaged competitiveness. However, that same exchange rate strength has given a boost to household real incomes that has supported growth in demand: retail sales growth has recently accelerated to 7.3%. At the same time the unemployment rate is at a 25-year low of 5.23 %. Wage growth is also accelerating ahead of an increase in the minimum wage. That does not make for a benign inflation environment.




There is no easy answer for Brazil. Remember our line that while emerging markets don’t have the same structural problems as the developed economies, they have their own structural problems. Brazil risks going down the path of relying on monetary policy to fix an economy constrained by broader structural factors. Supply-side reforms (sound familiar?), especially with regard to the labour market and aimed at boosting productivity seems a sensible path to take.

In the meantime it appears likely the central bank will bring the Selic rate down a bit further to around 9%. That’s low by historical standards. Headline inflation is also likely to move lower in the months ahead, but the authorities need to remain vigilant to signs of re-emergent inflation pressures. The biggest risk to long-term prosperity in emerging markets is any lack of commitment to contain inflation.