Sunday, October 28, 2012

Good US GDP result, headwinds remain

US economic growth picked up in the third quarter of the year, posting a seasonally adjusted annual rate (saar) of 2.0%.  That’s slightly higher than market consensus and a stronger result than the 1.3% increase reported in the second quarter.  However, headwinds remain, not the least of which is the looming fiscal cliff.
 As indicated by recent retail sales and other consumer-oriented data, the key contributor to the third quarter result was higher consumer spending.  As I have commented on previously, higher consumer confidence on the back the recovering housing market and recent sharemarket strength.  That saw consumer spending rise at a 2.0% saar in the quarter, largely on the back of stronger durable goods spending.

However, the factors we continue to rely on to be the key driving forces of the American recovery did not fare so well.  Exports fell at a saar of 1.6% while business fixed investment grew at a paltry 1.5% with equipment and software spending flat.  The slowdown in global growth and concerns over the fiscal cliff are weighing on both sectors.

Looking ahead it remains to be seen whether this pace of consumer spending is maintained in the end of the year.  While we believe we are the early stages of a mutually reinforcing cycle of a recovering housing market, higher consumer confidence and more stable consumer spending, fiscal cliff uncertainties and continued deleveraging will weigh on consumer spending over the short and long term respectively.

Business investment is likely to remain soft in the period ahead, largely due to fiscal cliff concerns.  Core capital goods orders have fallen sharply recently so a contraction in business investment appears on the cards for the current quarter.  However, we believe that once the fiscal cloud has lifted, we would expect business investment to pick up again.  The good news on the export front are the signs of stabilisation of the recent slowdown in global growth, supporting our view of a modest pick-up in global growth next year.  

For now the key uncertainty is the fiscal cliff.  As discussed before, we think post-election the politicians will kick the can down the road.  Unfortunately that means the uncertainty goes on for longer; businesses who are delaying hiring and investment decisions because of fiscal uncertainty will have reason to delay further.  Delaying decisions of key fiscal policies means the debt ceiling will need to be lifted again, probably in March.  That risks another acrimonious political debate as we saw last year.  That will depend on the strength of mandate of the new (or renewed) President.  Will he have the House and the Senate?  I think that may be wishful thinking.  More on the fiscal cliff next week.

Thursday, October 25, 2012

Balanced statement from RBNZ

The first statement from the Reserve Bank of New Zealand under the leadership of new Governor Graeme Wheeler was appropriately balanced.  The statement finishes with: “For now it remains appropriate for the OCR to be held at 2.5%.”  I concur and continue to believe the next move in interest rates is up.

With respect to the global economy the Bank continues to point to the fragility of the global economy but notes the improved sentiment and a more balanced risk to the outlook.  Agreed.  Recent data, particularly out of America and China, has been supportive of our view that the recent slowdown in growth is bottoming out and that a modest recovery is likely next year.  The US “fiscal cliff” is the major near-term uncertainty.

The paragraph on the domestic economy was essentially unchanged from September: there are positives and negatives for the growth outlook.  On the plus side we have the increasingly evident recovery in the housing market and the Canterbury rebuild while on the downside we have fiscal consolidation and the high New Zealand dollar.  Our own growth forecasts for the second half of 2012 have the New Zealand economy growing at around half the pace of the first half before picking up into 2013.

The Bank acknowledges the current low inflation rate (headline inflation 0.8% for the year to September), but continues to expect inflation to head back to the middle of the target range.  Again, that’s consistent with our own view. 

All that means the Bank retains its tightening bias, it’s just a matter of when to begin the process.  I think that’s entirely appropriate.  While I would never rule anything out, an interest rate cut retains a low probability.  Most calls for a reduction in interest rates appear tied to the perception that such a move would bring the New Zealand dollar down.  I’m not convinced that’s the case.  The NZD is high for a number of reasons, not the least of which is quantitative easing in America and elsewhere.

At possibly high risk of reading too much into a couple of phrases, I like the acknowledgement that further recovery in the global economy remains “heavily dependent on policy implementation”.  I think in many countries around the world policy makers have become too reliant on monetary policy to fix their woes.  As I’ve said many times before monetary policy can’t fix structural economic problems, for that we require a broader policy response.   It will come as no surprise to regular readers that I also like the statement:  “We will continue to monitor inflation indicators, such as pricing intention and inflation expectation data, closely over coming months.”   

Those sentences together seem to me to be an entirely apt reminder that monetary policy plays an important but limited role in building higher sustainable growth and that role is anchoring inflation expectations.   If that makes me a hawk, then I’m happy to be one.

Sunday, October 21, 2012

Further incremental progress in Europe

I’ve come to learn the best one can hope for out of any European Summit is incremental progress.  The latest Summit didn’t disappoint.

The key outcome was further progress on European banking union.  Remember if full fiscal union is too challenging (at least right now) a banking or financial union is the next best thing.  The June summit commitment to banking union was really nothing more than a commitment to consider the concept.  After the latest Summit we now have a firmer timetable for the establishment of the Single Supervisory Mechanism (SSM), which will be run by the ECB.  The communiqué commits to agreeing the legislative framework for its establishment by 1 January 2013.  That’s a positive step forward.

However, what excited me most about the June summit was the possibility the ESM would be used to recapitalise banks directly.  On that there is still less clarity.  The communiqué states that work on the operational implementation will take place over the course of 2013”.  That’s still too vague for my liking.  At issue is whether the ESM will be able to act retrospectively.  Under current rules, Spain will have to finance its own bank bailout, just as Ireland is (Ireland has won agreement its bank bailout will be treated the same as Spain’s).  However, German Chancellor Angela Merkel is not keen on the ESM being able to bailout banks for past mistakes stating that debts incurred in the past should be the responsibility of national governments and that if direct recapitalisation is possible “it will be for the future”.  There’s obviously still a lot of detail to work through.  Watch this space.

There was no major development with respect to Spain at the Summit.  Spanish bond yields have moved sharply lower in recent weeks, helped recently by Moody’s sovereign rating decision.  In my view lower bond yields do not reduce the need for a bailout, that’s because yields are mostly lower in anticipation of a request for assistance.  However, it’s also important to acknowledge progress is being made in Spain: the latest budget was another step forward (although built on likely too optimistic growth forecasts), labour costs are falling and the current account deficit is reducing (albeit mostly due to the recessionary impact of lower imports).  We still expect the Government to request a formal bailout; it seems to me to be just a matter of when.  Spain has significant refinancing needs next year which they seem to be unlikely to achieve without ESM/ECB assistance. 

With respect to Greece, the Government won praise for its efforts to get the fiscal consolidation plan back on track.  That should open the door to receipt of the delayed bailout tranche next month.

Friday, October 19, 2012

Recovery in China on the way

China GDP growth slowed as expected into the third quarter of 2012.  The good news was that partial activity data for the September month supports our view of a modest cyclical recovery.

GDP growth slowed from 7.6% in the year to June to 7.4% in September.  That reflected a 2.2% rise in the quarter. The NBS has only recently started producing quarterly GDP data, so we are not putting too much weight on it, but the series shows the weakest point in the cycle was the March quarter with q/q growth of 1.5%.

The good news came in the detail of the September month partial data.  Industrial production rose from 8.9% in August to 9.2% in September.  The recent slowdown reflects destocking efforts which may still have further to run.  However, lower inventories along with a modest recovery in demand next year bodes well for production further down the track.

Retail sales data was also good with the annual rate rising from 13.2% to 14.2% from August to September.   Domestic demand has held up well during the recent slowdown and reflects the authorities rebalancing efforts. 

Fixed Asset Investment also rose, primarily reflecting initiatives to boost infrastructure spending.  Manufacturing investment remains soft reflecting overcapacity.  Residential investment is still soft also although signs the recovery in house prices and sales bodes well for a modest recovery in construction in the period ahead.

This data comes on last week’s good loans and money supply data.   With monetary policy efforts focussed on reductions in the bank reserve rate, this is where we have been looking for early signals of a cyclical turning point.  I like what I see.  Export growth also rebounded in September, although that data is notoriously volatile.  It's too to expect a sustained increase in China exports. 

This data supports the view that we are on the verge of a cyclical pick-up in GDP growth.  That further reduces the need for urgent and aggressive policy action; we expect authorities will continue the process of policy "fine tuning".  We are happy with our view that GDP stabilizes at 7.4% into the fourth quarter for full year annual average growth of 7.6% with a recovery to 8.0% in 2013.

Thursday, October 18, 2012

The US housing market, consumption and near-term growth prospects

I like what I’m seeing in America at the moment:  the housing market is staging a modest recovery, consumer confidence is moving up and consumer spending has had another relatively good quarter.   I’m almost tempted to have another crack at predicting a more sustained recovery in the US economy.  The key word there is “almost” – there are still a number of headwinds, not the least of which is the uncertainty around fiscal policy in 2013.

There’s only one way to describe US September housing starts: a surge.  Starts were up 15% in September to an annual pace of 872,000 – the highest level since the depths of the GFC.  Furthermore previous months’ data was revised up and it was good to see the gains were broad-based across single-family and multi-family dwellings.   Permits rose 11.6%.  After such a hefty rise in the month we wouldn’t be surprised to see a bit of a correction next month.  That excitement of course continues to be tempered by the fact the improvement is off a low base but the trend is undeniably positive.  Housing starts are now nearly back up previous cyclical troughs!!
That news comes right on the heels of another good retail sales result in September.  That shows that higher (less bad to be precise) consumer confidence levels are feeding through into real activity.  I’m a little bit surprised at that – although the overall consumer confidence index rose 9.0 points to 70.3 in September, most of the improvement came through in the expectations (forward looking) series which rose 12.6 points to 83.7.  The current economic conditions series rose a more subdued 3.7 points and remains depressed at 50.2. 

Obviously improved expectations about the future have been sufficient for folk to open their wallets.  Sales rose 1.1% in the September month following a stronger-than-initially-reported 1.2% gain in August.  The first thing to do when you get a stronger than expected retail sales result is to look at core sales (which takes out car sales, petrol and building materials), but that also put in a solid 0.9% m/m gain.  Sales were strongest in electronic stores (the Apple effect?).

Nominal sales are up a 5.5% annual rate over the September quarter.  That suggests that consumption is likely to make a slightly stronger contribution to Q3 GDP than it did in Q2.  We continue to expect Q3 GDP to print at around a 1.6% seasonally adjusted annual rate (saar).

But what about further out?  The improvement in the housing market, the rise in consumer confidence and relatively robust retail sales are inextricably linked.  The recent stronger share market will also be having a positive impact on confidence.  But there are reasons to be cautious, as indicated by still soft current conditions readings in the consumer confidence surveys.  We think that reflects still high petrol prices, uncertainty around the “fiscal cliff” and the continuing softness in the labour market (although the surprise drop in the unemployment rate to 7.8% in September will have helped).  All are likely to conspire to see a lower GDP growth outcome in Q4.  We’ve currently got 1.2% (saar) pencilled in.  More generally however, the improving housing market will help lend an element of stability to the albeit subdued rate of GDP and employment growth.

Tuesday, October 16, 2012

NZ CPI lower than expected, but no rate cut

New Zealand September quarter CPI inflation printed at +0.3% q/q, lower than the average market expectation of +0.5%.  The annual rate of increase now stands at 0.8%, below the bottom end of the Reserve Bank’s target range.  However, the lower than expected result does not change our view of the next move in interests being a rate hike in June 2013.

The key feature of the result was the continued inflation-dampening impact of the high New Zealand dollar.  Tradeable sector inflation came in at 0% for the quarter for an annual rate of -1.2%.  However, non-tradable inflation came in at +0.5% q/q for annual rate of +2.3%.  The distinction is important for reasons other than discerning the impact on inflation of changes in the level of the New Zealand dollar: it is non-tradable inflation that the Reserve Bank has most direct impact on via its monetary policy settings.


Another important factor in today's result is the continued emergence of inflationary pressures in the housing sector.  This is a key factor in our belief that an interest rate cut remains unlikely in the period ahead.  Remember, monetary policy settings are already highly stimulatory.

At this point I'm still happy with the view that the next move from the Reserve Bank is a rate hike.  However, likely soft GDP growth over the next six months suggests the Bank still has time on its side.  After growing 1.6% in the first half of 2012 we believe New Zealand GDP growth will be around half that level in the second half of the year: we have +0.4 q/q pencilled in for the September quarter and +0.5% q/q in December.

With respect to the global economy, we believe we are currently seeing the early signs of stabilization in the recent slowdown in economic growth.  By early 2013 we expect there will be clear signs of a (modest) recovery.  The key risk to that view is the impending US “fiscal cliff”.  At this point our view remains that can gets kicked down the road a few months.  

A recovery in global growth will be supportive of a recovery in NZ export demand and commodity prices.  Furthermore, we expect Christchurch rebuilding efforts to be gathering momentum as 2013 progresses.  This will be a key factor behind the expected absorption of spare capacity in the domestic economy next year.

It's important not to read too much into historical inflation results.  While they have some information content it's important not to forget that monetary policy is about where inflation is heading, not where it's been.  I'm therefore still happy with our central case scenario that the RBNZ will start to move interest rates higher from June next year.

Tuesday, October 2, 2012

September PMIs

September PMI data was generally better across the board with increases in the China and US indices and a Europe index that didn’t get any worse. 

The US was particularly pleasing with a rise from 49.6 in August to 51.5 in September which puts the index back into expansion territory.  The biggest gain came through new orders which rose from 47.1 to 52.3.  All the key indices moved in the right direction: the inventories index fell, the employment index rose and while the export index remained under 50, it put in a modest improvement.
 We’re not reading this result as a sign of a resurgent US economy, but rather previous readings had become too pessimistic for an economy that we believe is continuing to expand on average at around a 2% annual pace.  There are still near term headwinds such as fiscal uncertainty and broader global economic weakness that will continue to constrain growth, especially exports.

The Europe PMI came in at 46.1 in September, up from 46.0 in the prior month.  The good news in this case is that it didn’t get any worse.  This supports other data that tells us the European recession intensified into the third quarter and there are no signs of imminent recovery.  Notably data out of France deteriorated sharply.  Up until recently France, along with Germany, had been withstanding the austerity headwinds better than most.

The China PMI was better, rising from 49.2 in August to 49.8 in September.  New orders were 49.8 (up from 48.7) with export orders rising to a “less bad” 48.8 (46.6).  Weak external demand, particularly out of Europe, will continue to be the major constraint on this sector in the near term.  This result makes us more comfortable that while we expect China GDP growth to slow further to Q3 to around 7.4%, we don’t expect it to deteriorate further into the end of the year. 
The global PMI came in at 48.9 for September, up from 48.1 in August.  The improvement was mostly driven by the recovery in the US index.  That’s in line with the recent downward revision in our calendar 2012 global GDP growth to 3.0% (see Global Growth Outlook).