Wednesday, November 28, 2012

Greece - still not a full solution

Markets have taken the latest Greek debt machinations in their stride.  Perhaps that’s because there are bigger things to lose sleep over at the moment, such the US fiscal cliff.  Regardless of the reason, Greece still matters so long as the risk of contagion from a messy default lingers.

Measures announced yesterday should go a reasonable way towards reducing Greece angst for a little while longer.  At issue was the 2013 Budget showing a debt to GDP ratio reaching 190%, well in excess of the expected peak of 167% expected just in March.  That’s due to the recession being deeper than expected on the back of ever more austere budget measures which were on the back of the recession being deeper than expected....and so on.

So if you thought the target of reaching a debt to GDP ratio of 120% by 2020 was dubious in March, it had just become a whole lot more dubious.  Fortunately the “troika” (the European Commission, the IMF and the ECB) have realised that if Greece is to move to a position of fiscal sustainability and economic viability, a more balanced approach is required.  The authorities therefore agreed to give Greece an extra two years to reach it primary budget surplus target of 4.5% of GDP, shifting the data out from 2014 to 2016.  That’s a positive and pragmatic step forward.

That left the issue of how to fund the budget gap that extension would create and to move the debt to GDP ratio to more sustainable levels over time.   For that a number of solutions have been developed to achieve medium-term sustainability within tight political (other Euro zone countries) and operational (ECB) constraints.

The measures include a reduction in the interest rate Greece pays on its debt and extension of the debt maturity.  Also, national central banks are to repatriate their profits on ECB holdings of Greek government bonds back to Greece.  The Eurogroup Communique also makes reference to Greece considering debt buy-backs.  The speculation is that the EFSF will make cheap funds available to Greece to buy back outstanding debt at 35% of face value.  The IMF is withholding its share of the next tranche of the bailout funds until it sees more detail on this part of the plan.

As a result the Greek debt to GDP ratio is expected to fall from 175% of GDP in 2016 to 124% in 2020 (previously 120%) and to “substantially lower” than 110% by 2022.

The bit I still worry about is the high degree of structural reform required in Greece, particularly with respect to the labour market, if it is to meet the growth projections underpinning the Budget forecasts.  It’s hard to see much progress on that front while the country remains in deep recession.  So while this package of measures parks the Greece problem for a little while by establishing a modified fiscal trajectory, it is not yet solved.

Tuesday, November 27, 2012

Fiscal cliff negotiations begin in earnest


Fiscal cliff negotiations have begun in earnest.  I remain of the view that the there will be a positive outcome.  Remember “positive” in this context means fiscal policy will be more contractionary next year than this, but not to the full extent the cliff would suggest.
 
The good news is that US underlying economic fundamentals continue to improve.  Recent housing market and manufacturing data continue to turn up, and that’s even in the aftermath of super-storm Sandy.  Also initial jobless claims are heading back down from their Sandy-induced spike higher.
 
Furthermore, market expectation is that US third quarter GDP will be bumped up from an initially report seasonally adjusted annual rate (saar) of 2.0% to around 3.0% when the first revision is released this week. That means the slowdown we expect to see in the current fourth quarter will be coming off a higher base.
 
We know that firms have been delaying hiring and investment decisions in the face of fiscal uncertainty.  As the fiscal murk clears we expect to see a bit of catch-up activity on both fronts which we expect to flow through into the number in the first half of next year.
 
That means a higher level of fiscal contraction will be happening at a time when underlying fundamentals are improving.  The organic recovery we are seeing in the US housing market is especially pleasing in that regard.  Another positive, or at least non-negative, is that the drag on GDP growth from US state and local Government appears to be diminishing.  That’s a good thing as Federal austerity steps up a notch.
 
Despite our expectations of an eventual positive outcome the next month of negotiations will not go smoothly.  Sure President Obama has a fresh mandate and the GOPs have no moral authority to assert their programme on an electorate that chose the other team, but neither will they cave in on their principles.  Be prepared for a bumpy ride.

Tuesday, November 20, 2012

Outlook for monetary policy in New Zealand

Recent data has pointed to a soft patch in the New Zealand economy in the third quarter of 2012.  The September quarter Household Labour Force Survey (HLFS) was exceptionally weak with employment falling and the unemployment rate rising to a 13-year high.  Weak retail sales data has us now expecting GDP growth of only 0.2% q/q in the third quarter.

We have long expected that growth would be weaker in the second half of the year than it was in the first.  March and June quarter GDP results were both higher than expected for a total of 1.6% for the first six-months of the year (3.2% annualised).  My mistake was to bank those gains into higher expected growth for the year.  Prior to the revision down in Q3 growth I had expected annual growth of 2.6% in calendar 2012, which now looks like coming in at 2.3%. 

Annual growth drops down further to just under 2% (our estimate of New Zealand post-GFC potential GDP) in the year to March 2013 as the strong March 2012 quarter drops out of the annual calculation.  From there we continue to expect a modest recovery in growth over the course of 2013, largely on the back of stronger construction activity and not just out of Christchurch.

 
However it’s the labour market that has me most puzzled right now.  As I said in the post below, the weak reading from the HLFS was inconsistent with other labour market data especially wages, unit labour costs and anecdotal skills shortages.  Regular readers will know I believe that New Zealand’s rate of structural unemployment is higher than it was pre-GFC, but that shouldn’t be causing us too many problems just yet.  Furthermore, I just don’t believe the significant productivity gains recent ongoing growth but weak labour market implies. 

So what will the RBNZ think about all of this?  More importantly, what does it mean they are likely to do at the next Monetary Policy Statement on December 6th.

The last set of forecasts we have from the RBNZ are those incorporated in the September Monetary Policy Statement.  The near term growth numbers look weaker: we how have growth for the second half of 2012 at +0.7% for the half year compared to the Bank’s +1.1%.    The biggest change will be in the labour market where the Bank was forecasting an unemployment rate of 6.4% by March 2013 and 5.3% a year later, which we now have at 6.8% and 6.0% respectively.  Labour costs will be much in line with the previous forecast, but the starting point for inflation will be lower given the softer than expected Q3 inflation outcome.

But that’s where we think the differences will likely end.  Forward looking indicators are still supportive of the medium-term growth outlook still looking reasonably good, if not robust.  Consumer and business confidence are looking consistent with ongoing growth and recent PMI and PSI data from the BNZ suggest the September quarter weakness should prove temporary.  Another key indicator that has been supporting the broader recovery story is the nascent recovery in credit growth.  We are also increasingly confident of a modest recovery in global growth next year.  In particular we remain optimistic that US fiscal cliff issues will be resolved and China activity data is looking more upbeat.


We think the Reserve Bank will continue to forecast a pick-up in GDP growth and a reduction in the unemployment rate over the course of 2013 – but the difference will be the starting point.

Then there’s the housing market to consider.  Activity in the housing market is clearly improving.  Sales activity is recovering, house prices are moving up and housing permits are on the rise.  Importantly, this is not just a Christchurch phenomenon, other parts of the country are seeing recoveries  too.  One of the questions I get asked most often is whether there is a bubble forming in the Auckland housing market.  I don’t think there is, but there is clearly a shortage of housing in Auckland that requires a supply-side response.  So a construction-fuelled increase in activity is still on for 2013.  This is likely to be sufficient we think to see GDP growth up to 3.0% in the year to March 2014.

We also can’t ignore a number of post-GFC realities.  Growth was always going to be challenging, especially for the retail sector.  Consumption has been, and will continue to be, constrained by household deleveraging, the soft labour market and only modest wage gains.   These are at least partly a function of structural change, not tight monetary policy. Furthermore, it remains the case that some degree of economic rebalancing is desirable: i.e. away from consumption and housing and towards investment and exports.  These are all factors the RBNZ will be considering as it makes its decision on interest rates for the December MPS.

In the absence of a clear sign as to whether the recent weakness in activity will be sustained, they are likely to continue to assume that higher growth is still likely into 2013.  The RBNZ also needs to take a cost benefit approach to its decision on the 6th.  We don’t think a cut in interest rates right now will lead to a significant difference in growth.  Interest rates aren’t precluding higher consumption and neither are they precluding business investment and hiring decisions – other global and structural factors are at play.

The exchange rate is a bigger problem than interest rates.  Regular readers will also be aware that we don’t think a cut in interest rates will have much impact on the New Zealand dollar.  Interest rate differentials aren’t leading to a higher New Zealand dollar.  We put most of the “blame” for that on the still relatively high terms of trade and quantitative easing in other jurisdictions.  The new Reserve Bank Governor was of the same view in his maiden speech recently.


But what lower interest rates would do right now is provide further stimulus to an already recovering housing market.  That is undesirable from a medium-term  rebalancing perspective.  Calls for lower interest rates right now are missing the point.  New Zealand, like most of the rest of the developed world is facing structural issues that monetary policy is powerless to influence.  Higher productivity is the answer.

For me the most likely, and most prudent course of action  on December the 6th is for the RBNZ to leave interest rates unchanged.  They will however most likely shift out their expected tightening from the end of 2013 to the beginning of 2014.

 We have been expecting the tightening cycle to begin in mid 2013.  We now shift that out to the less definitive “second half of 2013”.  I’m still happy to be forecasting an earlier tightening than the RBNZ is likely shift to next month.  My assessment is they are underestimating some of the structural challenges in the economy, but we are still some time away from that becoming evident.

Friday, November 16, 2012

Odds of a NZ rate cut rises, but still not our base case

The New Zealand economy hit a soft patch in the third quarter, at least in terms of employment and retail spending.  The key question is whether the recent run of poor data has changed our view of a modest acceleration in growth next year, largely on the back of higher construction activity.  The short answer is no.  The key question with respect to monetary policy is whether it’s changed the RBNZ’s view of the future.  We will find that out at the next Monetary Policy Statement on December 6th.

The rise in the Household Labour Force Survey (HLFS) unemployment rate to 7.3% in the September quarter was both a surprise and a disappointment.  It was a surprise largely because it was inconsistent with other labour market indicators.  The earlier release of the Quarterly Employment Survey (QES) had made me MORE comfortable with my expectation of a modest increase in employment and a decline in the unemployment rate in the HLFS.  How wrong was that?

Wage data in the QES was also consistent with a labour market that is muddling along.  Hourly earnings were up 2.8% y/y and unit labour costs up 1.9% y/y.  That’s not indicative of a strong labour market, but neither is it a sign of weakness.  Even more difficult to interpret was the combination of a 2.0% y/y fall in hours worked in the HLFS and a 1.9% increase in paid hours in the QES.  Confusing? Suffice to say we will be monitoring labour market indicators closely in the period ahead.

The weak labour market picture was lent some credence by the reported weakness in the September quarter retail sales.  We had expected a soft number following the reasonably strong June quarter and our expectation that it was likely we would see a reduction in the annual given the strong base of September 2011 which had started to benefit from Rugby World Cup activity.  We also keep reminding ourselves that this is not meant to be a consumer driven recovery!!  However, the -0.4% q/q out-turn (in inflation adjusted terms) was weaker than we were expecting.

Our expectation was the second half of 2012 would be weaker than the first half, but it now looks weaker than our initial estimate.  The retail sales result knocks my +0.4% Q3 GDP forecast down to +0.2%.  We still expect construction and exports to be strong, however high export growth will be moderated somewhat by the fact that some of this (dairy) will be coming out of the build up in inventories that boosted growth in the first part of the year.

In terms of monetary policy, the key question is whether the weakness we have seen in the data over the last few days is the start of a new trend or just a short-term bout of weakness.  I’m thinking it’s the latter at this point.  That’s supported by the forward looking indicators we monitor such as business and consumer confidence and dwelling permits which continue to point modest underlying growth and pick-up in building activity in the months head.  So while the odds of a rate cut have certainly risen in the past 10-days, we still expect the next move from the RBNZ to be a tightening in monetary conditions.  More on New Zealand growth, inflation and the outlook for monetary policy next week.

Tuesday, November 13, 2012

China activity data provides upside risk to GDP

Last week’s plethora of China activity data was all better than expected.  Annual growth to October in retail sales, exports, fixed asset investment and industrial production were all up on the growth recorded in the year to September.  It’s only the more recent release of new loans growth and money supply data that has taken the shine off a little bit by not meeting expectations.  Credit conditions remain relatively tight however social financing appears on track for a record year which will provide ongoing support for GDP growth. 
The authorities have maintained a cautious approach to easing with only a modest cut to interest rates in the middle of the year and three reductions to the bank reserve ratio that still leaves it significantly higher than the historical average.  More recently the authorities have been using short-term liquidity measure to free-up credit markets.

The tick down in annual inflation over the last two months suggests policy could have been eased more aggressively however the authorities have also been concerned not to reflate the bubble in some parts of the residential property market.  Also the labour market and domestic spending (nominal retail sales +14.5% in the year to October) have held up well, negating the need for more aggressive policy action. 

While we expect inflation to head higher from the current 1.7% annual rate in the period ahead, it appears unlikely to test the official target of 4% any time soon.  The PBoC appears likely to continue the process of “fine tuning” policy settings but they have ample room to be more aggressive should that be needed. 

At the moment it looks like it won’t be needed.  Our China GDP forecasts have annual GDP growth stabilising at the September level of 7.4% into the end of the year.  That would give annual average growth of 7.6% for the 2012 calendar year, just a tad higher than the official target of 7.5%.    The better activity data suggests there is an element of upside risk to our year-end forecast.  It’s been a long time since we’ve been able to say that about China, or any country for that matter.

We are also keeping a watchful eye on the leadership transition currently underway.  So far signals from the Communist Party Congress (at least from outgoing President Hu Jintao) appear supportive of continued rebalancing in the economy towards consumption.  Less positive are the signals that a heavy state involvement in key industries will be maintained.  That will constrain gains in productivity that will be essential if incomes are to rise to support higher consumption, at the same time as inflation is kept in check.

Thursday, November 8, 2012

Four More Years

Who said it would be close?  Yesterdays US election showed the risk of relying on opinions polls to predict US elections when what ultimately matters is the share of electoral college votes.  On that front, President Obama has won well.

As I said last week, what ultimately mattered for us was the strength of the Presidents mandate, regardless of who won.  On that front the legislative process will remain fraught as Congress remains divided: the GOPs retained control of the House while the Democrats retained control of the Senate.

Early on it appeared Obama might win the Presidency but lose the Popular vote.  That would have made things more challenging for Obama as the GOPs would have no doubt claimed the moral victory.  As it turned out Obama assumed the lead as the vote count moved progressively west.

The immediate challenge for the President is averting the fiscal cliff.  On that I don't have much more to say at this point than what I said last week.  Both parties will need to work together.  The President can argue a fresh mandate, but a smooth process relies on the GOPs following the lead from Romney's concession speech and not risking partisan bickering and political posturing.  I hope that was more than just graciousness in defeat. We will soon see.

The challenges for America go beyond the immediate need to resolve the fiscal cliff.  There is still the bigger challenge of long-term fiscal sustainability.  That requires a comprehensive and credible long-term plan.  All we can really say at this point is that fiscal consolidation under Obama is likely to mean a mix of both revenue and expenditure initiatives.

The Obama victory removes some uncertainty around monetary policy.  The GOPs had been critical of recent Federal Reserve actions and Romney had committed to not renewing Ben Bernanke's tenure when his current term expires in early 2014.

More generally the election campaign was light on any broader policy agenda - from both sides.  A stronger America needs more than central bank action and aversion of the fiscal cliff. 

Tuesday, November 6, 2012

Crucial vote in Greece this week too

The US isn’t the only country facing a crucial vote this week.  On Wednesday the Greek Parliament votes on the latest round of austerity measures thrashed out with the “troika” of the European Commission, the International Monetary Fund and the European Central Bank.  That vote will be followed by a further vote on the 2013 Budget at the weekend which will come just a day before the next Euro-group meeting of Finance Ministers in Brussels that should, assuming everything goes smoothly in the Greek Parliament, unlock the next tranche of bailout funds.

It appears that one member of the governing coalition, the Democratic Left, does not support the package.  They have been arguing for more concessions on labour reform.  Even without their votes, the package is still likely to be approved.  Prime Minister Samaras’ New Democracy Party and Pasok together control 160 seats in the 300-seat parliament.  That’s comfortable assuming members vote on Party lines.

The austerity package includes a number of fiscal and structural reforms that should save 13.5 billion.  However, the Budget will also show the debt-to-GDP ratio heading over 190% of GDP by 2014, rather than the peak of 167% envisaged  at the time of the March bailout agreement.  That’s a function of a deeper recession (the lost balance between growth and austerity coming home to roost) and delays to the fiscal consolidation plan caused by the inconclusive May election.

The stakes are therefore higher than just receiving the next tranche of the bailout.  Agreement on the latest austerity plan is also likely to bring revised bailout terms to provide an extra 13-18 billion in financing.    This could include a number of options such as lowering the interest rate on bailout loans.

The debt burden remains too high and it appears less and less likely that Greece will meet its debt to GDP target of 120% in 2020.  However, we continue to believe it’s best for all concerned if Greece and the rest Europe sort this out together.

Monday, November 5, 2012

Good run of US data continues

A slew of US economic data over the past week supports the view of continued modest economic growth.
October payrolls surpassed expectations with a gain of 171k with gains recorded in most sectors.  The prior two months were also revised upwards.   Private payrolls expanded 184k as the government sector continued to be a drag on overall employment growth.  Especially pleasing was the 13k bounce back in manufacturing employment and the 17k gain in construction, indicating recent better data out of the housing market is flowing through to employment.
The unemployment rate rose from 7.8% in September to 7.9% in October.  That was driven by another modest gain in the participation rate following the low point in August.  Despite the increase in the month, the trend in the unemployment rate is down but progress remains arduously slow (hence QE3). 
A decline in the unemployment rate is usually accompanied with an increase in wages.  Not this time. Hourly earnings were flat over the month with the annual rate running at only 1.1%.  With spare capacity in the labour market still so high, there is limited pressure on wages.  However, we remain of the view that structural unemployment in the US is higher than pre-GFC. 
The ISM manufacturing index rose modestly to 51.7 in October, with positive contributions from production and new orders.  The new orders index came in at 54.2 which is consistent with continued expansion in the sector.  The export and import indices were both weak no doubt reflecting lower global growth, especially China and Europe.  Overall, the survey is consistent with our view that while we expect continued growth in the fourth quarter, it is likely to be below the 2.0% recorded in the third quarter.
Personal consumption expenditure rose 0.8% in September, up from 0.5% in August.  In real terms however, the September increase halves to 0.4% following 0.1% in August.  On the other side of the equation personal incomes rose 0.4% in September.  However, in real terms incomes were flat following a 0.3% decline in August.
That suggests higher expenditure over the month came from savings or borrowing.  That’s why we have been cautions about extrapolating better consumer spending in the September quarter further out.  While we think improving consumer confidence (Conference Board Consumer Confidence rose 3.8 points to 72.2 in October) the highest level in four years) will help stabilise consumer spending, we are not expecting it to be a driving force of the recovery until either jobs growth accelerates or wages rise more significantly.
In other data released last week the Case-Shiller house price index rose 0.9% in August to be up 2.0% for the year.  Construction spending rose 0.6% in September.  Residential outlays rose 2.7% in the month while private non-residential outlays remained weak.  Finally, factory orders rose 4.8% in September, although that wasn’t enough to offset the 5.1% decline in August.
Of course the potentially biggest economic story in America last week was super-storm Sandy.  Early estimates put the damage at US $50 billion.  In terms of GDP impact, the initial impact will be negative the medium term impact will be positive as rebuilding of homes, buildings and infrastructure takes place.  Of course that makes no allowance for the immense anguish and suffering of those who have been directly impacted.
All together last week’s data points to an economy that continues to expand, albeit at a modest pace.  Fourth quarter will most likely be weaker than the seasonally adjusted annual rate of 2.0% recorded in the third quarter.

Friday, November 2, 2012

The US election and fiscal cliff

Elections are always important, but next week’s US Presidential election is more critical than most, at least for near-term fiscal policy.  At issue is the so-called “fiscal cliff” and the unlikely event that inaction from policymakers will see a significant increase in fiscal contraction in 2013 as tax cuts expire and automatic spending cuts (sequestration) begin.  What we don’t know is what action will be taken to avert the cliff and when that action will be taken.  The uncertainty will start to be lifted as we find out next week who is in charge in the White House.

Of course whoever the President will be come January is only part of the political equation.  The question I get asked most frequently at the moment is who I would prefer to see in the White House.  The more important question for me is the strength of the President’s mandate.  That will be determined by whether he has both, one or neither of the House or the Senate.

Since the mid-term elections in 2010, President Obama has had to manage a divided Congress.  Recall it was at that point the Democrats lost the House but retained the Senate.  That has made it difficult to make decisions and enact legislation as witnessed by the debacle of last year’s debt ceiling debate.

It seems unlikely that we will see a President emerge from the election with a united Congress, although Romney probably has a slightly better chance of achieving that than Obama.  So it seems most likely that we will see a President with a divided Congress.  Of course the other possibility is a President with neither the House nor the Senate.  That will make implementing the President’s legislative program somewhat fraught.  We will know soon.

The good news is that both Democrats and Republicans appear united on a number of the fiscal cliff elements that will need to be agreed on in pretty quick order.  For example it seems likely the Bush tax cuts get extended in totality (Romney), or at least in part (Obama).  It also seems more than likely that the Payroll Tax Cuts and the Unemployment Insurance will end.  As you would expect, there will be most vigorous debate around the programmed spending cuts.  We think decisions on at least that part of the “cliff” will get kicked down the road.  Based on those assumptions we think the fiscal drag on growth increases from around 0.7% of GDP in 2012 to1.3-1.5% in 2013.

All things considered (or at least as best one can consider things right here and now) I’m still happy with my 2013 US GDP forecast of 2.0%.  The good news is that the politics of the fiscal cliff and then the implementation of a greater degree of fiscal contraction next year will be playing out at a time when US economic fundamentals are starting to look, if not stronger, at least more stable.  The improving housing market is having a positive impact on consumer confidence and the stability of consumer spending.  It also appears increasingly the case that the recent slowdown in global growth is starting to bottom out, supporting our view of a modest pick-up in global growth next year.  On the downside, however, we know businesses have been delaying hiring and investment decisions on the back of fiscal uncertainty.  That will continue to be a drag on growth until the fiscal landscape is more certain.

Another near term complication is that Congress will need to raise the debt ceiling again soon after the election.  The current limit of $16.4 trillion is likely to be reached by around year-end.  The Treasury can buy some time by disinvesting federal employee retirement funds, but that will only ever be a very temporary measure and would only delay the inevitable to February or March at the latest.  How that plays out will depend on the political landscape after the election, but I also think the politicians were taught a valuable lesson by the rating agencies and the public outcry during and following last year’s debate.

Once the near term fiscal landscape becomes clearer there will still be a couple of not-insignificant issues to think (worry?) about.  The first is monetary policy under a Romney Administration.  The Republicans have been critical of recent Federal Reserve policy action.  Romney has already committed to not reappointing Ben Bernanke when his term expires in 2014.  That and the implications for quantitative easing would become an issue for markets at some point.

The other issue is fiscal policy over the longer term.  Fiscal cliff resolution will not address the bigger question of US long-term fiscal sustainability.  That requires a credible long-term fiscal plan.  All we know at this point is that a long-term fiscal consolidation plan authored by Mitt Romney is likely to be heavy on spending cuts, while an Obama plan would be more balanced between lower spending and higher revenue.  Either way, it was the absence of such a plan in Europe that made the Euro zone debt crisis worse than it needed to be.  Take note, America.