Friday, June 28, 2013

US GDP revised down, but consumer spending bounces back

This week’s downward revision in US Q1 GDP was a surprise.  However, rather than a new surprise, it’s probably best described as a reversal of an old surprise.  Earlier in the year we had been surprised by the resilience of consumer spending in the face of higher taxes; this week’s revision in the data was mostly a reduction in the earlier estimate in consumption expenditure.  In that respect, the data now actually makes a bit more sense.

While that’s history, knocking Q1 GDP growth down from an annualised 2.4% to 1.8% does impact my US GDP forecast for the year.  Leaving my quarterly track for the rest of the year unchanged I’m now picking 1.9% annual average growth for calendar 2013, a tad below our estimate of trend growth.

The growth track for the rest of the year continues to have the current June quarter as the weakest quarter in 2013.  However, I’m not expecting a sharp slowdown from the (new) Q1 result.  In that respect it was pleasing to see May consumer spending post a +0.3% rise following the -0.3% decline in April.  That has our expectation of annualised growth of +2.0% for consumption and +1.5% for GDP in Q2 alive and well.

Personal income growth was also stronger in May (+0.5% m/m) than it was in April (+0.1% m/m).  Wages and salaries growth was +0.3% m/m reflecting continued solid (though unspectacular) jobs growth.  Consumer spending has also been helped by recent low inflation and the resultant boost to real disposable incomes which were up +0.4% in May.  The Personal Consumption Expenditure (PCE) deflator rose +0.1% over the month with the annual rate coming in at +1.0%.  The core PCE deflator, the Fed’s preferred inflation measure is running at +1.1% y/y.
We expect consumption growth to move higher in the second half of the year on the back of higher employment and income growth, as well as the continued improvement in the housing market.  This is the key contributor to our expected pickup in GDP growth in the second half of the year.  The key risk to that view is sequestration.  Our assumption is that much of the impact is already reflected in soft federal spending results in Q4 last year and Q1 this year, although we think there is still more downside to come through in the payrolls numbers.  Watch this space - June payrolls data will be interesting in that regard.
Markets are now focussed firmly on the point at which the Fed starts to reduce the pace of the asset purchase program, with economists seemingly split between September and December this year.  I’m still holding to the line that December is the earliest we would expect the Fed to start tapering QE.  I think there will still be too much uncertainty around the strength and sustainability of pickup in GDP growth, the outlook for jobs growth and, more importantly, the necessary turnaround in continued soft inflation readings for the Fed to act any earlier than that.

Monday, June 24, 2013

China's Divergent PMIs

China's June flash HSBC PMI was weaker than expected, coming in at 48.3, down another big notch from the 49.2 recorded in May.  New export orders were especially weak.  While we weren't expecting to see any recovery in this index just yet, the further sharp fall was an unwelcome surprise.

This result has opened up an even bigger gap between the HSBC index and the official PMI (at least up to the latest reading in May).  So which one is right?  Given their different makeup, they are both an important part of reading the Chinese economy.  The HSBC index is oriented towards the small and medium sized enterprises (SMEs) while the official index gives a better picture of the overall manufacturing sector.  With the HSBC index capturing the SME sector it is also more highly correlated with exports than overall economic growth.

The differences in the construction of the two indices notwithstanding, the latest result puts a further dent in my China cyclical upturn story.  The year to June GDP result looks like coming in at 7.6% rather than the 7.8% I had pencilled in. I have already lowered my calendar year GDP forecast for 2013 from 8.2% to 7.9%, which now has more downside than upside risk attached to it.

While I don’t like revising forecasts (I find it’s vastly preferable to be correct right from the start), lower growth in China is not causing me a high degree of consternation.  Our long-term China story is one of a move to a structurally lower level of growth.  That’s as the easy gains from urbanisation and productivity have been had and as the economy rebalances towards consumption from the previous growth model of investment and exports.

Importantly, the authorities don't seem concerned either, apart from some liquidity injections last week to reduce high short-term interest rates.   The focus for them seems to be very much on structural reform rather than initiatives to boost near-term growth.  While that means lower growth in the years ahead, it also means more sustainable growth.  As long-term investors, we should be ok with that strategy.

Thursday, June 20, 2013

NZ GDP growth a tad weaker than expected

NZ March 2013 quarter GDP came in at +0.3% for the quarter, below market expectations of +0.5% and our own expectation of +0.6%.  Nevertheless, I find it hard to get too disappointed given that any growth in the quarter essentially banked the large +1.5% in the December 2012 quarter.  Annual (production based) growth came in at +2.4% for the year to March, close to expectations helped by upward revisions to previous quarters.

On a sectoral basis the only real surprise was the March quarter saw more of a hit from the drought than we expected.  The agriculture sector was down 4.7% over the quarter, mostly driven by lower dairy production.  That has me thinking that much of the drought effect may now be in the numbers, although I’m wary of a further hit in the June quarter.

Other than agriculture, most sectors were in line with expectations including a significant 9.6% boost in residential construction over the quarter for an overall construction increase of 5.5%.  Pending construction activity in the form of architectural and engineering services also provided a boost to Q1 activity and an indication of things to come.

Looking at the data through an expenditure lens, exports were stronger than expected rising 2.5% in the quarter to be up 8.5% on the year.  Services exports also put in a hefty rise (consistent with yesterday’s current account data).  We wonder about the sustainability of such a significant increase.

The disappointment was the decline in business investment in plant and machinery equipment which fell 6.2% over the quarter, nearly reversing all of the surprisingly strong gain in the December quarter.  As we’ve said many times before, a stronger more sustainable New Zealand rate of growth is highly dependent on export s and business investment.  However, robust business confidence gives me some confidence that business investment will recover in the not too distant future.

All things considered, this is not a bad result.  At this stage I am leaving my June quarter forecast at +0.5% for the quarter and for a move higher in GDP growth in the second half of the year.  That will give us annual growth of 2.7% for the 2013 calendar year.  Not bad by developed world standards.

The Fed

Today’s FOMC statement did not deliver the expected dovish tones.  Speculation has risen in markets recently that the Fed would soon begin reducing the pace of asset purchases.  The FOMC did nothing today to dispel that expectation, in fact Chairman Bernanke’s post meeting remarks said that policymakers expect to begin tapering asset purchases “later this year” and continue “in measured steps through the first half of next year, ending around mid-year.  Our own view has been the Fed will begin tapering late this year at the earliest. 

It’s important to note the policy outlook is heavily contingent on economic conditions playing out as expected.  Importantly, the Committee sees that downside risks to the outlook for the economy and the labour markets having diminished since the US autumn (when QE3 began).  Bernanke also stated the policy outlook was based on the unemployment rate moving down to 7% by the middle of next year. 

Latest Fed forecasts have scaled back their GDP forecasts for this year, but they still imply stronger growth in the second half of this year than we have seen in the first half.  Growth forecast for next year were nudged slightly higher.  Inflation forecast were lowered for this year (from the Statement: “partly reflecting transitory influences”), but they note that longer-term inflation expectations have remained stable.  Inflation is expected to rise next year.  While much attention is being paid to the GDP and unemployment rate forecasts, remember it’s the FOMC’s inflation expectations that will ultimately determine the path for monetary policy.

It’s also important to remember that a timetable for reducing quantitative easing is not as hawkish as a tightening in policy.  Interest rate increases are still a long way off with the majority of FOMC participants not expecting a rate hike until 2015.

Today’s Statement moves our expectations of the start of the Fed tapering more firmly into later this year.  But as with the Fed themselves, that is contingent on the expected pick-up in GDP growth, continued declines in the unemployment rate (through more jobs, not lower participation), and increased confidence that inflation will start to head towards 2% over time.   In that sense, the beginning of the Fed reducing its asset purchase program is good news.

Friday, June 14, 2013

RBNZ June MPS - a well-executed communications strategy

There must be the odd occasion where the RBNZ wishes it wasn’t obligated to produce a quarterly Monetary Policy Statement (MPS).  With things going exactly the way the RB wants them, at least with respect to the trade weighted exchange rate, yesterday’s MPS became an exercise of producing 38-pages of commentary and forecasts without giving any opportunity for anybody to interpret anything in the document as being in any way remotely close to hawkish.  They did a great job.

The outlook for the economy is broadly in line with our own.  In particular they are forecasting a modest pick-up in growth despite the headwinds of the recent drought, the firm exchange rate and fiscal consolidation.  They see GDP growth peaking at around 3.5% next year, only modestly ahead of our 3.3%.  That level of growth relative to potential GDP generates eventual upward pressure on prices and a gradual move in inflation back to the mid-point of the target band. All sound and reasonable stuff.

The only question for me was how they were going to deal with the recent decline in the exchange rate.  In the end they took the prudent approach of largely ignoring it, although admittedly much of the decline in the TWI came after the Bank would have finalised their projections and much of the commentary in the document.

Such an approach is prudent for two reasons.  Firstly, and most simplistically, a lower exchange rate means higher inflation (all else being equal) and a higher interest rate track.  Such a track in yesterday’s MPS would have been received as hawkish.

Secondly, the recent decline in the NZD versus the USD is to do with a stronger USD in anticipation of the US Federal Reserve starting to reduce the pace of its asset purchase program.  We expect the FOMC at its meeting next week to comment that the market has got too far ahead of itself in that expectation.  In that respect we don’t view the recent decline in the TWI as the beginnings of a trend decline over time.  That means that at this point there is just as much chance of Kiwi heading higher again as there is of it moving lower.  It remains the case that we only expect the trend decline to begin once the Fed starts tapering, and we don’t think that is imminent.

I’ve recently characterised the Bank’s current challenge as being between a rock (the exchange rate) and a hard place (the housing market).  With respect to the housing market the Bank acknowledges the ongoing strength.  The central projections do not assume any introduction of macro-prudential tools, which the Governor commented in the post-MPS media briefing could be deployed as early as next month.  However I continue to believe the risk is that the Bank believes the deployment of such tools will do more to cool the housing market than they actually will.  While the strong housing market is predominantly a risk to financial stability, we believe higher interest rates are part of managing that risk.

The upshot is I don’t buy the RBNZ’s view that interest rates will remain unchanged until the middle of next year.  I’m happy to remain at the hawkish end of spectrum in assuming that while there is a chance of the Fed reducing the pace of its asset purchase program this year, there is the chance of a more sustainable move lower in the NZD which would open the window of opportunity for a 25bp rate hike this side of Christmas.  However, I freely acknowledge there is a reasonable chance that I join the forecasting throng and move that first hike into early next year.

Tuesday, June 11, 2013

China data disappoints, but no easing...yet

China activity data in May was biased to the disappointing end of the spectrum. Trade data was the most disappointing although we think the softer-than-expected export data reflects the high level of mis-reporting earlier in the year rather than a sharp decline in activity. 

It was this mis-reporting that led to a move higher in our China activity index earlier this year which has now reversed.  But just as we thought export growth data was unrealistically high earlier this year, the 1.0% growth recorded in the year to May probably understates the true picture.  Watch this space.

As well as exports, annual growth rates of imports, nominal fixed asset investment and industrial production all slowed over the month.  Only retail sales blipped higher.  That has us thinking that June year GDP growth will come in at around 7.6/7.7% after recording growth of 7.7% in the year to March.

Loans and Total Social Financing also come in below expectations over the month.  But while annual money supply (M2) growth came in lower over the month, at 15.8% it remains well in excess of the official target for this year of 13%.

Inflation also came in lower than expected.  The CPI printed at 2.1% in the year to May, down from 2.4% in the year to April.  PPI data also came in lower than expected.  It's important to note however that the downside CPI surprise was in vegetable prices, which could prove to be temporary.  However, the lower May reading means inflation is unlikely to meet my 3% expectation for the calendar year.

While activity data disappointed in May and inflation undershot expectations we think it’s premature to expect any aggressive stimulus action from the authorities.  Growth is by-no-means collapsing.  And remember the authorities have already taken action to prevent another bubble forming in the residential property market. 

We think interest rate cuts are only likely if it looks like GDP growth is going to undershoot the official target for 2013 of 7.5%.  That is not our base case at this point, although I acknowledge it as a risk.  At the very least monetary policy is going to be able to remain accommodative for longer than we previously expected.

Prior to this recent run of softer data it was my expectation that higher credit growth would contribute to stronger gains in real GDP growth this year, as it has in prior periods.  We still think growth moves modestly higher this year, but this view is now dependent on a “real” pick-up in exports (that is also reflected in higher industrial production) as growth moves higher in America and stabilises in Europe later this year.

Saturday, June 8, 2013

Another solid jobs report in America

US payrolls expanded 175k in May, broadly in line with market expectations and better than my expectation (fear?) that by the middle of the second quarter of the year we would be seeing a sharper slowdown in jobs, especially in the Government sector on the back of the sequester.  The unemployment rate nudged up to 7.6% from 7.5% in April reflecting a blip higher in the participation rate.

On a sectoral basis jobs growth was strong in the retail sector which added another 28k jobs in May while business services added 57k.  Manufacturing jobs fell for the third month in a row, consistent with the recent decline in the employment sub-index in the manufacturing PMI.  Current weakness in manufacturing reflects weak inventory building and soft external (export) demand.  The stronger growth we expect to see later this year, driven predominantly by the housing market, will be positive for the manufacturing sector.

The surprise for me was the only modest 3k drop in government employment over the month.  The decline in Federal government jobs was offset by gains at the State and local level.  As I’ve mentioned before, state and local government went through their own fiscal consolidation earlier than Federal Government, and is now largely through the process.  In that respect, now is a good time for Federal Government to be going through its adjustment phase.

Average monthly jobs growth this year stands at 190k.  Part of that reflects the particularly strong January and February months which in turn reflected the end-2012 fiscal uncertainty that pushed some activity, including hiring, into the early part of this year, which was captured in the February payrolls gain of 332k.  Over the past three months the average monthly gain has dipped to 155k, consistent with the recent softening in activity data including manufacturing and consumer spending.

The rise in the unemployment rate on the back of modest increase in the participation rate, which rose off its 34-year low of 63.3 in April to 63.4, is consistent with our (and importantly the FOMC’s) view that part of the recent decline in the participation rate is cyclical.  If that continues it is quite conceivable that we could see the trend decline in the unemployment rate stall, or possibly reverse, at the same time as we see continued modest jobs growth.

In terms of implication for the increasingly schizophrenic (good description, thank-you Shane) QE tapering discussion, I think the labour market is still falling short of the substantial improvement the Fed wants to see before looking to reduce its asset purchase program.  There has been too much focus on the unemployment rate getting closer to the Feds target of 6.5% and not enough on the rate of jobs growth.  The Fed has indicated that +200k per month jobs growth is consistent with the substantial improvement they are looking for in the labour market.  The current 3-month average of 155k falls well short of that.  If the unemployment rate were to continue to the 6.5% level without the required level of jobs growth I have no doubt the Fed will “re-set” the unemployment target.

That means right here right now we see no imminent tapering of the Fed’s asset purchase program.  The earliest we would expect to see that would be the end of the year which requires a number of preconditions: a pick-up in growth from the 1.5% (saar) we expect in the June quarter, a commensurate improvement in jobs growth, further declines in the unemployment rate on the back of jobs growth rather than further declines in the participation rate, and greater confidence that (core PCE) inflation is heading back towards 2%.  When you think about it like that it’s actually quite a high hurdle.

Tuesday, June 4, 2013

US and China PMIs both surprise

The US and (official) China May PMIs surprised on the downside and upside respectively.  We have been surprised by the resilience of the US data in the last few weeks in what should be the weakest quarter of the year for growth.  In that respect the May PMI didn’t disappoint.  Meanwhile in China, their May PMI is the first good bit of news we have had in a while, supporting our story of a modest cyclical rebound.

In the US the manufacturing PMI fell to 49.0 in May, down from 50.7 in April.  Average market expectations had been expecting a rise to 51.0.  Some of the regional manufacturing surveys had been weak recently, so this result is not inconsistent with the messages from around the country.

All the major sub-indices were weaker in the month with production, new orders, exports and imports all lower.  The employment index was also softer but only a tad, coming in at 50.1 from 50.2 in April.  Inventories bucked the trend with a rise after falling in each of the last three months, but rising inventories itself a sign of weakness and perhaps a precursor to some softer activity data ahead.

As I said at the start, that’s not inconsistent with our view that the June quarter would be the weakest quarter of the year.  The March quarter benefitted from the postponement of activity at the end of last year on the back of the fiscal cliff uncertainty and super storm Sandy.  The June quarter was going to be the period in which the full force of fiscal drag would make itself known: we expect annualised growth of 1.5% in the June quarter, down from the 2.4% recorded in the March quarter.  We continue to expect a stronger second half of the year as the effect of fiscal drag wanes and as the housing recovery continues.

In China the official PMI for May came in at 50.8, a slight improvement in the 50.6 recorded for April and better than average market expectations of a decline to 50.0.  The improvement in the official PMI contrasts with the trend decline in the HSBC PMI that dipped down to 49.2 in May.  Remember the official PMI captures large enterprises (SOEs) while the HSBC index captures smaller enterprises.

The production index was the major mover, rising from 52.6 in April to 53.3 in May.  The new orders index move was more subdued rising from 51.7 to 51.8 over the month, while new export orders rose from 48.6 to 49.4.  On the other hand, inventories of finished goods rose from 47.7 to 48.6.  As with the US, rising inventories is not a sign of strength.  On that note the employment index also slipped slightly.  The other notable component was the purchase price index which rebounded from 40.1 to 45.1 over the month, indicative of some normalisation of input prices.

The best news was the rise in the import index, which rose from 48.7 to 50.3.  This index has been below 50 since April 2012.  Whether this is export (China exports have a high imported component) or domestic demand related remains to be seen, but we’ll take it either way.  While it’s dangerous to read too much into one monthly PMI, this result makes me more comfortable with my expectation that annual China GDP growth will be higher in the year to June than it was in the year to March.