Friday, July 26, 2013

While I was away...

I’ve just come back from a few days away in the glorious Hawkes Bay.  While catching up with developments of the last few days, there were a few things that caught my attention…

While acknowledging the generally positive tone of recent US data, especially the labour market, some US June month activity data was a tad weaker than expected.  June retail sales rose 0.4% in the month versus expectations of 0.8%.  Sales were softer still once automotive and petrol sales were excluded, falling 0.1%.  While the housing market is on an improving trend off a low base, building permits and housing starts were also weaker than expected in June, falling 7.5% and 9.9% respectively.  The poor housing stats result was probably weather-related.  The Leading Index was also flat between May and June.

It therefore looks like my 1.2% (saar) expectation for Q2 GDP data due next week could be a bit “toppy”.  I’d already shaved a bit of following weaker than expected trade data (net exports).  It’s important to remember that June quarter growth should not be seen as a bellwether for US growth in the period ahead.  We have long expected the second quarter to be the weakest for US growth this year reflecting the fact that fiscal drag would be at its zenith in the period.  While most forward indicators continue to point to a stronger second half of the year, I’m still not as convinced as some that the Fed will start tapering in September.  Revisions to historical GDP released at the same time could be critical, as will payrolls data next Friday.


The July China flash manufacturing PMI was softer than expected, coming in at 47.7 in July.  This suggests further downside risk for GDP growth this year.  Remember this index is the SME export-dominated index.  While we weren’t expecting to see any recovery in this index until later this year as America and Europe post stronger growth, the slip in the index this month was significant.  I expect the official PMI which has broader coverage to continue to hold up better but it seems likely this index is now destined for a sub-50 print in July.  That means risk to my 7.6% China GDP forecast for 2013 is biased to the downside.  The authorities seem still content to focus on reforms rather than stimulus, although the announcement of tax breaks for small companies and a speeding up of infrastructure construction will lend some support to growth.

In brighter news, the Euro zone flash PMI printed over the 50 benchmark in July, its strongest reading since early 2012.  The composite index (manufacturing and services combined) came in at 50.4, up sharply from 48.7% in June.  That supports our view that while we don’t expect rampant growth anytime soon, economic conditions in the Euro zone are beginning to stabilise.  There might even be an element of upside risk to my q/q forecast of zero for Q2 GDP.  With forward indicators continuing to improve (German business confidence rose for a third straight month in July) I think we see modest growth in the second half of the year which would result in annual growth (q4/q4) of zero for calendar 2013.   

UK GDP second quarter growth came in at 0.6% q/q, in line with market expectations.  Annual growth is now 1.4%.   It’s pleasing to see the UK string two consecutive quarters of growth together after the economy posted a more modest 0.3% expansion in the March quarter, especially following recent downward revisions to historical GDP growth.  This latest result leaves the UK still 3.3% below its pre-GFC peak but suggests some momentum was starting to build.

I was surprised to see in the minutes of the July MPC meeting at the Bank of England that no-one supported an expansion of the Bank’s asset purchase program.  That’s surprising on two fronts.  Firstly, at the previous meeting 3 people (including previous Governor Mervyn King) supported an expansion of the program, although that was voted down by the other members.  Secondly, this was Mark Carney’s first meeting in charge and the perception was that he would be more inclined towards further monetary accommodation.  Perhaps at this point they believe that given the better tone to the data, the development of their forward guidance process will be sufficient to achieve their objectives.

Finally at home the RBNZ’s July OCR review statement was interpreted as hawkish.  The offending comment was the “…removal of monetary stimulus will likely be needed in the future…”. That’s certainly the first move towards an explicit tightening bias as opposed to the implicit bias in its interest rate projections.  I’ve kept with an expectation of a first tightening in December this year while most of the rest of the economic prognosticators have shifted to March 2014.  I think it will clear by year-end that higher interest rates are warranted and that March will ultimately prove to be too far out for the Bank’s comfort.  If the RBNZ wants to stick to its expectation not to move rates this year, then the January OCR review is also a possibility for the first move.  Time will tell.  

Monday, July 15, 2013

China GDP growth slips to 7.5%

China GDP growth slowed further in the year to June, slipping to 7.5% from 7.7% in the year to March.  This was in line with our and the markets expectation, and with the trend slowdown in growth of some of the key activity indicators we have seen in recent months.

The quarterly rate of GDP growth came in at 1.7% in the June quarter, only marginally stronger than the weak 1.6% March quarter result.  We don’t put too much weight on these numbers.

Looking at the key activity data, growth in industrial production slowed further, falling to 8.9% in the year to June, down from 9.2% in May.  This reflects weak external demand and no doubt also the recent tightening in monetary conditions, including the stronger RMB. 

Fixed Asset Investment continued its decline since the start of the year with year-to-date growth slipping to 20.1% in June, down from 20.4% in May.  Real estate and infrastructure investment are holding up reflecting the strong housing market and government program's respectively, but manufacturing investment remains weak reflecting excess capacity and tighter credit conditions.

The only bright piece of news in the data was retail sales.   Monthly growth in nominal sales has been on an improving trend since the crackdown on "lavish and wasteful" government spending earlier in the year. However, part of that improvement needs to be attributed to price rises.  But it also underlines that, at least thus far in the slowdown, the labour market has been holding up well and supporting consumption.  The performance of the labour market will be critical in the period ahead in terms of just how much of a slowdown the authorities are willing to tolerate.

That's the key question going forward.  Up until now, the authorities have continued to choose reform over stimulus or quality of growth over quantity.  That was made very clear with the June credit crunch and the residual tightening in monetary conditions which will most likely lead to tighter credit conditions in the second half of the year.  Indeed the annual rate of growth in both loans and the money supply weakened in June, the latter falling to 14.0%, down from the 15.8% recorded in May.  The official target for the year is 13.0%.

Tighter credit conditions, soft external demand, currency appreciation and excess capacity in the manufacturing sector are all growth-negative factors in the period ahead.  However, if consumption holds up and exports pick up later in the year as growth in America strengthens and Europe stabilises, my 7.6% annual average forecast might still be achievable.  That said, I freely acknowledge the risk to that forecast is biased to the downside.  I'm taking comfort from the fact the authorities will likely step in to support growth if it weakens too much further, especially if it threatens jobs growth.  I'd expect that stimulus to be of a fiscal rather than a monetary nature.

In the meantime expect more reform noise and hopefully action, especially with respect to capital account and interest and exchange rate liberalisation.  Environmental policies will also be high on the agenda.  How well those reforms are implemented will be critical.  The recent crackdown on shadow banking was well-intentioned but heavy-handed.

Finally, remember this: our China story has long been one of a structural slowdown over time.  In our last strategic asset allocation review we assumed a 10-year average growth forecast for China of 7%.  That implied a range of 6-8%.  The upside of lower growth in China is more sustainable growth, assuming a timely and effective reform program.

Saturday, July 6, 2013

Another solid US jobs report

The US labour market put in another solid performance in June.  Non-farm payrolls increased 195k with another 70k added by way of revisions to prior months.  The unemployment rate remained unchanged at 7.6%, although a rough back-of-the-envelope calculation suggests it was perilously close to dropping back to 7.5%.  On the back of this result, Richard Fisher’s "feral hogs" had another big day at the office, pushing bond yields sharply higher.


The sector breakdown of the payrolls growth was largely as expected: 13k new construction jobs in line with recent gains in housing starts, 37k in retail trade and 53k in business services.  Weak sectors were also as expected with declines registered in government (-7k) and manufacturing (-6k), with the latter in line with recent ISM manufacturing surveys and softer export growth.

The June result plus revisions means non-farm payrolls have now averaged 196k over the last three months and 202k over 2013 thus far.  Private payrolls have averaged 199k over the last three months.  Labour market growth certainly has a more solid and more importantly, sustainable feel to it.  However, jobs growth of that magnitude is still only consistent with GDP growth of around 2% per annum (our forecast is an annual average 1.9% for calendar 2013).

The June unemployment rate was unchanged at 7.6%.  A dip lower was prevented by a second consecutive monthly tick higher in the participation rate to 63.5%.   A higher participation rate is an important sign of a return to a normally functioning labour market.  But its relatively low level continues to point to the challenge of getting the disenfranchised marginal unemployed person back into the labour market. 

As we've said for some time, while we know there are structural reasons for a lower participation rate, we believe there was a strong cyclical component as well.  As the economy and labour market conditions continue to improve, we expect the participation rate will continue to rise, limiting further declines in the unemployment rate.

Average hourly earnings rose 0.4% in the month to be up 2.2% over the year.  The annual rate of increase is towards the top end of the range since 2009.  Combined with low inflation, we are seeing a rise in real incomes which will continue to support consumer spending, a key factor behind our expectation of stronger growth in the second half of the year.

What's the Fed to make of this?  The more consistent solidity (note careful choice of “solidity” over "strength") of jobs growth means the Fed is right to start reducing the pace of its asset purchases soon.  I'm still favouring December over September, but the reality is the market has already more than priced it in so at this level of yields, the precise timing is now mostly of academic interest.  Remember the end of QE is a good thing - it means the US economy is better able to stand on its own two feet.  And the rise in real yields indicates this is more a normalisation of monetary policy and economic growth expectations than a spike higher in inflation expectations.  In that respect, higher interest rates are actually a good thing.

However, don't ignore the unemployment rate.  That's the measure of spare capacity in the labour market that will ultimately determine the Feds view on the outlook for the output gap and inflation and the timing of when they will end QE and when they will start to raise interest rates.   We agree with the Feds indication of no increase in interest rates until 2015.   With the dramatic increase in yields today that means the bond market is even further ahead of reality than it was last week.  Oink!

Friday, July 5, 2013

The ECB and BOE - accomodative monetary policy is still alive and well

As we suspected, both the European Central Bank (ECB) and Bank of England went out of their way overnight to emphasise that recent increases in interest rates and expectations of tighter monetary conditions is a US-centric phenomenon.  Statements from both central banks were decidedly dovish.  It was, however, all talk with no new action from either central bank.

For his part ECB President Mario Draghi moved to forward guidance on rates, incorporating a continued bias to ease, by stating the ECB will keep rates at the current or lower level for an “extended period”.  The move away from the previous policy to “never pre-commit” was made necessary by the recent tightening in monetary conditions reflected in higher Eurozone interest rates.  At the press conference he said the extended period would be determined by the medium-term outlook for inflation, growth and credit conditions.  Draghi again highlighted the potential for lower interest rates, including the possibility of negative deposit interest rates.

It remains the case that while there has been relative calm in financial markets in Europe, it is yet to translate into higher economic growth.  Recent data, while better, is still best described as being “less bad”.  And the financial calm itself remains fragile.  Latest political ructions in Portugal could lead to fresh elections and a backlash against austerity.  In Greece the troika is meeting to discuss the next tranche of bailout funding at the same time the Greek Government wants to access some of the funding allocated for bank recapitalisations to meet its own financing gap, a result of the privatisation program being behind schedule.  Privatisation was always going to be challenging, but it means Greece is now behind in its bailout commitments.

In the UK this was Mark Carney’s first MPC as Governor.  While recent data has been better, it came just after the release of revisions to historical GDP data showing the UK economy has made less progress than previously estimated at clawing its way back to pre-GFC levels.  According to the Office of National Statistics, UK GDP is now 3.9% below its pre-GFC level compared with 2.6% previously.  That will have reinforced the dovish tone in today’s statement.

The Bank noted the recent rise in interest rates and stated the rise in rates was inconsistent with what is happening in the UK economy.  “Since the May Inflation Report, market interest rates have risen sharply internationally and asset prices have been volatile”.    And from later in the statement: “…in the Committee’s view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy”.

While the statement was unambiguously dovish, there was no mention of specific action.  Mr Carney has only just taken charge so it was probably too early for any significant action, the minutes of the meeting, which will be released in a couple of weeks, may be more illuminating with respect to market expectations of greater use of forward guidance and/or a boost to the BoE’s asset purchase program.  Indeed today’s statement, which was more fulsome from what we would normally see from the BoE, specifically mentioned the latest remit letter from the Chancellor of the Exchequer to the MPC asking the Committee to provide an assessment in August of the case for adopting some form of forward guidance.  Watch this space.

Today statements highlight the different states-of-play for each of the US, Eurozone and UK economies with respect to growth and the outlook for inflation.  In the US, fundamentals are improving, growth is expected to pick up this year and the output gap is expected to eventually close.  At the same time the Eurozone remains in recession while in the UK, the economy is finding it difficult to generate momentum with the result a large and persistent output gap.  While there was no action from either central bank today, we would expect both to be more aggressive, especially if rates continue to head higher.  Accommodative monetary policy is still alive and well.

Monday, July 1, 2013

More "Fed-speak"

Various US Federal Reserve officials have been making speeches in the last few days in an attempt to calm market jitters following the June FOMC meeting and the markets expectation of an imminent end to the Feds asset purchase program.

The Dallas Fed President Richard Fisher went so far as to label market participants, who have pushed bond yields sharply higher, as “feral hogs”.  I vastly prefer former NZ Prime Minister David Lange’s kinder, gentler reference to “reef fish”.  Other speeches from the likes of Bill Dudley (New York Fed) and Dennis Lockhart (Atlanta Fed) were tamer by comparison but made highly pertinent points.

In particular from Dudley: “If labor market conditions and the economy’s growth momentum were to be less favourable than in the FOMC’s outlook – and this is what has happened in recent years – I would expect that the asset purchases would continue at a higher rate for longer”.

The fact of the matter is it’s by no means certain the Fed will start to reduce the pace of its asset purchase program soon.  As I said following the FOMC meeting the hurdle to tapering is high.  While we agree with the Fed that US growth will be higher in the second half of this year, our forecasts aren’t as high as theirs.  Furthermore, while we think employment growth continues, we were intrigued by the blip higher in the participation rate in May which contributed to a RISE in the unemployment rate.  Friday’s June labour market report will be fascinating.  And perhaps most importantly, there is no sign yet that the recent drop in inflation is indeed due to “transitory influences”.  The annual rate of PCE inflation was unchanged at 1.1% in May.

What we have seen in the last few days is interest rate markets anticipating the end of QE.  While it’s reasonable for markets to anticipate events, we agree with the argument that markets have got somewhat ahead of themselves.

On the other hand, I like the fact that the move higher in interest rates is reflected in higher real yields.  That means that rather than an igniting of inflation fears, we are seeing a normalisation of expectations for monetary policy and with that, economic growth.  In that respect interest rates are actually rising for the right reasons.

China: towards lower but more sustainable growth?

China’s liquidity squeeze has eased significantly following intervention by the PBoC.  Interbank funding rates surged to over 10% last week, well outside their normal range of 3-4%.  Eventual action from the central bank saw rates back down to around 5%.  The residual tightening in interest rates, along with recent RMB appreciation, represents a tightening in overall monetary conditions that has us knocking back our China calendar 2013 GDP forecast to 7.6%.

The authorities were initially reluctant to intervene, citing seasonal factors as the cause of the credit crunch and that ample liquidity would see those pressures eventually ease.  But what began as a liquidity squeeze to clamp down on China’s shadow banking sector was heading towards a full-scale credit crunch.  They were eventually forced to intervene to soothe market concerns about a sharp slowdown in growth. 

The intention to clamp down on undesirable banking practices is admirable.  It reinforces that the current leadership is more “reform” than “stimulus” focussed.  While that means lower near-term growth, it‘s not inconsistent with our expectation that China is moving to a structurally lower level of growth over time.  But with a strong reform program including capital account and financial sector liberalisation (including interest and exchange rates) that growth should prove to be more sustainable.