Friday, September 27, 2013

Japan's consumption tax

US fiscal deadlines aren’t the only significant fiscal issue worthy of attention right now.  Japanese Prime Minister Abe will soon make a call on whether to proceed with the scheduled increase in the consumption tax from 5% to 8% in April next year.  Media reports suggest he is waiting for the results of next week’s Tankan survey before making a final decision.

Our expectation is the Government will proceed with the increase.  Any plans to delay or shelve the increase will be viewed negatively by markets given the implications for medium-term fiscal outcomes.  The consumption tax increase is correctly viewed as a small step along the long road towards Japanese fiscal sustainability.

The questions right now are, firstly, whether the Government go ahead with the full 3% increase or phase it more gradually (e.g. 1% per annum).  The second issue is the extent to which they will attempt to offset the economic impact with other fiscal measures and, if so, what impact they will have.

The tax increase will raise an estimated ¥8 trillion and add around 2% to inflation.  The impact on the economy will be significant.  Before the tax is implemented there will be the inevitable bringing forward of expenditure leaving a deep hole following the increase.  And in an environment of muted wage growth, higher inflation will be a hit to real household incomes.

It is therefore not surprising the Government is looking at options to mitigate the negative impact on economic growth.  These options appear to include further measures to increase public works investment, tax breaks for capital investment, tax incentives to increase labour compensation and reductions in the corporate tax rate.

Efforts to stimulate business investment are well intentioned but the impact could be disappointing.  While much of the recent revision up in Q2 GDP was due to stronger investment, I think businesses will maintain a caution approach to investment, largely because there is yet little confidence that the current better growth will prove sustainable.  Sustainably higher growth needs stronger investment which in turn requires greater confidence that Prime Minister Abe will make more progress on his “third arrow” of structural reform.

Furthermore, it appears likely firms would take a cautious approach towards investment given the uncertainty about how the economy will perform after the tax increase.  Also there is a second increases in the consumption tax scheduled for 2015 (from 8% to 10%).

Our current Japan GDP forecasts incorporate the increase in the consumption tax, but don’t allow for any offsetting measures yet.  I’ll wait for the detail.  Of course there is also the possibility of further monetary stimulus should the new tax burden prove too great.  Our forecasts have annual average calendar year GDP growth of 2.0% this year, 1.5% in 2014 and 0.6% in 2015.


Thursday, September 26, 2013

From the election in Germany to US fiscal angst

Now that the first tapering “stop-go” decision and the German election are out of the way, attention has turned swiftly to the upcoming fiscal deadlines in America.

In Germany the focus is now on coalition negotiations.  As was widely expected, Merkel’s CDU/CSU party took the greatest share of the vote.  The only question was whether the current coalition partner FDP would make it past the 5% threshold for seats in the Bundestag.  In the end it failed meaning the most likely scenario now is the so-called “grand coalition” between CDU/CSU and their former coalition partner and currently second biggest partner in the Bundestag, the centre-left SDP. 

Negotiations are likely to take some time.  SDP will be anxious to avoid a scenario whereby their support-base fades away as the junior partner of a coalition.  They will want some major “wins” in coalition talks to appease their support base.  And don’t be surprised if there is also talk at some point of a SDP / Greens coalition with the remnants of the east German communist party, Die Linke (The Left).

Markets have taken the election in their stride.  As we said at last week’s Portfolio Watch webinar, all of the major parties have similar views on Europe meaning there was little implications in the way forward for the Euro zone in this election  (although the German Constitutional Court may still through a curve-ball in that direction). Policy differences were mostly contained to domestic issues.   Also there was no risk of the sort of public backlash against the political establishment we have seen in the likes of Italy with the rise of the Five Star movement.  The only anti-euro (officially “euro-sceptic”) party was the new AfD party which also failed to get to the 5% threshold, although did well to achieve 4.7% of the vote at their first election and could be expected to build on their support base in the years ahead.

In the meantime, attention is now firmly focussed on fiscal negotiations in the US....again.  In the absence of a bi-partisan medium-term fiscal strategy (which we expect to be the next thing on the agenda after Hell freezes-over) or a political scenario in which the President also has majorities in both houses of Congress, fiscal angst is just something we will have to get used to.  In the lead up to the US election last year remember our wish was simply for a President with a strong mandate regardless of party affiliation.  Foiled again....

Where are we right now?  A new Budget needs to be agreed for the 2014 fiscal year by the end of the month.  A Continuing Resolution has been passed in the House and a vote is expected in the Senate shortly where it will most likely fail.  The Republicans are attempting to tie their support for a new Budget to the defunding of “Obamacare”.  This is the major sticking point, even though the President will argue he won a fresh mandate only last year including his healthcare plan.  There is only so far the Republicans can push things.  Then there is the debt ceiling which needs to be raised by the end of October.

It’s important to note that the current negotiations are taking place at a time when we are seeing a sharp turn-around in the government’s fiscal position.  That’s of course largely thanks to the tax increases that were effective from the start of this year and the more recent sequester.  Revenues are higher (up 12.8% in the year to June) and expenditure is lower (down 3.9% in the year to June).  The deficit is now 4.3% of GDP, significantly better than the peak deficit of 10.1% of GDP at the start of 2010.

Over the next few days and weeks we expect considerable fiscal sabre-rattling.  But as we have for every fiscal negotiation so far, we expect an 11th hour resolution.  In the meantime, if you start to get worried, just remember this is politics.  No-one wins from a shut-down of the US Government, least of all the Republicans.

Thursday, September 19, 2013

NZ GDP better than expected

June quarter GDP came in at +0.2% for the quarter.  That was bang on average market expectations but higher than my zero.  Annual growth came in at +2.5% with annual average at +2.7%.  Both annual rates were higher than expected by virtue of revisions that saw three of the previous four quarters revised upwards.

On a production (sector) basis much of the detail was as expected.  Agriculture (-6.4 q/q) fell sharply on the back of the drought while business services (+2.6%) and retail trade (+2.1%) posted strong growth.  The surprises for me were a smaller than expected decline in the manufacturing sector and stronger than expected construction activity, the latter thanks to strong infrastructure investment.

On the expenditure side, again much of the detail was as expected.  There was a big negative contribution from net exports as exports fell -5.9% (q/q) and Imports rose +1.3%.  On the plus side, personal consumption rose 1.5%.  The surprises in this measure of GDP were a positive contribution from government expenditure and a more significant build- up in inventories.

While the drought has now knocked about 0.7% off GDP growth in the March and June quarters of this year, overall GDP growth has weathered the drought surprisingly well thanks to the offsetting influences of strong household expenditure and construction activity.  Furthermore following the drought, growing conditions have benefited from a wet and warm winter which is supportive of a recovery in dairy volumes.  That will turn what has been a significant headwind for growth into a positive in the months ahead.

There is nothing in this result to alter our expectations of stronger growth in the period ahead.  We think both September and December quarters of this year are likely to post GDP growth of around 1% each per quarter as construction cointinues to grow and households continue to spend.  

While that level of growth is significantly stronger than the first half of the year its, only slightly ahead of the same period last year thanks to the ripper December 2012 quarter increase of 1.6%.  That has us expecting calendar year annual average growth of 2.8% in 2013, pushing on to 3.5% during 2014.

And the answer is NOT to taper, at least not yet

In typical economist fashion I am both not surprised and surprised (in that order) by the FOMCs decision this morning to leave its asset purchases program unchanged at $85 billion per month.   As you know our read of recent US data suggested the case for a tapering announcement from the Fed today was no better than 50:50.  However, having started the monetary policy “normalisation” process, pragmatism suggested they would start a gradual taper process.

While the Committee believes downside risks to the economy have diminished, the pace of economic expansion is clearly still not sufficient for them to start to reduce the pace of additional stimulus.  The labour market remains a key concern given the continued decline in the labour force participation rate.  They are also concerned by the interest rate increases that had already occurred and the impact that was having on the economy.   As we expected, the Fed lowered their economic growth forecasts today.

Furthermore they are also concerned about the upcoming fiscal debates, although that’s not new news.  Given the lack of a comprehensive US fiscal strategy, political noise appears likely to be a feature of the US fiscal landscape for some time to come.   That said, the US fiscal deficit is on a steeply improving path which you’d think would make the next round of negotiations easier and smoother than previously.

The immediate impact of today’s decision is as you’d expect: risk on.  Where markets go from here will depend on the flow of data.  While we expect September quarter GDP will be a tad softer than the June quarter, we expect activity will be stronger in the fourth quarter, although still likely below a sub-3% annual pace.  That means that data will be little changed by the time of the October FOMC meeting, but picking up into the meeting scheduled for December 17-18.

Finally, I can’t help feeling today is a bit of a lost opportunity.  The markets were getting used to the idea of tapering and were prepared for it.  December now seems the most likely time to start, or at least announce, the tapering process.  In the meantime it’s back to data watching.

Monday, September 16, 2013

To taper or not to taper, that is the question.

It’s all eyes on the Fed this week as it contemplates whether to announce the timeline for tapering its asset purchase program.  As I’ve said consistently over the last few weeks the data that’s important to that decision is decidedly mixed.

Recent data has included some positives such as the more forward-looking PMI surveys, but some of the actual activity data such as durable goods, factory orders and consumer spending has been on the soft side.  In fact my Q3 GDP forecast of 2.2% (seasonally adjusted annual rate) is lower than June’s 2.5%.  That said I still think that by the time we get December data, the second half of the year will have proven to be stronger than the first half, but not by much.

The labour market has been a more consistent performer but at a slower rate of improvement now than appeared just a few months ago.  It wasn’t that long ago that payroll gains were averaging 200k per month in 2013.  That average has now slipped to just over 180k.  That’s not bad, but neither is it great.  The August unemployment rate dipped lower again to 7.3%, but again on the back of a decline in the participation rate, which in itself is hardly a sign of a robust labour market.

Furthermore, inflation remains low and stable, with not much in the way of indication that current low inflation will prove transitory.  In fact the quarter-on-quarter annualised rate of increase in the core personal consumption expenditure deflator continues to move down.

From my perspective then the labour market data is a “yes” for tapering, inflation is a “no”, and growth is a “maybe”.  However, since the Fed Chairman Bernanke first openly contemplated tapering markets began to price it in.  Pragmatism (i.e. reducing uncertainty and volatility) suggests to me the FOMC will announce its tapering plan this week, but as I’ve said before, the mixed nature of the data suggests a gradual approach to reducing its purchases in the order of $10 billion per month from the current level of $85 per month.

I also expect that given they are transitioning back to forward guidance as the primary policy instrument, we will see the Committee wanting to reinforce its zero interest rate policy by dropping the level of the unemployment rate at which it will start to contemplate interest rate increase.  That is currently 6.5% and appears likely to be lowered to 6.0%.  The mechanics of recent declines in the unemployment rate justifies such a move.

I was also going to comment this morning on the debate about the next Fed Chair, but with Larry Summers having pulled out of the race there isn’t much point.  It suits the promotion of my own views however to make one point and it’s this: I think Summers has been unfairly labelled as anti-QE and therefore hawkish.

My read of his comments is that he is not so much anti-QE as he is questioning of its effectiveness.  I have considerable sympathy with that view.  But be consistent.  If he thinks it has been ineffective at stimulating demand then he is unlikely to think that it would be a problem for inflation.  I don’t buy the argument that he would have unwound QE faster than a Bernanke or a Yellen and that he would ultimately be proven to be more hawkish.  The think the biggest risk for monetary policy is a policy mistake, and given the Fed is in uncharted waters, the risk of making a mistake seems the same regardless of who is in the Chair.

Furthermore, I continue to be bemused by the weight of expectation that is placed on the role of monetary policy to fix what ails America.  A necessarily broader policy response is still required.  I think that’s two points so I better stop now.


Thursday, September 12, 2013

A balanced statement from the RBNZ

A balanced Monetary Policy Statement (MPS) from the Reserve Bank of New Zealand today, but it’s not one without risks.  The good news is the Bank well-aware of those risks.  The key question for today was how the Bank would incorporate the imminent arrival of speed limits on high loan to value ratio (LVR) loans into the outlook.  More precisely we were keen to see what impact the Bank was expecting those restrictions to have on their projections for the housing market, the broader economy and most importantly their interest rate projections.

The Bank expects the introduction of high LVR restrictions from October 1st to lower house price inflation price inflation by 1 to 4 percentage points with a more modest effect thereafter.  They also expect growth in household credit to be 1 to 3 percentage points lower over the next year.  The Bank used the mid-point of those ranges for their central projections.  I agree there will be some impact and in the direction the Bank anticipates, but the quantum of those impacts is the moot point and will only be proven in time.  Therein lays the key risk to the Bank’s projections.

Other developments since the June MPS the Bank had to factor into their statement today were stronger-than-expected net migration, the stronger terms of trade and the recent depreciation in the New Zealand dollar.  All of those factors contributed to a rise in the projected interest rate track.  However, the resultant lower house price inflation from the LVR restrictions is expected to dampen household consumption and reduces the projection for the 90-day interest rate by 30 bps.   The net effect is an interest rate track in this MPS that is 50 basis points higher than in the June MPS with an indicative first tightening around March next year.

In general the outlook for GDP growth in the Bank’s forecasts is much in line with our own.  Their GDP track is a tad higher than ours, but there’s not much in it.  They had clearly finalised their forecasts before the recent run of weaker June quarter data which they acknowledged today took their published +0.4% June quarter forecast down to +0.1%.  That compares with my zero.   But this largely reflects the lingering impact of the summer drought which has been followed by the good growing conditions that comes with a warm winter so a low June quarter number should be seen as little more than a “statistical burp”.  At the same time their September quarter forecast of +0.8% is probably a bit light.

The Bank stuck to the line of not expecting to raise rates this year. That’s the final nail in the coffin for my December tightening prediction.  That nail had already been driven two-thirds in with the continued commitment to keep rates unchanged at the time of the announcement of the LVR restrictions in August.  I’m now with the consensus (and of course the Bank) with a first hike in March next year.

Here’s the risk.  The Bank is expecting LVR restrictions to have a meaningful impact on the housing market, consumption and inflation.  My definition of “meaningful” is sufficiently meaningful to have an impact on the interest rate track.  The danger is LVR restrictions don’t have a meaningful impact, but in waiting for that impact to occur the Bank finds themselves behind rising inflation pressures.  The early warning signs of inflation are emerging in expectations surveys, pricing intentions and rising capacity utilisation.

Leaving it too late would then require a more aggressive tightening further down the track.  Remember the “give growth a chance” mantra from the 2003-07 cycle that saw the OCR eventually peak at 8.25% and a domestic recession.  My preference is still for an early and gradual approach to the cycle.  There’s only one hurdle for me getting what I want: I’m not the Governor of the Reserve Bank.

Taking an early and gradual approach seems to me to be the best chance of locking in a low interest rate cycle and minimising upside risk to the exchange rate over time.  I get the concern about higher interest rates impacting on the exchange rate, but there’s more to the exchange rate than interest rate differentials, not the least of which is the rampant terms of trade and quantitative easing in some countries.  And of course there will be more news on that front with the FOMC meeting next week.  Watch this space.

Wednesday, September 11, 2013

August China data a nice surprise

It was another good month for China data with most indicators exceeding expectations in August.  The recovery in the July data was off the low point in the cycle last year so this round of data was going to be the true test of a genuine recovery in activity.  The better data has certainly been beneficial to the China share market which is now around 20% higher (according to the MSCI China index) than the lows reached in July.

Annual growth in industrial production moved back into double digits at 10.4% in August, up from 9.7% in July.  Retail sales moved higher in both nominal and real terms and fixed asset investment rose in year-to-date terms.  Within the investment result, manufacturing investment managed to post another improvement in its growth rate which was a surprise.  That data followed the earlier release of trade statistics showing an acceleration in export growth to 7.2%, up from 5.1% in July.  As a growth signal only imports were disappointing: the annual rate of growth declined from 10.9% in July to 7.0% in August, although lower imports of course helps net exports in the GDP calculations. But remember we thought the July result was probably overstating the strength.  Finally, new loans growth was also stronger than expected.

This data is consistent with other indicators suggesting improvement in economic activity.  The recent manufacturing PMI results (both the HSBC and official NBS indices) have been positive.  Stronger readings on employment within those surveys also help explain the stronger retail sales.  And recall we have expected stronger exports on the back of stronger growth in the US and Japan and stabilisation in Europe to act as a brake on the recent slowdown in growth.  Indeed annual growth in exports to Europe rose for the second month in a row.

At the same time inflation remains subdued.  Annual inflation dropped back from 2.7% in July to 2.6% in August, the result of a slowing in the annual rate of food prices.  Non-food inflation was unchanged at 1.6%.  While inflation has remained well under control so far and well below the official target of 3.5%, we have seen little scope for interest rate reductions.  That view is reinforced by this round of activity data which, at worst, further reduces downside risks to growth.  Monetary policy action is likely to remain contained to continue to ensure there is sufficient liquidity in the banking system.  I’m still happy with my 7.6% GDP forecast for calendar 2013.

Monday, September 2, 2013

PMI in China and GDP in Brazil and India

China’s official PMI index continued to improve reaching 51.0 in August, up from 50.3 in July.  The market was expecting a result around 50.6.  All the sub-indices improved with the new orders index rising from 50.6 to 52.4.  Stronger orders mean stronger production in the next few months which helps support the recent stabilisation in industrial production. This result makes me much more comfortable with my 7.6% GDP forecast for this year.

Our expectation for China growth this year was that exports would provide some positive impetus, fixed asset investment would likely decline further on the back of tighter credit conditions, especially manufacturing investment, while retail sales would most likely track somewhere in the middle.

The expected pick-up in China exports is based on our view of continued growth in Japan, at least before the consumption tax hike takes effect next year, stronger growth in America in the second half of the year and stabilisation in Europe.  In that respect the increase in the new export orders index from 49.0 to 50.2 was especially good to see.

From a policy perspective this also means the authorities are likely to continue the process of “fine tuning” with any new initiatives likely to continue to be small and aimed at the SME sector.

In Brazil Q2 GDP growth came in stronger than expected at 1.5% q/q, compared with average market expectations of around +0.9%.  Second quarter growth was always expected to show a relatively good result, but then be followed by some moderation in domestic demand in the second half of the year.  Indeed over the last few months we have lowered our calendar year forecast to 2.0% (annual average).  This latest result provides some upside to that forecast but given that most of the surprise in the Q2 result came from the agriculture sector, I’m wary that may reverse out over the next few months, so I will leave it where it is for now.

In India June quarter GDP printed at 4.4%, below consensus expectations and down from the 4.8% recorded in the March quarter.  The mining and manufacturing sectors both contracted over the quarter.   The services sector grew, but this appeared to be government spending related.

Looking ahead we expect growth in India to slow further in next few months due to the recent tightening in financial conditions.  We expect the RBI will cut rates again but only once the pressure on the exchange rate has diminished.  That means my current forecast of 5.6% growth this year is looking optimistic and will be revised down.  Watch this space.