Thursday, October 31, 2013

The Fed and the RBNZ

There were no real surprises from either central bank today.  It is simply a question of when: for the Fed when to start tapering its asset purchase program and for the RBNZ when to start raising interest rates. Both probably erred on the side of being slightly less dovish than the average market expectation.

After deciding not to taper in September, October was always going to be too soon to see the required improvement in economic growth and the labour market the FOMC wants to see.  That made December the next most likely date for an announcement on the tapering of their asset purchase program.  With the disruption from the recent partial government shutdown and the debt ceiling debate, expectation had started to shift to a March start date.  Today the Fed was less explicit in signalling a delay than the “doves” were expecting.  That said, the minutes of the meeting will be a fascinating read in a couple of weeks time.

The bottom line is this: tapering of the Fed’s asset purchased program is coming, it’s just a question of when.  And the answer to that question will be dependent on the data flow over the next few months.  We agree with the statement that “taking into account the extent of federal fiscal retrenchment over the past year, the Committee sees the improvement in economic activity and labour market conditions since it began its asset purchase program as consistent with growing underlying strength in the broader economy.”  The FOMC is still looking for more evidence that underlying progress will be sustained.

Given likely data disruptions over the next few months (see the note on consumer confidence below) it seems to us to be unlikely the FOMC will have sufficient evidence of the sustainability of the pickup in growth before the end of the year.  That means a March 2014 start to tapering, with the program ending towards the end of 2014, is now the most likely scenario.

The delay to Fed tapering and the implications for the New Zealand dollar is one of the changes the RBNZ had to incorporate onto their OCR Review comments today.  The other is of course the fact that growth is looking a tad higher (at least in the short-term) than their forecasts released in the September Monetary Policy Statement.  The Bank today referred to September year growth as estimated to be “more than 3%” which suggests a September quarter growth estimate closer to our 1.1% than the 0.8% they forecast in September.

The bigger question for today was how the Bank was going to deal with the recently stronger New Zealand dollar.  The Bank acknowledged that development by commenting that “(s)ustained strength in the exchange rate that leads to lower inflationary pressure would provide the Bank with greater flexibility as to the timing and magnitude of future increases in the OCR.”

Despite the important qualification (“that leads to lower inflationary pressure”), that comment means there are risks to my view that the Bank starts to tighten in March next year.  Indeed it appears other economists are already shifting their rate hike expectations out to April or June.  As regular readers would no doubt expect, I’m not shifting yet.

Signals are pointing to sharply higher growth in the period ahead.  Likely growth of 3.5% by the middle of next year is well ahead of potential and the output gap is as good as closed.  That means capacity constraints and upward pressure on prices while the OCR remains at record lows.  The real risk is that in waiting for the exchange rate to behave the Bank gets behind the curve on domestic inflationary pressures and we create a bigger problem down the track.

Wednesday, October 30, 2013

Politics and the US consumer

Politicians in America seem to be doing their best to derail the gradual upward trend in consumer confidence that has been in play since the deepest darkest days of the GFC.  Some of the biggest retracements in that upward trend have been related to the various fiscal crises that have occurred in recent times, starting with the 2011 debt ceiling debate (and subsequent credit rating downgrade by Standard & Poor’s).  

This time is no different.  Consumer confidence fell from an upwardly revised 80.2 in September to 71.2 in October, a steeper than expected drop based on average market expectations.  This result was surveyed during the moments of greatest political intransigence over the month and doesn’t capture the ultimate (albeit short-term) resolution.


As I said a couple of weeks ago, the big question for me about the impact of the latest bout of political brinkmanship was not the direct impact of the partial government shutdown, but rather the impact on business and consumer confidence and spending, investment and hiring decisions.  This result does not bode well for December quarter private consumption expenditure (PCE).

That said it’s interesting to note that while the current economic conditions component of the survey fell from 73.5 to 70.7 over the month, the future expectations component fell from 84.7 to 71.5.  It is current economic conditions which has a greater impact on consumer’s immediate spending intentions so it remains to be seen the extent to which the drop in confidence translates into real spending decisions.  Of course that also depends on the extent to which we see a rerun of the political shenanigans later this year and/or early next year.

In terms of the impact on GDP, todays September retail sales report was actually a bit stronger than an initial glance suggests.  Total sales fell 0.1% in the month but after excluding automotive and gasoline, sales were up a more robust 0.4%. Sales are still a respectable 3.2% up on year ago levels.  The September result has me still comfortable with my expectations of third quarter PCE growth broadly in line with the growth rate of 1.8% we saw in the second quarter.

I have lowered my PCE expectations for the fourth quarter on the back of recent events I still expect it to be modestly higher than the third quarter at 2.2%.  While politics will likely throw further bouts of uncertainty and volatility into the consumption story, we continue to expect consumer confidence to trend higher over time, largely on the back of the continued improvement in the housing market.

Wednesday, October 23, 2013

US payrolls and Fed tapering

The September payrolls gain of 148k was disappointing – market expectations were for a gain of 180k.  Revisions didn’t add much this month with August revised up 24k but July revised down 15k.  The unemployment rate dropped to 7.2% over the month and for once occurred for all the right reasons – the household survey showed a gain in employment, a decline in the number of people unemployed and a flat participation rate.


Looking at the sectoral breakdown, construction posted a solid gain of 20k in the month.  The downside surprises came in manufacturing where employment was flat and there was an only soft gain in private services of 100k.  There was a gain of 22k in the Government sector, all coming from state and local government where the process of fiscal adjustment is further advanced than at the federal level.

This result shows labour market strength remained only modest leading into the Government shutdown.  It’s hard to imagine a stronger result in October given the disruption to activity and the likely delay to private sector hiring decisions given the uncertainty of the fiscal impasse.

While we think the direct impact of the shutdown on economic activity will likely prove to be limited, it remains to be seen what the impact will be on consumer and business confidence, especially in light of the fact we will be doing this all again next year.  I’m not convinced the Tea Party faction of the Republican Party will capitulate readily, although I’d be very happy
to be wrong on that point.  The first important date is the December 13th deadline for a House and Senate budget conference committee to end negotiations on a Budget resolution.  I don’t have high hopes for that process meaning we will head into the New Year with spending authority needing to be renewed by January 15th to avoid another government shutdown.  And of course the debt ceiling will need to be raised by (or shortly after) February 7th.

A December tapering decision by the Fed seems increasingly unlikely.  It became clear from their September deliberations that any decision to taper their asset purchase program would be data dependent rather than any other agenda.  They just won’t have enough by way of “clean” data to make a call this side of Christmas.  A March tapering decision looks increasingly likely.

Monday, October 21, 2013

China data as expected

China GDP came in bang on expectations at 7.8% for the year to September, up from 7.4% in the year to June. However, growth rates in the monthly activity indicators showed some loss of momentum reinforcing our expectation that growth will slow into the end of the year.  That said we still expect annual average growth of 7.6% this year, just ahead of the official target of 7.5%.


Growth in Industrial production slowed to 10.4% yoy in September, down from 10.4% in August.  Power, steel and cement production all slowed although value-add in the automotive sector improved.  This week’s flash HSBC PMI for October will be an important indicator of how manufacturing was faring at the start of the fourth quarter.

Growth in fixed asset investment (FAI) slowed with growth coming in at 20.2% ytd in September, down from 20.3% in August.   Infrastructure investment remains the strongest component of investment, although growth slowed over the month.  Manufacturing and residential property investment both accelerated over the month.  We expect infrastructure investment will continue to drift lower into year-end, while some further modest upside can be expected in residential investment.  We are cautious about the outlook for manufacturing investment given tighter credit conditions and excess capacity in some areas.  Overall we expect FAI growth will be sub-20% by year end.

Retail sales growth was disappointing.  While nominal sales growth slipped only slightly from 13.4% yoy in August to 13.3% in September that was largely due to higher inflation.  Real retail sales growth fell from 11.6% yoy in August to 11.2% in September.   Disposable income growth accelerated over the month which bodes well for consumption spending although as we head into the end of the year annual growth will be impacted by the high base effect from the end of last year.

Net exports made a negative contribution to GDP growth in the September quarter.  We expect exports to strengthen next year as global growth moves up a notch.

Earlier in the month it was reported that inflation for September came in at 3.1%.  That reinforces our expectation that scope for monetary stimulus remains limited with the authorities remaining focussed on structural reform.  In that regard the upcoming Third Plenary session of the Communist Party is critical.

Thursday, October 17, 2013

A deal appears done

There’s good news and bad news this morning.   The good news is a deal is within reach to end the US partial Government shutdown and to raise the debt ceiling.  The bad news is this is only until January 15th for the Budget and February 7th for the debt ceiling, so we get to do it all again real soon.

The direct cost of the shutdown will be reversed quickly as furloughed workers receive back pay and government agencies catch up with postponed spending.  But given the short-term nature of the deal, and the real risk that we see continued short-term deals through 2014, I worry about the impact on business and consumer confidence.  Stronger business and consumer confidence remains an important part of the pick-up in growth we expect to see later this year and into 2014.  A hit to confidence will ultimately prove damaging to economic growth.

Markets have breathed a small sigh of relief, with reaction no doubt tempered by the short-term nature of the deal.  If anything is surprising it’s the fact that Treasuries have rallied.  We read that as the pricing out of default risk.  Even a small risk of a very bad outcome is meaningful in terms of basis points.

Furthermore, I was somewhat dismissive of the FOMC citing the then upcoming fiscal deadlines as a reason not to taper their asset purchase program in September.  As it turns out the Committee was quite prescient.  If ongoing political brinksmanship and fiscal uncertainty is damaging to confidence and economic growth it will have obvious implications for monetary policy.

On a political note, I spent a bit of time working in the New Zealand Parliament so I fancy myself as thinking I know a bit about political strategy.  I continue to struggle to understand the Republicans strategy of running headlong and eyes wide open into a battle they were never going to win.  Given how they play their cards next year, mid-term elections could prove very interesting.  In the absence of a bi-partisan medium-term fiscal strategy (which is never going to happen), the next best thing is a strong President with control of both the House and the Senate.  Watch this space.

Thursday, October 10, 2013

The Washington impasse continues....

The fiscal impasse in Washington continues and signs of an imminent resolution are not good, so further angst and market volatility appears likely in the days ahead.  However, at the risk of appearing overly sanguine, I’m confident a solution will be found.  While I was initially of the view the Budget and the debt ceiling would be dealt with separately, as time is running out a joint solution to both now needs to be found.

Estimates are the shut-down is costing the US economy around 0.1% of GDP a week, but this will be made up once the shutdown ends and government spending catches up.  Lawmakers have already agreed to currently furloughed workers receiving back pay.

Of course the need to raise the debt ceiling is the more critical issue.  The US Government is expected to reach the current $US16.7 trillion debt ceiling on October 17th and effectively run out of available cash to pay the bills, including social security and Medicare, by the end of October.  That means that if the debt ceiling is not raised, the Government will need to quickly bring its spending back into line with revenue.  Given the US is currently running a budget deficit of close to 4% of GDP that would necessitate a sharp and immediate drop in Government spending.  And in order to avoid default, the Government would also have to prioritise debt interest payments, requiring deeper cuts elsewhere.

But I don’t think it gets to that.  I said last week that no-one wins from a US Government shut-down, but everybody loses in a failure to raise the debt ceiling and an eventual US default.  Both sides are aware of the consequences of default and House Speaker John Boehner is on record as saying he won’t allow that to happen.

That just leaves the how and the when.  As we saw with the fiscal cliff negotiations at the end of last year, the closer we get to the deadline the more the pressure grows for a resolution, on both sides of the debate.  The Republicans are wearing most of the blame for the shut-down and would also for any failure to raise the debt ceiling.  And the President doesn’t want to go down in history as the first to preside over a US debt default.

A last minute solution will likely be found.  Speculation is it will involve some form of tax reform, perhaps a concession on a small part of “Obamacare” (the medical devices tax has been mentioned) and perhaps some longer term initiatives to address growth in entitlements.  Whatever the answer ends up being, they’re not there yet.  Watch this space.

Wednesday, October 2, 2013

No deal....

So the 11th hour resolution proved elusive this time.  The cynics amongst us must, as they have many times since the GFC, be again musing on whether the biggest challenge facing many democracies today is democracy itself.

With the failure of the House and the Senate to reach an agreement on a Continuing Resolution (CR), the US Government has moved into its first shutdown in 17 years.  Both sides were actually getting closer.  A House position that started with the defunding of the Affordable Care Act (“Obamacare”) was soon whittled away to a one-year delay and a ban on health-care subsidies for Congressional staff.

The House has appointed a conference committee to negotiate with the Senate, should the Senate wish to participate.  If they go to conference the process is to agree a position which is then returned to both the House and the Senate for a vote.  Assuming it would pass both chambers, it would then go to the President for either his signature or veto.

If the Senate doesn’t agree to go to conference we see a continuation of the recent process whereby both sides continue to whittle away at the gap between the two sides, where it appears to me the only outcome can be a “clean” CR (i.e. with no conditions on the Affordable Care Act) which funds the Government for a period of time, although not for the full fiscal year.  The biggest unknown is how long either of these two routes will take.

Markets are taking this in their stride.  At this point my expectation is the shut-down will be relatively short.  As I said the other day, no one wins out of a shutdown, least of all the Republicans.   A short shut-down means that in terms of economic impact, it should prove to be more of a disruption rather than anything more serious.

However, it must be said that relationships between the House, the Senate and the President appear to be at a low ebb.  That’s a concern because there is a bigger issue on the horizon in the form of the need to raise the debt ceiling by the end of the month.  Failure to act decisively on that issue could have more serious implications.  Watch this space.