Tuesday, November 19, 2013

China reforms positive for medium-term growth

After being somewhat disappointed with the initial communique following the Third Plenum of the 18th Party Congress, the full report detailed a quite ambitious reform program which provided positive surprises in some areas.

Key reforms include encouraging more private investment in state businesses; loosening the one child policy; land and “hukou” (the household registration system) reforms to encourage further urbanisation; price liberalisation to allow the market to play a greater role in determining the prices of energy and resources; faster exchange rate, interest rate and capital account liberalisation; fiscal reforms that transfer some spending responsibilities from local to central governments.

In general these reforms are indicative of a leadership that wants markets forces to play a greater role in the economy, more specifically in the allocation of resources.  That is perhaps most important in investment where an emphasis on Government-led investment has detracted from productivity and led to a build-up of excess capacity.  Furthermore the hukou reforms, along with changes to the social safety net, will act to discourage precautionary savings and support consumption.  That will assist the rebalancing of the economy.

In some areas there is an obvious lack of detail and, as with all ambitious reform programs, the key to success will be the efficacy with which the reforms are implemented.   There is no reason to doubt the commitment to implement, especially given the establishment of a high-level committee to oversee the reforms.  More detail will come out in the next few months as individual Ministries develop their plans.

We’ve always maintained a constructive view on the outlook for China while at the same time acknowledging substantial supply-side reforms were essential for continued robust and sustainable economic growth.  While there is always more that could be done, the Third Plenum has exceeded (at least my) expectations.


Monday, November 11, 2013

US jobs and China activity data

Fed tapering is coming, it’s just a question of when.  Last week I would have put the chances of a December tapering announcement from the FOMC at 20% with an 80% probability of March.  Following the better-than-expected October payrolls data the odds are still in favour of March but are now 60:40.  The odds would have been even were it not for the fact the detail behind last-weeks better-than-expected Q3 GDP data was soft.

October payrolls came in at +204k, well ahead of expectations of +120k.  Furthermore there was a hefty upward revision to August and September of +70k.  Three-month average payrolls growth is now back up to 202k.  Readings on the average hourly work week and hourly earnings were a tad softer than expected although they may have been impacted by the government shutdown.  In general though there was little sign of impact from the shutdown on hiring activity.

One area it did have an impact was in the household survey which derives the unemployment rate.  Despite the better than expected payrolls employment, the unemployment rate nudged up from 7.2% in September to 7.3% in October.  That in part reflects a significant drop in the participation rate over the month which possibly reflects furloughed workers reporting they were not seeking work and therefore not being counted in the labour force.  That should reverse out next month.

In terms of the Fed, we know their decision to taper will be dependent on the data flow.  While the payrolls data was good in that regard, the optimism will be tempered by the detail of last week’s Q3 GDP.  While headline GDP topped forecasts by a significant margin that was most mostly due to a build-up in inventories while final demand was quite soft.  Furthermore, the increase in inventories will likely unwind over the next few months.  That has us continuing to expect a March 2014 start to tapering but December is very much in the frame.

In China October activity data was consistent with a stabilisation of growth in activity at around 7.5%.  Export growth was stronger than expected and industrial production nudged higher again.  Retail sales growth continued to travel sideways at around 13% while growth in fixed asset investment continued to slow in year-on-year terms.  That’s all consistent with our view that growth in exports would recover along with global growth, that investment growth would slow and that retail sales would do something in between!  At this point I’m still happy with my 7.6% forecast for 2013 annual average GDP growth.

Further out the growth outlook will be determined by the outcome of the current 3rd Plenary Session of the Party Congress.  We may start to see details emerge over the next few days about the likely reform program that will be a key determinant of medium-term growth.  As I've said many times structural reform and rebalancing of the economy are important elements of ensuring strong non-inflationary growth in the period ahead.

Friday, November 8, 2013

Surprise rate cut from the ECB

While it could be argued that the recent decline in Euro zone inflation and downward revision to Euro zone growth forecasts by the European Commission means last night’s rate cut by the ECB was not a surprise, the bigger surprise would be if they think it will make any difference.

The ECB cut its main refinancing rate 25bps to 0.25% and its marginal lending facility 25 bps to 0.75% while keeping the deposit rate unchanged at 0.0%.  The ECB maintained its easing bias indicating that interest rates are likely to remain “at present or lower levels for an extended period of time”.

Recent inflation data has spooked the ECB.  Headline inflation dropped to +0.7% yoy in October with core coming in at +0.8% yoy meaning that deflation is the greater immediate risk than inflation.  While ECB President Mario Draghi stressed that he does not expect deflation, at least not in the true sense of the word, the ECB does now expect a “prolonged period of low inflation”.

The fundamental problem is low growth and the yawning chasm that is otherwise known as the output gap, best indicated by the current Euro zone unemployment rate of 12.2%.  While we were confident of an end to the Euro zone recession in 2013, we have remained cautious about the extent of the pick-up in growth.  Indeed the European Commission this week revised their 2014 Euro zone growth projections down, albeit only a tad from 1.2% to 1.1%.  We think they are still too optimistic – we are happy with our forecast of +0.8% for next year. 

Euro zone growth is constrained by ongoing austerity at the sovereign level, deleveraging at both the corporate and household level, and weak domestic demand on the back of the high unemployment rate.   The issue for the ECB is the transmission mechanism of its actions through to growth and ultimately inflation.  Market interest rates are already lower than the policy rate making ECB rate cuts largely symbolic. I’d prefer to see something more targeted such as credit expansion aimed at the SME sector, the primary source of job creation in most developed economies.

US GDP better...and worse...than expected

Third quarter US GDP came in at a seasonally adjusted annual rate of 2.8%, well ahead of consensus expectations of 1.8%.  But the data wasn’t as good as a cursory look at the headline result would suggest, indeed final domestic demand rose just 1.7% over the quarter.

The upside surprise came in two areas.  Inventories made a +0.8 percentage point contribution to the result.  We expect that will unwind in short order with inventories now likely to detract from growth in the fourth quarter.  Also residential investment, which rose at a +14.6% annual rate over the quarter, was much stronger than flat housing starts data over the period suggested.

The disappointment came in the more core components of GDP with both consumption and business investment coming in weaker than expected.  Consumption rose 1.5% in Q3, lower than the 1.8% recorded in Q2.  I had expected Q3 to come in at about the same level as Q2.  Business investment rose a disappointing 1.6%.  As I’ve said many times before – a sustained pickup in growth needs stronger business investment.

Net exports added to growth in the quarter, but only because the growth in imports slowed more than the growth of exports.  Declining growth in both sides of the external accounts doesn’t paint a particularly robust picture of either domestic or external demand.

This result does not portray a particularly robust picture of the economy as we headed into the government shutdown in October.  It’s on the impact of the shutdown that market interest now rests with the first significant piece of October data, non-farm payrolls, due out tonight. 

While we continue to believe the shutdown will have an only modest impact on activity the inventory build-up in Q3 has changed the likely profile of GDP growth in the second half of the year.  I was originally expecting +2.0% in Q3 followed by 2.8% in Q4.  With the 2.8% now in for Q3, I’ve shifted my Q4 forecast down to 2.0%.  That still leaves our annual average forecast for calendar 2013 at 1.7% with 2014 still expected to be stronger at 2.8% as the impact of fiscal drag wanes.

Wednesday, November 6, 2013

Strong NZ labour market

New Zealand labour market data was unambiguously strong in the September quarter.  Employment expanded 1.2% over the quarter, although we think that in part reflects some catch-up from previous quarterly results that looked too low to us.  Annual employment growth for the year to September now stands at 2.4% which seems about right.

The unemployment rate declined from 6.4% in June to 6.2% in September.  A sharper fall was precluded by a more than decent bounce higher in the participation rate from 68.1 to 68.6 over the quarter.  That in itself is a sign of a labour market in good health.

Wage growth remains subdued.  The private sector ordinary time Labour Cost Index rose 0.4% in the quarter to be up 1.6% for the year.  The annual rate of growth in unit labour costs has been drifting lower over recent quarters, although given how low inflation has been, you could be forgiven for being surprised it hasn’t been lower.  The annual rate of increase in the unadjusted index (nominal wages) rose slightly from 3.0% in June to 3.2% in the year to September.

There is nothing here to spook the Reserve Bank of New Zealand.  Like us they will be seeing much of the strength in the quarterly employment data as catch-up.  That said a strong increase in hours worked over the quarter supports expectations of a strong GDP growth in Q3 (our forecast +1.1% q/q, risk biased to the upside).

The subdued wage picture will continue to lend the Bank comfort with the inflation outlook.  Our expectation is that we are close to the low point in the wage cycle.  Stronger economic growth in the period ahead will be accompanied by relatively strong employment growth which we expect will be sufficient to see wage growth move higher over the course of next year.

While that wage growth will likely remain modest, it at least argues for a shift in monetary conditions towards neutral.  The annual rate of increase in unit labour costs only needs to move from the current rate of 1.6% to 2.0% to be consistent with inflation at the mid-point of the Reserve Bank’s 1-3% inflation target.  We continue to expect the first increase in the Official Cash Rate in March 2014.