Thursday, December 19, 2013

Strong NZ growth

September quarter GDP came in at 1.4% q/q and 3.5% y/y with annual average growth of 2.6%.  The quarterly number was stronger than my forecast of 1.2% and average market and RBNZ forecasts of 1.1%.  The annual growth rate is now at its highest since the September 2007.

Growth in the quarter reflected a stronger-than-expected bounce-back in the agriculture sector which rose 17% and contributed 0.9 percentage points to the quarterly result.  Other sectors were broadly in line with expectations. Residential construction also rose strongly, up 8.5%, but the overall construction sector was down slightly reflecting a decline in non-residential and infrastructure activity.

On the expenditure side of the accounts the most pleasing aspect of the result was a 3.1% q/q increase in gross fixed capital formation that was mostly driven by growth in plant and machinery equipment which was up 11.6% q/q.  As we’ve said for 5 years now, robust and sustained growth in the post-GFC New Zealand economy would require strong growth in business investment contributing to significant gains in productivity.

Statistics New Zealand also rewrote history today.  Growth in 2011 was revised up while growth in 2012 was revised down.  Both the March and June quarters of this year were revised up a combined 0.2%, indicating the economy weathered the drought a tad better than had been reported earlier.

The easy part of the growth story for this year was that given last summer’s drought, the second half of this year was always going to be stronger than the first - the only question was by how much.  This is a solid result, indicating that all the positives we’ve talked about for the economy all year are finally coming through in the numbers.  We expect another strong quarter in December with growth of 1.0% q/q pencilled in.  That will give us annual average growth of 2.8% in calendar 2013 which we expect to rise to 3.7% by the end of 2014.


The better than expected result today along with the positive revisions to the March and June quarters means growth has been stronger than the RBNZ expected this year.  That stronger growth along with the US Federal Reserve’s announcement today that they will start to wind back their asset purchases from January reinforces the expectation of a March 2014 hike in the OCR from the RBNZ.

Taper time

The Federal Open Market Committee decided today to get on with the job of reducing the pace of their asset purchase program.  The Committee decided to reduce the program by $10 billion per month to $75 billion per month, cutting both Treasury and MBS purchases by $5 billion each.  Markets have responded well, bolstered by changes to the language around their forward guidance which reinforces that interest rates will remain low for a long time.

The Committee noted recent data which “indicates that economic activity is expending at a moderate pace”.  Indeed our read of the data has been that the labour market data has become more consistently solid and that is showing through in real economic activity such as household spending.  If the Committee hadn’t announced a tapering decision today, they would have at least had to acknowledge they were very close to doing so.

Market reaction has reflected that while the Committee announced a reduction in their asset purchase program, the overall tone of the statement was on the “dovish” side.  Firstly, the Committee said that the future path of tapering was not on a pre-determined path and would remain data dependant. So long as the labour market continues to improve and inflation moves back towards its long run objective “the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings”.

Secondly, forward guidance was strengthened, but through their use of language rather than the expected change to the level of the unemployment rate at which they would consider interest rate increases.  The Committee states that “it likely will be appropriate to maintain the current target range for the Fed funds rate well past the time that the unemployment rate declines below 6.5%, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.”   Previously the Committee had signalled to maintain the current target range for the Fed funds rate at least as long as the unemployment rate remains above 6.5%.

Importantly, the decision to start tapering has removed a major distraction for markets.  The key risk around tapering risk was always the initial announcement.  But today demonstrates the Committee continues to manage its communications exceptionally well.  Furthermore, since the decision in September not to taper, markets have become increasingly comfortable with the idea.  That has of course been helped by the recent strength in the data.

The overriding message today is that while the US economy still requires the ongoing support of low interest rates for some time to come, there has been sufficient improvement in the fundamentals to justify the winding back of asset purchases and that given the outlook, particularly for inflation, it will be a long time before interest rates need to rise.  That’s all good news.  

Monday, December 9, 2013

US jobs, growth and tapering

The November jobs report was the latest in a run of recent data that supports the story of a more sustained improvement in jobs growth and more robust economic activity.   The last few days of data have evened up the odds between a December and March tapering and reduced the odds of the FOMC continuing the current asset purchase beyond March to close to zero.

Payrolls expanded a better-than-expected 203k in November.  As is usual the private services sector provided the lion’s share of the jobs growth but construction and manufacturing both chimed in with solid growth of 17k and 27k respectively.

The unemployment rate dropped from 7.3% in October to 7.0% in November.  It would have declined further had it not been for the part reversal of the large drop in the participation rate in October.


The good news doesn’t end there.  The gain in payrolls combined with an increase in the average workweek to generate a 0.5% increase in hours worked.  Add that to the 0.2% increase in average hourly earnings and you get a big increase in aggregate wage and salary income in the month.  That bodes well for consumer spending in November and into Christmas.

This result comes hot on the heels of other data that, on balance, supports the story of a pickup in economic activity into the end of the year and beyond.  Consumer confidence has picked up following the disruption of the government shutdown supporting further gains in personal spending and automotive sales.  And while the services PMI came off a tad in November, the manufacturing index improved.  Housing has been more mixed but there’s nothing in the recent data to suggest that activity is being too adversely affected by the recent rise in mortgage interest rates.

September quarter GDP was also revised up recently to 3.6% at a seasonally adjusted annual rate (saar) from the initially reported 2.8%.  Recall we cautioned at the time of the release that much of the strength in the quarter was due to large increase in inventories while private demand was disappointingly soft.  That story hasn’t changed with the revisions.  While fourth quarter GDP is expected to show an improvement in private demand, the headline result will be hit by the inevitable reversal in inventories.  We expect growth to print at 1.5% (saar) for the quarter, resulting in calendar 2013 annual average growth of 1.7%.

Recent data supports the expectation of a further pick-up in growth into 2014.  More stable jobs growth, higher household spending, stronger global growth and significantly reduced negative impulse from fiscal policy should contribute to growth of 2.8% next year.

Which brings me to the current market distraction of when the FOMC will start to taper its asset purchase program.  You will recall after the FOMC meeting in September I described the decision not to taper as a lost opportunity.  By the time of the meeting markets were getting more comfortable with it.  And as it has turned out, the labour market weakness over the US summer that was the primary reason not to taper in September has, to a large extent, been revised away.

Furthermore, given the recent better-than-expected October retail sales data and the likelihood of a good result for November sales (which will be released before the December FOMC) there seems little reason for the Committee to draw the saga out any longer.

In reality December and March are both in play for a tapering announcement with the odds now evenly split.  January is also a possibility but it seems to me if they don’t announce tapering in December, whatever the concern is that’s holding them back will unlikely be resolved just a few weeks later.

We still believe the announcement of the tapering timeline will be accompanied by a strengthening in forward guidance via a lowering of the unemployment rate at which the Fed will start to consider interest rate increases.  The decline in the unemployment rate continues to overstate the strength of the labour market.

Something that should not be ignored is the market reaction to the payrolls data on Friday.   Recently markets have weakened on strong data and strengthened on weak data as the prospects of imminent tapering have ebbed and flowed.  But on Friday the market reacted favourably to the strong payrolls data.  The FOMC may take that as a sign of market confidence that the US economy is ready to stand on its own two feet.

Wednesday, December 4, 2013

GDP Growth in Brazil and India

Two important emerging market GDP results were released this week.  In India September quarter GDP growth came in slightly stronger than expected, while growth for the same period in Brazil was disappointingly soft.

In India GDP expanded 4.8% yoy in September, up from 4.4% in the year to June.  This was higher than market expectations of 4.6%.


On a sectoral basis the upside surprise was agriculture with industrial growth also bouncing back after a weak June quarter.  Growth in the services sector continued its decline.   On an expenditure basis growth was driven by the two factors we expect to continue to drive a pickup in growth in the period ahead; exports and investment.  Higher exports had been showing though in the monthly trade data which largely reflects the recent weakening in the exchange rate.  Investment rose 2.6% yoy in September, up from -1.2% last quarter.  Consumption was soft reflecting weaker government spending as fiscal policy tightens.

Looking ahead I’m comfortable with my annual average forecast of 4.7% growth for the current calendar year, rising to 5.5% in 2014.  The positive impetus into next year comes primarily from efforts to unlock the pipeline of investment projects.  Exports will continue to benefit from the weaker exchange rate and a pick-up in global growth next year.  Offsetting those positives we expect fiscal policy to remain contractionary which will keep consumption contained.

The news out of Brazil wasn’t so good.  GDP growth in the September quarter posted its first quarterly contraction since the March quarter of 2009.  GDP contracted -0.5% qoq to be up 2.2% in the year to September.  That compared with 3.3% for the year to June.  We warned at the time it was released that strong June quarter growth (which was revised up from 1.5% qoq to 1.8%) would not be sustained and there would be payback in the third quarter, but the result was lower than expected.

The weakness was across all sectors of the economy.  Agriculture gave back most of the gains of last quarter while the industry and service sectors slowed to a virtual standstill.  Most disappointing however was the decline in exports, especially given the recent depreciation in the exchange rate.

As we’ve discussed before, the Brazil economic story is largely one of structural roadblocks.  It seems counter-intuitive that as growth slows, the Brazil central bank is hiking the Selic rate to contain strong inflation pressures.  Easier monetary policy is not the answer in Brazil.  Indeed we argued as monetary policy was easing aggressively over 2011/12 that it would be quickly followed by an aggressive tightening cycle.

Looking ahead this result knocks my calendar 2013 GDP forecast back to 2.3% (annual average).  Into next year we believe the impact of higher interest rates will more than offset the competitiveness gains from the weaker exchange rate, especially given the structural impediments to growth.   We continue to expect 2.0% growth next year. 

Monday, December 2, 2013

Euro zone inflation, unemployment and the ECB

Euro zone inflation ticked up slightly in November with the annual rate of headline inflation rising from +0.7% yoy to +0.9%.  Core inflation also rose from the 0.8% yoy to +1.0%.  Recent fears of deflation (at least in the true sense of the word) were overdone although we believe the Euro zone is in for a prolonged period of low growth and with that, low inflation.

Unemployment data was also a tad better with the unemployment rate moving down a tad from 12.2% in September to 12.1% in October.  This is noteworthy in that it’s the first decline in unemployment since early 2011 when the rate stood at 9.9%.  We don’t believe Euro zone growth will be strong enough in the period ahead to make significant inroads into unemployment any time soon.  It’s more likely that modest growth will be accompanied by at best a very gradual decline.  Call it secular stagnation if you like.


Both pieces of news will be welcomed by the ECB as they head into this week’s policy meeting.  There is however, still a significant job of work to be done to get the Euro zone growing and for inflation to even look like getting close to the ECBs definition of price stability.

The key to stronger growth in the Euro zone is the same as it always was – significant structural reform and stronger investment.  That begs the question what more the ECB can actually do.  As you know we believe cutting interest rates, as they did last month, is nothing more than symbolic.   Regular readers know we believe that too much responsibility has been placed on monetary policy to fix what ails some of the key developed economies in the post-GFC world.

Last week there was media speculation around other measures the ECB could employ.  That speculation included cutting the deposit rate and the possibility of another LTRO aimed at SME lending, most likely something similar to the UK’s “Funding for Lending" program.  We like the prospect on more focussed attention on business lending, especially in the SME sector where most new jobs are created.

On the subject of the UK’s funding for lending program last week the Bank of England and the Treasury announced a change to the program whereby incentives for mortgage lending would end but would continue for business lending.  That reflects recent strength in the housing market and consumption, but maintains support for the missing part of the recovery so far – business lending.  Without higher business lending we worry about the sustainability of the recent recovery in UK growth.  In terms of interest rates, the change means the policy rate can stay lower for longer.