Friday, August 22, 2014

The PrEFU, PMIs and the FOMC

I’ve been a bit of a lazy blogger this week so this is a bit of an “omnibus” post on the key events of the week (at least according to me!) - the PrEFU in New Zealand, the latest flash PMI results from around the world and the release of the minutes from the July FOMC meeting.

Starting at home the Pre-Election Economic and Fiscal Update (PrEFU) contained little in the way of surprises.  The Treasury has knocked a bit off their near-term growth estimates reflecting weaker dairy prices, offset to some extent by stronger net migration.  This has brought their forecasts closer to ours.  Like us they believe the New Zealand economy is past the peak in quarterly growth rates although our numbers are still a tad softer than theirs – but we’re talking about a difference of 0.1% per quarter on average.

The lower growth numbers has had a small impact on the key fiscal indicators over the forecast horizon but the underlying trend improvement in the operating balance and debt ratios remains unchanged.  The Treasury is still expecting the return to fiscal surplus to be achieved in 2014/15.

Importantly from the perspective of the Reserve Bank, fiscal policy remains contractionary over the forecast period with an average fiscal impulse of -0.4% per annum, unchanged from the Budget.


The Government continues to keep its fiscal powder dry – there was no news in the PrEFU on how they intend to use their new initiative allocation.  That means they go into the business end of election campaign with their fiscal options open.   That said the National Party campaign launch is this weekend so we may see some policy shots fired there.

Further afield we saw the latest round of flash manufacturing PMI’s from Markit this week and they were a bit of a mixed bag.  The good news was the surge higher in the US index to 58.0 in August from 55.8 in July.  That’s its highest reading since early 2010 and supports our expectations of stronger US growth in the second half of the year on the back of further gains in employment underpinning solid consumption growth.

The Japan index also rose over the month from 50.5 to 52.4 supporting the view that growth will resume in the third quarter after the bigger-than-expected contraction in the second quarter.  But with a return to trend growth in Q4, that still only delivers annual average growth of around 1.0% this year.


The China and Euro zone indices were disappointing.  The slip in the China index from 51.7 to 50.3 along with the recent softness in the some of the July activity data has effectively removed the bias towards upside risk to growth in the second half of the year.  We think GDP growth tracks around 7.4-7.5% for the rest of the year, supported by likely further tweaks to fiscal and monetary policy settings.

The Euro zone remains the problem child in the global economy.  Disappointing Q2 GDP growth is being followed with weakness in Q3 activity data.  The manufacturing PMI fell from 51.8 to 50.8 over the month, a 13-month low.  While we expect reduced fiscal drag, easier monetary conditions and a weaker Euro are collectively expected to keep the Euro zone from slipping back into recession, it’s no surprise the secular stagnation stories are starting to reappear.  More on the Euro zone next week.

Finally this week the minutes from the July FOMC meeting were interesting on a couple of fronts.  A discussion around the slack in the labour market revealed that the majority of meeting participants thought the recent improvement in the labour market had been faster than expected and that “conditions had moved noticeably closer to those viewed as normal in the longer run”. 

At the same time Staff forecasts showed a downward revision in their estimate of potential GDP, the natural conclusion from which is the output gap is now smaller than it was before and that all else being equal the Committee is getting closer to tightening monetary policy.  There was also a discussion at the meeting on the stimulus exit strategy. 

Those discussions were entirely appropriate for this stage of the cycle and there was nothing in any of this to change my view that QE will be finished in October but no rate hikes to mid next year.  Janet Yellen’s upcoming speech at the annual monetary symposium in Jackson Hole might add further colour...but then again it might not.  Mario Draghi is also speaking so watch out for that.