Tuesday, March 25, 2014

Weak flash PMI in China

The March flash HSBC PMI for China came in weaker than expected at 48.1.  The market consensus was looking for a modest rebound from the 48.5 recorded in February.  The further softening of the data confirms our suspicions there has been more to the recent soft data than just the usual New Year volatility.

The production sub-index moved to an 18-month low.  But despite the overall weakness in the index the new exports orders sub-index moved back into expansion in March.   That’s consistent with our story of a soft start to the year from a growth perspective on domestic weakness, but with some strength in exports emerging as the year progresses.  On balance though this result has put further downside risk on our year to March 2014 GDP forecast of 7.4%.

Perhaps the biggest surprise in the result was the rebound in the employment sub-index from 47.2 to 49.3.  The labour market remains a key determinant in the leadership determining the balance between pushing on with the reform agenda or cyclical support for the economy.  A March GDP result much below our estimate will likely lead to new measures to support growth which we expect would be focussed on fiscal stimulus (infrastructure) and liquidity provision.

The official PMI index is released next week (April 1st).  The HSBC index is narrower focussed than the official index and tends to be more volatile.  Importantly the official index captures the larger state owned enterprises.  That release will be the next critical piece of data to help inform the extent of the slowdown at the start of the year and the likelihood of any policy intervention.  Watch this space.  

Thursday, March 20, 2014

No Change in policy direction from the Fed

US Federal Reserve FOMC meetings always garner a bit of attention.  This week’s meeting was more interesting than most, being the first meeting in which Janet Yellen was in the Chair.  But while there were some changes to the Statement, the FOMC’s policy direction is fundamentally unchanged.

The most immediate question for policy (and markets) was how they would judge and respond to recent weakness in the economy.  As most analysts have, the FOMC was happy to attribute the soft data to the weather and conclude the economy remains fundamentally sound.  We agree with that, although we add in the inventory cycle as another reason for the recent weakness and is why we are happy being at the lower end of market expectations for US GDP growth this year.

Given that view the Committee proceeded with a further reduction in their asset purchase program to US$55 billion per month, the third consecutive reduction of US$10 billion per month.  While the Committee again reiterated that reductions in the program are not on a pre-set course, todays move confirms our suspicions that the hurdle for reducing (or indeed increasing) the pace of tapering is set quite high.  The reality is the market volatility that would result from altering the pace of the purchases would be more costly to the real economy than the benefit of the change in quantum of purchases.

While broad policy direction was unchanged, the Committee did change its rate guidance from a quantitative approach to qualitative: the 6.5% unemployment rate threshold for considering rate hikes is now gone.  With the unemployment rate currently at 6.7%, that level is likely to be breached soon.  In its place, the Committee will now “take into account a wide range of information, including measures of labour market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments”.  That’s great and simply indicates further normalisation of the monetary policy process. 

However to reinforce the Committee’s expectations that it will maintain the current target range for the Fed funds rate for a considerable time the Committee felt compelled to stress that the change in guidance did not indicate any change in the Committee’s policy intentions as set forth in its recent statements.

The most interesting aspect of the central tendency forecasts was the higher policy rate forecasts.  The 2015 median rate moved up to 1.00% from 0.75% and the 2016 median was higher at 2.25%, up from 1.75%.  We’re pretty relaxed about that (as Yellen also appeared in her press conference).  Those rates are still well below the Committee’s estimate of the equilibrium rate.

If you doubt the Feds “dovishness” you just need to read this: “….even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run”.  This is not an FOMC that’s going to be in a hurry to tighten.

Strong New Zealand GDP growth

GDP growth came in bang on market expectations at +0.9% qoq for the December quarter of 2013.  That’s a great follow-up to the (revised) 1.2% qoq recorded in the September quarter and left annual growth at 3.2% for the calendar 2013 year (annual average of 2.7%).

The data was strong across the board – strong growth may have had its genesis in the dairy and construction sectors but it is now becoming increasingly widespread in nature.  The mining sector was up 10.5% over the year, manufacturing up 3.4%, construction up 7.6%, wholesale trade up 3.8% and retail trade and accommodation also rose 3.8%.

On an expenditure basis, high consumer confidence, rising house prices, strong net migration and strong employment growth are supporting private consumption and residential construction.  Business investment was also strong on the back of high business confidence. 

Business investment is an important part of the recipe to lift potential GDP. Growth is already in excess of potential which we put at around 2.0-2.5% (the RBNZ is more precise at 2.4%, rising to 2.8% as the cycle evolves). The output gap has closed meaning spare capacity has been absorbed and inflation is already off its lows.  This latest result is all the evidence the Reserve Bank needs to continue to follow through with its projected interest rate increases in the months ahead.

We expect annual growth to move higher over the next few quarters as weak drought-affected numbers from last year drop out of the annual calculation and get replaced by quarterly growth rates that will be close to 1% per quarter.  We expect annual average growth of 3.7% in calendar 2014, dropping back to around 3.0% in 2015 reflecting tighter monetary conditions.     

Friday, March 14, 2014

China data underwhelming

China activity data for the start of 2014 came in well below market expectations.  While we expected the start of the year would be the weakest point in 2014, this data suggests downside risk to our forecast of 7.4% GDP growth for the year to March 2014.

Growth in industrial production came in at 8.6% for the January-February period, down from 9.7% in the year to December.  Fixed asset investment growth fell to 17.9%, which is about the same pace as late last year but below the full 2013 year growth rate of 19.6%.  Growth in retail sales dropped from 13.6% in December to 11.8% in Jan-Feb.

This data came hot on the heels of weaker than expected February export data last week.  That said the February result came after stronger than expected January data.  Taken together the two months came in slightly below year ago levels which seems a more realistic picture for exports at this stage of the year.

Our expectation for China GDP growth this year was for a weak start with a stronger finish as exports picked up on the back of stronger global growth as the year unfolds.  We continue to expect that pattern of activity through the year, although the weak start could be a tad softer than our current forecast of 7.4% for the year to March 2014.

At this point I’m sticking to my full-year 2014 forecast of 7.5% GDP growth, although acknowledge the risk have shifted to the downside.  However, if data continues to come in soft we expect the leadership will change its preference for structural reform over cyclical support for the economy.

So long as the labour market holds up we think the authorities will be comfortable with slightly lower growth.  However with the recent confirmation of the growth target of 7.5% for 2014, the key word in that sentence is “slightly”.  The good news is that with inflation well contained, there is ample room on both monetary and fiscal policy to support growth with fiscal policy (infrastructure) the likely first cab off the rank should they decide to do something.

Thursday, March 13, 2014

RBNZ begins the tightening process

The case for tightening became sufficiently compelling for the Reserve Bank of New Zealand (RBNZ) to raise interest rates today, lifting the Official Cash Rate (OCR) 0.25 percentage points to 2.75%.

As you know, we believe the case for tightening has been compelling for a while.  That’s for all the reasons the RBNZ outlined today: New Zealand’s economic expansion has considerable momentum, growth in demand has been absorbing spare capacity and inflationary pressures are becoming apparent, especially in the non-tradeables sector.

There was unanimity of view in the market that the Bank would move today.  That meant the main point of interest was the forward track for interest rates.  In extending the forecast rate track out to March 2017 the RBNZ has signalled a rise in interest rates (90-day bills) to 5.3% at the end of the period which implies an OCR of around 5.0% or a tad more.  That’s consistent with our view of a peak in the OCR cycle of around 5.0-5.5% as outlined in our recent paper “The New Zealand Tightening Cycle” which you can read here

The RBNZ is often criticised for stomping on growth as soon as it gets going.  The most important factor for the RBNZ is not the absolute rate of growth but rather how the economy is growing relative to its potential to grow.  What the RBNZ has done today is start a process whereby some heat gets taken out of the cycle which will ultimately help extend the longevity of the expansion. 

Saturday, March 8, 2014

Good job gains in the US, wage growth higher

After a number of months of soft job data the better than expected gain of +175k in February supports the story that, aside from the weather, the US economy is continuing to expand at a reasonable clip.  Furthermore continued gains in wages alongside soft inflation tells us real incomes are improving which will support consumption growth in the period ahead.

Jobs growth was broad-based over the month, although we saw a third consecutive month of weakness in federal payrolls.  The unemployment rate ticked up to 6.7% over the month as the labour force grew more than employment in the household survey.

The impact of the weather was still evident in the data.  The number of workers who normally work full-time but were forced to work part-time rose sharply to 6.9 million in February, around five times greater than a typical February.  Furthermore the average work week fell to its lowest level since the start of 2011 resulting in a fall in aggregate hours worked.  That supports the case for a soft GDP reading in Q1 2014.  I’m still expecting a number around 1.0-1.5% at an annual rate.

The growth in average hourly earnings rose to 2.2% in the year to February.  The rise in wages along with jobs growth and low inflation supports our view that rising real incomes will contribute to stronger consumer spending and real final sales over the course of the year.  But at the same time remember wages (or more precisely unit labour costs) will be where signs of inflation will emerge first.  That’s not yet, but it’s just a question of time…


Wednesday, March 5, 2014

Australia GDP better than expected

Australia’s economic growth was better than expected in the December quarter of last year, rising +0.8%.  That’s ahead of consensus expectations of around +0.7% and up on the +0.6% recorded in the September quarter.    Annual growth came in at +2.8% with annual average coming in at +2.4%.

The good news is the Australian economy appears to be coping with the challenging transition following the mining investment boom.  In particular there was a 2.4% increase in exports leading to a strong contribution from net exports over the quarter.

Consumer spending and dwelling investment both posted solid increases which were helped along by a modest decline in the savings ratio which fell from 10.6% to 9.7%.  Take note New Zealand: a high savings rate can provide some buffer for spending when times are tough.  No savings, no buffer.

As had been signalled last week, private sector investment was weak over the quarter but this was partly offset by a surprise increase in public capital investment.

This result put alongside the recent lift in business confidence, building approvals and retail sales suggest the Australian economy is coming through the post mining investment boom in reasonable shape and that lower interest and exchange rates are having some impact on exports interest rate sensitive sectors of the economy.

Our Economics team in Sydney is forecasting a pick-up in growth this year with annual average growth likely to come in at around 3.0%.  That’s on the back of strong growth in exports but with consumption and dwelling investment making solid contributions too. 

Sunday, March 2, 2014

China official PMI softens

China’s official PMI index fell from 50.5 in January to 50.2 in February, slightly better than consensus expectation of 50.1.  All sub-indices bar one (suppliers delivery times) were weaker in February than January.  As I said with the release of better-than-expected trade data recently it’s important not to read too much into the Chinese data at the start of the year as it can be quite noisy.  That said the two most critical of the sub-indices, production and new orders, showed bigger declines than the overall index which shouldn’t be dismissed too readily.

Our forecast for China GDP growth this year is 7.5% which is a modest deceleration from the 7.7% recorded in 2013. As you know there are two critical and offsetting factors that will determine the growth outcome in China this year; the extent to which higher export growth on the back of higher global growth offsets the weakness in investment given the tightening in credit conditions.  Given our view that higher exports would come later in the year, our expected profile of GDP growth over the year is for it to start off soft and end the year modestly higher.  The PMI data is certainly supporting the first (and easiest!!) part of that story.

The other newsworthy development in China has been the recent decline in interest rates and the exchange rate.  Given the lack of transparency around the PBOC its actions are open to debate and conjecture.  Given the weakness in some of the recent data those market movements could be interpreted as an easing in monetary conditions to support growth.  Or worse, the exchange rate appreciation could be seen as an abandonment of the leadership’s intention to rebalance the economy.

I don’t think it’s either of those things.  Part of the intention to liberalise financial markets is to allow a greater role for the market in determining financial market prices.  With respect to the exchange rate, we think PBOC is simply wanting to introduce two-way volatility into the exchange rate, leading eventually to a widening of the trading band. That also helps send the message that CNY appreciation is not a one way bet.  We expect the CNY to continue appreciating this year.  Fundamentals support continued appreciation with the current account still in surplus, although at 2.1% of GDP in 2013, it is much reduced recently.  Also, continued Fed tapering and the resultant reduction of capital inflows (and possibly outflows) will also limit the appreciation.

Another important part of the China story will unfold this week with the announcement of the official growth target for 2014.  We expect it to remain unchanged from last year at 7.5%.  While we dont think recent financial market developments are a concerted effort to ease monetary conditions, given benign inflation there is room to move on both monetary and fiscal policy should the China leadership become concerned about the growth outlook.