Thursday, April 24, 2014

Another 25bps from the RBNZ

In a widely anticipated move the Reserve Bank of New Zealand continued the process of removing the significant monetary accommodation from the economy with a second 25bp hike in the Official Cash rate (OCR) to 3.0%.

With the hike widely anticipated the interest for today was the accompanying press release (this being an OCR review, the RBNZ releases just a one-page comment rather than a full Monetary Policy Statement).  Markets were looking for any indication of the extent to which recent developments, including the strength of the exchange rate and the lower-than-expected March quarter CPI out-turn, had swayed the RBNZ from the path articulated in the March Monetary Policy Statement.

The press release made no specific reference to the March CPI, choosing to remain future-focussed which is entirely the right place to keep the focus.  And the exchange rate got the usual digs about being a headwind to the tradeables sector and unsustainable at the current level.

The RBNZ clearly wants to get on the job of raising interest rates “towards a level at which they are no longer adding to demand”.  That’s reflected in their acknowledgment that New Zealand’s economic expansion has “considerable momentum” and “spare capacity is being absorbed, and inflationary pressures are becoming apparent”.

The exchange rate is a clear frustration.  While it seems obvious for the RBNZ to state that the “speed and extent to which the OCR will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures…” they have added an extra clause to that sentence  “…including the extent to which the high exchange rate leads to lower inflationary pressure.”

So while the RBNZ appears undeterred from the process of removing monetary accommodation, the exchange rate could still come into play if inflation continues to print on the downside of expectations and the exchange rate is deemed to be the culprit.

Wednesday, April 23, 2014

America’s next problem is inflation

The return of more solid-looking activity data reinforces for me that US economic fundamentals are continuing to improve and that the next problem for the economy is inflation.  That means the next challenge for markets is the inevitable end of the Federal Reserve’s zero interest rate policy – it’s just a question of when.  Right now the best answer to that question is not yet.

There is also an increasing “solidity” to recent inflation outturns.  At the headline inflation level food prices are rising at a solid clip, posting 0.4% m/m increases in both February and March.  That’s on the back of the extreme drought conditions prevailing on the west coast which is impacting on prices for fruit, vegetables and dairy products.

We should be more interested in core inflation.  Prices increases there have looked a little more solid recently too with rising prices for apparel, medical care and airline fares.  But two-thirds of the 0.2% m/m increase in March came from rising shelter costs along with rents and owner occupied rents.  The shelter index is up 2.7% over the past year – its largest annual rate in six years.  We expect the continued improvement in the housing to put a solid floor (the pun was unintentional) under future core inflation outcomes.
While the FOMC has dropped its quantitative guidance with respect to the unemployment rate, we still look to the labour market to provide the clearest and earliest signs of generalised inflationary pressure.  With demand expected to continue to improve in the period ahead hiring will also pick up, as will wage growth.

The conventional wisdom is that the pick-up in the labour market will be gradual and will therefore put only very limited upward pressure on consumer prices given the significant amount of spare capacity in the labour market.  Seems to me the next question is just how much spare capacity is there?  More on that soon.

Tuesday, April 22, 2014

Stronger growth returning to America

Stronger March month activity reinforces that soft data at the start of the year was mostly related to the poor weather.  It will also help take the rough edges off what was shaping up to be a weak GDP report for the first quarter.

Retail sales came in at +1.1% for March, helped along by a sharp increase in automotive sales.  Aside from that sales were solid across most of the other retail groups.  This result along with an upward revision to February should see real consumer spending come in a touch over 2% (annualised rate) in the first quarter of 2014.

Housing starts were up 2.8% to an annualised 946k in March and, as with retail sales, February was revised higher.  Forward looking building permits fell 2.4% but that was on the back of a 7.3% rise in February.  Despite the drop back in permits housing starts should continue to grind higher to around 1.1 million for the year – or around half the rate that prevailed in the lead up to the GFC.
Industrial production was up 0.7% in March which followed a 1.2% gain in February.  Output was up across a broad range of sectors with the 0.5% increase in manufacturing especially pleasing.  We still look to stronger activity in the manufacturing sector to be the catalyst for stronger business investment in the period ahead.

So a good run of data in the last few days. While that should see March quarter still come in a touch under an annualised 1.0%, it gives us confidence we will see a rebound to around 3.5% in the second quarter.  That reinforces for me that the next problem for the US economy is inflation and the next problem for markets is the end of the Fed’s zero interest rate policy – it’s just a question of when.  More on that tomorrow.

Thursday, April 17, 2014

China GDP growth better than expected

March quarter China GDP growth of 7.4% was better than the 7.3% expected by the market but down from the 7.7% recorded for calendar 2013.  Despite the better than expected GDP result  the partial activity indicators were generally on the soft side, suggesting near term growth risks remain to the downside.

Industrial production came in at 8.8% for the year to March, higher than the 8.6% recorded in the January-February period, but a bigger bounce had been expected following the disruptions of the Lunar New Year period.  At 8.7% growth for the quarter we would have expected GDP to be a tad weaker although the service sector posted stronger than expected growth.

Fixed asset investment fell from 17.9% in Jan-Feb to 17.6% in March with the decline most marked in the property sector.  We expect FAI will continue to drift lower in the period ahead.  Retail sales growth was in line with expectations of 12.2% which is up from 11.8% in Jan-Feb, but growth is still best described as sluggish.

I think risks to growth in the near-term remain to the downside.  That is largely a domestic economy story.  We continue to look to exports to provide some impetus to industrial production and GDP growth later in the year.  Recent weak export growth of -6.6% for the year to March has been distorted by inflated data last year.  Adjusting for those distortions shows export growth running closer to +7.0%. Furthermore the strongest (least weak?) components of the recent manufacturing PMI surveys have been new export orders.

While the near-term growth risks remain to the downside the better than expected March GDP out-turn along with continued strong jobs growth suggests there is no need for significant stimulus.  However, if growth does continue to look a bit soft, we expect to see further announcements similar to the “mini-stimulus” we saw two weeks ago.  Low inflation and last week’s sharp drop in M2 from 13.3% in February to a below target 12.1% in March provides plenty of room to ease further in need.

Wednesday, April 16, 2014

NZ CPI lower than expected but tightening to continue

New Zealand’s March quarter CPI came in lower than expected at +0.3% q/q/ for an annual rate of +1.5%.  That’s a tad lower than the 1.6% recorded for the year to December.  Market consensus was for a quarterly increase of +0.5% and an annual rate of 1.7%.  However, we don’t expect the Reserve Bank of New Zealand (RBNZ) to be in any way deterred from continuing the gradual removal of monetary accommodation in the months ahead.

The surprise in the result was the softness in tradeables inflation which came in at -0.7% q/q and -0.6% y/y with the downward pressure on prices coming from the strong New Zealand dollar.  That decline was more than offset by a 1.1% q/q increase in non-tradeables inflation which is now running at an annual rate of 3.0%.  Key contributors on that side of the equation were the expected increase in tobacco excise tax, but also continued strong increases in construction costs which are now running at an annual rate of 5.1%.

We don’t expect this result to deter the RBNZ from pressing ahead with the gradual withdrawal of monetary stimulus.  The reality is that GDP growth is running well ahead of potential, spare capacity is being absorbed and firms are finding it more difficult to find skilled labour and interest rates are still at exceptionally low levels.

Those factors being the case we still expect the RBNZ to lift the Official Cash Rate 25bps in each of April, June, September and December for an OCR of 3.75% by the end of this year, with continued tightening in 2015 taking the OCR to 5.25%.

That said, there are many factors that will ultimately determine the quantum and pace of the tightening cycle.  These include whether the RBNZ has been (and remains) sufficiently pre-emptive, how the economy responds to higher rates, where the neutral OCR is, what New Zealand potential growth rate is and, of course, the path of the exchange rate.

With respect to the exchange rate our interest rate forecasts assume some eventual downside in the New Zealand dollar.  Recent falls in commodity prices haven’t yet proven the catalyst for a weaker currency but we expect that as the Reserve Bank of Australia starts to hike rates later this year and as the US Federal Reserve moves closer to interest rate increases we will see some downside in the NZD.  If none of those work, the catalyst for the lower NZD will likely prove to be a downward revision of our and, more importantly, the Reserve Bank’s interest rate projections! 

But remember exchange rate risks are not one-sided. A sharper than expected fall in the exchange rate could lead to higher inflation and higher interest rates.

Friday, April 11, 2014

When Doves Cry: monetary policy in the G3

A key theme for us this year was that despite the improved global growth outlook, monetary conditions in the key developed economies would remain highly stimulatory and in two cases – the Euro area and Japan – possibly become easier.  Recent statements from the G3 central banks have not altered that view.

After the March Federal Open Market Committee (FOMC) meeting increases in interest rate projections (the dots in the central tendency projections) along with Chair Janet Yellen’s apparent definition of "considerable time" as six-months in the post-meeting press conference left markets concerned, overly in our view, that interest rate increases were closer than appeared likely before the meeting.

The release this week of the minutes from the March meeting should have left markets in no doubt as to the continued dovish bias of the Committee.  That followed an equally dovish speech from Yellen last week that, along with the minutes, consigns “dot-gate” and “six-months” to history as communication wobbles.

While the weather cops most (though not all) of the flak for the recent weakness in activity data, there was an interesting and important discussion about the degree of slack in the labour market. "Several" members of the committee thought there might be more slack in the labour market than suggested by the unemployment rate alone while “a couple” saw slack as more limited.

The weight of opinion in that discussion is consistent with Yellen’s speech last week in which she observed that the economy and the job market are not back to normal health and that the US economy needs extraordinary support for some time.  The discussion is not suggestive of a committee that is going to be in a rush to remove monetary accommodation.  That said the focus on the labour market reinforces for me that wages, more precisely unit labour costs, holds the key to the Fed’s next move.

The Euro zone economy is at a fascinating stage.  Growth is clearly better, but remains insufficiently robust to make any significant dent in spare capacity.  The complicating factor for the ECB is that the amount of spare capacity differs across the region, most notably between Germany where the output gap is small and closing and in the likes of Spain Italy and France where output gaps remain large.  On balance, risks to inflation remain to the downside.

The ECB left conditions unchanged at their meeting last week but clearly maintained an easing bias which was, if anything, reinforced by the comment that the Governing Council  is "unanimous in its commitment to also use the unconventional methods within its mandate in order to cope effectively with risks of a too prolonged period of low inflation".

All options remain on the table for the ECB including quantitative easing (QE).  Bank President Mario Draghi said the discussion was continuing around QE including determining which of private and public purchases would be most effective.

Just as there is a high hurdle for altering tapering in the US, there is a high hurdle to its introduction in the Euro zone and I'm not convinced the ECB is fully there yet.  But it can’t be ruled out either with high unemployment, continued corporate deleveraging and the risk of lower inflation.

The Japanese economy is also at a critical stage.  The Bank of Japan (BoJ) also left conditions unchanged this week but at the post meeting press conference Governor Haruhiko Kuroda acknowledged there was room for further easing, although he also said there is room to adjust conditions in the opposite direction i.e tighten.

While the BoJ was somewhat more cautious about the economic outlook this month, perhaps in response to the weaker than expected Tankan survey, I think they are being a tad optimistic about how well the economy will come through the April 1st consumption tax increase.

As discussed in the post below I think Japan is in for a period of low growth which along with the waning impact of the recent currency depreciation will see inflation turn down again in the months ahead.  That will force the BoJ’s hand if they remain committed to their 2% inflation target.

Friday, April 4, 2014

Mini-stimulus in China

This post started off yesterday as a discussion of the policy options open to the Chinese authorities should  they feel the need to do something to stimulate the economy and at what point they might do that.   After yesterday's announcement we know the answers to those questions are that fiscal stimulus is the first cab off the rank and they are worried about it now.

At issue is the weaker than expected activity data at the start of 2014 with industrial production, exports and retail sales all coming in below the bottom end of consensus expectations.  Our forecast growth track for this year assumed a soft start to the year on the back of domestic weakness, stabilisation in the middle of the year and some upside in the second half of the year on the back of renewed impetus to exports as global growth improves.

Data for the first two months of the year shifted the forecast risk to our March 2014 GDP forecast of 7.4% to the downside and forward looking data such as the PMI, while supporting our thesis of a soft domestic start to the year bolstered by exports later on, suggests growth would most likely deteriorate further in the year to June, to perhaps as low as 7.0%.

That’s all in the context of a 7.5% growth target and a strong commitment to structural reform.  There has been a high degree of equivocation over this year’s growth target with various members of the leadership talking at various times about the target not being a hard target and commenting that growth of 7.2% or 7.3% is “close to” 7.5%.

The prospect of a number closer to 7.0% in Q2 has been sufficient for them to act.  Remember the Chinese authorities have been able to continue to focus on structural reform because the labour market has been holding up well.  But there was always going to come a point at which they would become concerned about low growth and its implications for the labour market and opt for some cyclical support for the economy.

The good news is that with inflation running at 2.0% and a forecast budget deficit for 2014 of 2.1% of GDP, there is ample room to move on both monetary and fiscal policy.  The inflation target for 2014 is 3.5%.

As we suspected the initial step has been fiscal.  Yesterday’s stimulus package focussed on infrastructure (railway) and housing spending.  It also offered tax breaks to small business.    There is plenty more ammunition should it be required.  There is more room for fiscal stimulus, which we expect will remain targeted at infrastructure spending (more rail, social housing, energy saving initiatives, environmental protection).  On the monetary side of the equation PBoC has tool at its disposal to provide liquidity to keep the cost of capital down such as suspending repos and cutting the reserve ratio.

While the size of the package was relatively small by China standards the more important point, at least for financial markets, is that it has removed the uncertainty about at what point the authorities would step in and support growth.

Tuesday, April 1, 2014

Critical period ahead for Japan

There's an ongoing debate in Japan about the success or otherwise of “Abenomics”.  Regular readers will know I'm less than convinced that Japan is on a path to sustainable growth and out of deflation.  That still requires a good dose of the third arrow of Abenomics: structural reform.

We now also throw the scheduled increase in the consumption tax into the mix.  The tax increases from 5% to 8% today.  How the economy comes through the next few months will be a key determinant of what work is still left to do to for the Bank of Japan to meet its 2% inflation target.

Recent data out of Japan has been relatively good, at least by recent Japanese standards.  GDP growth came in at an annual rate of 2.6% in December although the quarterly rate disappointed on the back of soft net exports.  Since then activity data has strengthened as household spending picked up into the tax increase.  Retail sales came in at 3.6% for the year to February – still a solid increase even if it was lower than the 4.4% recorded for the year to January.

It's not rocket science to expect retail sales will be sharply lower in the period immediately after the tax increase. Indeed industrial production is already heading lower as the “rush demand” abates from retailers.  Production was down -2.8% in the month of February for an annual growth rate of 6.9%, down from 10.3% in the year to January.
The critical question is what happens after that?  While Japan is better placed now than it was at the time of the last hike in 1997 which pushed the economy into recession, we are still cautious about the outlook.  Firstly, beyond the initial slump in consumption spending, it seems to me retail sales will continue to be constrained by the decline in real incomes post the tax increase.
Secondly, recent export performance has been disappointing and can’t be expected to fill the gap, at least not in the short term.  Exports have not fired on the back of the depreciation in the exchange rate due to insufficient demand, particularly from Asia.  Stronger global growth, particularly out of Europe and America should help that later in the year.
The ¥5.5 trillion supplementary budget will also assist, although it remains to be seen how quickly projects can be implemented.  I also question how successful incentives for capital spending will be; I think business is looking for progress on structural reform before committing to new investment.
On balance I think we are in for a soft period of growth in Japan, with stronger growth reliant on a recovery in exports later in the year.  That appears likely to put a dent in the other success story of Abenomics: reflation.  Headline inflation appears to have stabilised at around 1.5% per annum recently while core inflation (excluding both food and energy) is running at 0.8%.
Much of the recent rise in inflation has been due to energy prices and the exchange rate depreciation.  In the near term we don't expect growth will be strong enough to sustain inflation at its current level let alone move it further towards the BoJ target of 2% (excluding the tax increase).  Of course the other tool Japan has now is quantitative easing.  If we do see a prolonged soft patch in growth and a drift lower in inflation, I expect we will see more action from the BoJ.