Friday, May 30, 2014

Weaker US Q1 GDP sets up strong Q2

March quarter US GDP was revised sharply lower on the back of a significantly lower inventory investment.  The initial print of +0.1% (annualised) was revised down to -1.0%.  However, all the signs are pointing to a strong bounce back in growth in the second quarter of the year.

The downward revision to inventories accounted for the entire GDP revision.  In total, inventories knocked 1.6 percentage points off GDP in the quarter.  The good news is that much of the inventory adjustment we expected to play out this year, and with that the drag on growth, has now already occurred.

As I pointed out following the release of the advance estimate the growth story in the quarter was not as bleak as the headline suggests.  Domestic demand came in at an annualised 1.6% in the quarter slightly higher than the initial estimate of 1.5%.  Consumer spending posted a solid 3.1% gain.

Nothing in the revision changes our view that the weak quarterly result was due to lower inventory accumulation and the poor weather at the start of the year.  Indeed partial activity data was already improving in the March month and on into April.  That makes me happier with my 4.0% (annualised) forecast for June quarter growth.  Annual average growth for calendar 2014 is expected to come in at 2.3%.

Tuesday, May 27, 2014

EU Election: keep calm and carry on

Euroskeptic nationalist parties put in a strong showing in the European elections and have essentially usurped the role of the left as the main opposition bloc in the European parliament.  This is a further manifestation of the recent rise of the anti-Europe parties in national elections such as the Five Star Movement in Italy, Syriza in Greece and the Alternative fur Deutschland in Germany.

While the outcome is worthy of some concern, don’t overdo it: the European Parliament has little power to initiate legislation.  Furthermore, while the euroskeptics have increased their share of the vote, they are essentially a disparate bunch with little to unite them in terms of policy specifics.

Of more concern to me is what the election means for the individual member state Governments and the necessary work still ahead in securing the sustainability of the Euro as a common currency.  Securing that sustainability requires further integration – not less.  My concern is that a further populist outcry against European integration may slow down or stall the necessary progress that needs to be led by the individual member states.  Time will tell.

Friday, May 23, 2014

Global manufacturing mixed in May

Preliminary manufacturing PMIs for the world’s major economies painted a mixed picture in May.  That said they were broadly consistent with our view of the state of play in those economies with stabilisation in China, rebound from weather induced weakness in America, post tax hike contraction in activity in Japan and continued weak growth in the Euro zone. 

The most encouraging sign was the rebound in the China index which rose from 48.1 in April to 49.7 in May.  The improvements came in the right areas with increases in the output, new orders and new export orders sub-indices.  That supports our contention of a stabilisation in the recent weakness in activity is occurring, although it is unlikely to prevent a further softening in GDP growth into the second quarter.  From a policy perspective it supports the case a continuation of the Government’s “fine tuning” approach to stimulus rather than anything more aggressive.

Japan’s index nudged a tad higher in May to 49.9 from 49.5 in April, but that comes after hefty declines in the two prior months.  This is the unwinding of the strong growth recorded in the March quarter (+1.5% qoq) as a result of the bringing forward of expenditure ahead of the consumption tax increase on April 1st.  We expect GDP to contract 1.0% in the June quarter and to remain soft thereafter.  We continue to believe the Bank of Japan will be easing again from about July.

The Euro zone index was disappointingly soft, falling from 53.4 in April to 52.5 in May.  This result follows the weaker than expected March quarter GDP result which came in at +0.2% compared with the average market expectation of +0.4%. With little reason to be optimistic about the growth outlook, we continue to be happy at the bottom end of market expectation for calendar year GDP growth.  Furthermore the output price index remained under 50 underlining downside risks to inflation which supports our expectation of further ECB easing when the Governing Council next meets on June 6th.

In the US the index rose for the second consecutive month to now stand at 56.2.  That supports the view that the economy will bounce back from the weather-induced weakness in the March quarter.  That said there is reason to still be cautious about the quantum of the bounce with weaker than expected industrial production in April and flat retail sales (albeit flat following a strong March increase).  March quarter GDP is likely to be revised down from the initial print of an annualised +0.1% but the June quarter is likely to come in around 3.5-4.0%.  However we don’t expect that pace to be maintained for the rest of the year.  We’re still happy with our below consensus forecast of annual average growth of 2.5% for the 2014 calendar year.

Thursday, May 15, 2014

New Zealand Budget 2014

  • The 2014 Budget has the Crown’s finances moving into the black in 2014/15 with a surplus of 0.2% of GDP ($372 million) in 2014/15.  Surpluses rise to 1.3% of GDP ($3.5 billion) by 2017/18. 
  • The Government has allowed themselves some room for new initiatives.  The Budget includes new initiatives of $1.0 billion in 2014/15 with education and health the main winners.  They have allocated $1.5 billion for new initiatives in 2015/16, rising by 2% per annum from 2016/17.   
  • The Treasury is forecasting robust economic growth in the period ahead accompanied by a declining unemployment rate and rising inflationary pressures.  Their forecasts are broadly in line with our own.
  • In a smart political move the Government is leaving its options open as to how they will utilise future new initiative allocations.  Options include tax reductions, operational and/or capital spending and debt repayment.  Auto-enrolment for KiwiSaver is also an option.   We expect we will hear more about those options in the lead up to the General Election on 20 September.

Key policy initiatives
  • The cornerstone of the Budget is a $500 million package aimed at supporting children and families, including extending paid parental leave, free GP visits and prescriptions for children under 13 years, and an increase in the parental tax credit.
  • $858 million is allocated over four years for early childhood education and schools.  This includes $359 million for the previously announced programme to strengthen leadership and quality teaching across school.  Schools’ operational grants will increase by $85.3 million.
  • $199 million new investment in tertiary education, including an increase in tuition subsidies in some disciplines, a further 6000 apprentices in the Apprenticeship Reboot programme and the establishment of three new Centres of Research Excellence.
  • A $1.8 billion increase in health spending over four years.
  • Housing sees $30 million to help the community housing sector provide more homes for high needs families and the Ministry of Social Development receives extra funding to assist people find the right housing option.
  • There are a number of initiatives to support business innovation, including $69 million over four years for New Zealand Trade and Enterprise to expand its presence in China, South America and the Middle East, $56.8 million over four years in contestable science and innovation funding, and $58 million in increased tax deductions for Research & Development by start-up firms.
  • A further $1 billion of the $4.7 billion in the Future Investment Fund from asset sales is allocated to infrastructure investment.
  • ACC is on track for a reduction in levies of around $480 million in 2015/16 depending on the outcome of public consultation.


It has been a long hard road to get the Crown’s books back into order.  Following a domestic recession that was followed closely by the Global Financial Crisis and the devastating Canterbury earthquakes, the Crown’s operating balance (OBEGAL) blew out to 9.2% of GDP in 2010/11.  A forecast surplus in 2014/15 is a creditable turnaround.
Repairing the Crown’s finances has been a significant drag on economic growth over the last few years.  Of course the upside of deeply contractionary fiscal policy is that has allowed the Reserve Bank to keep interest rates lower than would have otherwise been the case. 
The Government appears acutely aware of not providing extra pressure for the Reserve Bank to raise interest rates.  While this Budget includes higher spending and lower surpluses than previously forecast, it is not likely to lead the Reserve Bank to alter their views on the outlook for the economy or monetary policy settings.  The Government also appears aware of the risk of committing cyclical improvements in the Crown’s finances to new initiatives that may need to be unwound when the cycle turns.
A key feature of recent Budgets has been the tight control of expenditure.  While the Government has allowed themselves to spend more in this Budget, the ratio of spending to GDP is projected to decline to under 30% by 2017/18.  The decline of the Government as a proportion of the economy frees up resources for the private sector, the real wealth creators in the economy, to grow. 
Getting debt down is a critical part of ensuring financial stability and reducing vulnerabilities.  It provides a buffer to cope with the inevitable next downturn in the economic cycle and better prepares the Crown’s finances for the fiscal pressures that come with the aging of the population. 
That said, we continue to be disappointed in the Government’s continued commitment to current arrangements for New Zealand Superannuation.  We understand the politics but the significant opportunity cost of that commitment should be recognised.
The Government is leaving its options open as to how they will utilise future new initiative allocations.  Options include tax reductions, operational and/or capital spending and debt repayment.  Auto-enrolment for KiwiSaver is also an option.  We expect discussion of the options will be a key part of the election campaign for National.
Rising Budget surpluses is good for national savings.  However New Zealand’s biggest savings problem is poor household savings.  It is therefore not surprising that our vote for future policy initiatives is for those that focus on the building of private savings.

The fiscal numbers
The 2013/14 deficit (OBEGAL) is slightly worse than forecast in the Half Year Economic and Fiscal Update (HYEFU) on the back of recent weaker than expected tax revenues.  The Government is projecting a deficit of -1.1% of GDP in the current year compared with -1.0% in the HYEFU.   

However, this is made up on the back of stronger near-term GDP forecasts so that a surplus of 0.2% of GDP is expected in 2014/15, up from 0.0% in the HYEFU.   Surpluses continue to rise over the forecast horizon to 1.3% or $3.5 billion in 2017/18, although the surpluses are slightly lower in future years on the back of the allocations for new initiatives.

Core Crown expenditure declines as a percentage of GDP over the forecast period, reflecting tight control of expenditure and strong nominal GDP growth.  After peaking at 35.1% of GDP in 2010/11, the ratio is expected to decline to 29.9% of GDP in 2017/18. 

Core Crown revenue rises as a percentage of GDP over the forecast period reflecting stronger economic growth.  From a low of 28.6% of GDP in 2010/11, the ratio of revenue to GDP rises to 31.1% of GDP in 2017/18.

Net core Crown debt is expected to peak at 26.4% of GDP in 2014/15 before declining to 23.8% of GDP by 2017/18.  The Treasury expects net debt to be back to 20% of GDP in 2019/20, at which point the Government expects to resume contributions to the New Zealand Superannuation Fund.

The economic assumptions
The Treasury’s economic growth assumptions are broadly in line with our own.  Treasury is estimating growth of 3.0% for the year to March 2014 (AMP Capital 3.1%), rising to 4.0% (AMP Capital 3.8%) in the year to March 2015.  Growth then slows as monetary conditions tighten, the terms of trade decline and net migration slows.  Treasury is forecasting growth to come back to 3.0% (AMP Capital 2.8%) in the year to March 2016.

We have the unemployment rate falling a bit faster than Treasury: they expect an unemployment rate of 5.1% in March 2016, compared with our forecast of 4.8%.  The Treasury believes inflation will reach 2.5% in March 2016 which is a bit higher than our forecast peak of 2.3%.  We expect similar degrees of deterioration in the current account balance to a deficit of around 6.0% of GDP by March 2016.

On balance, the Treasury’s fiscal forecasts appear based on sound and reasonable economic assumptions.

Wednesday, May 14, 2014

China data shows beginnings of stabilisation

The most you can say about China’s April activity data is it is showing the beginnings of stabilisation.  Growth in fixed asset investment, industrial production and retail sales were all weaker than market expectations while external sector data came in stronger.  That said the data was broadly in line with our view for this year of continued weakness in investment, stability in retail sales and a recovery in exports.  Continued benign inflation gives ample room for the Government to continue their “fine tuning” approach to stimulus.

Investment continues to be the most significant drag on China economic growth.  Year-to-date growth in fixed asset investment activity declined to 17.3% in April from 17.6% in March.  This is now the lowest level since 2002.  The slowdown reflects over-capacity, which will continue to take some time to unwind, and relatively tight credit conditions.

Nominal retail sales growth slowed from 12.2% yoy in March to 11.9% in April.  However, real growth showed a slight improvement rising from 10.8% to 10.9% over the month.  Industrial production slowed a tad further from 8.8% in March to 8.7% in April. 

Imports and exports both came in stronger than expected with exports up 0.9% yoy. Export growth continues to suffer from the base effect of over-reporting last year.  Growth is probably running closer to 6-7%.  Import growth is being held back by weak domestic demand, which we expect will remain relatively flat in the period ahead.  However, given the high imported component of China’s exports, recovery in export growth later this year as the US recovers from poor weather and as activity in the Euro zone continues to expand will also see import growth move higher as the year progresses. 

Money supply (M2) growth recovered to 13.2% yoy in April, up from the low of 12.1% recorded in March.  The official target for M2 growth this year is 13.5%.  CPI inflation is now running at 1.9% yoy, well short of the 3.5% target for this year and the lowest inflation reading since late 2012.  The latest decline was driven by falls in food prices with core inflation remaining around the recent trend level of 1.6% yoy. 
The Government has taken a fine tuning approach to stimulus which has been mostly focussed on infrastructure spending.  There was also a cut to the required reserve ratio recently but only for rural banks.  While we think GDP growth will slow further into the second quarter, we expect the authorities will continue the current approach of providing only modest cyclical support.   

Friday, May 9, 2014

ECB to ease in June?

The European Central Bank (ECB) left monetary condition unchanged at its May meeting but the Governing Council (GC) is clearly concerned about the inflation outlook.  While they didn’t do anything today, dovish comments from ECB President Mario Draghi suggested the central bank was just waiting on further information before acting next month.   That new information will include updated staff forecasts, March quarter GDP data (scheduled for release on May 15) and of course there will be the next monthly readings on inflation
and credit growth.

At the press conference today Draghi stated the ECB is happy the recovery is firming up, but they are dissatisfied with the projected path of inflation.  That’s consistent with our view  that while the growth outlook is improving in the Euro area it will prove to be insufficient to make any serious dent the significant amount of spare capacity across the region which poses downside risks to inflation.  Indeed annual inflation is currently negative in five member states.

So what could they do in June?  While the ECB confirmed its unanimous commitment to using unconventional instruments within its mandate, it’s too early to expect quantitative easing.  It’s more likely we will see a cut to interest rates (a cut to the refinancing rate and a negative deposit rate).  That would most likely reverse the recent drift higher in market interest rates.  However such a move would be large symbolic as it would prove insufficient to cure what ails the Euro area, although it might be sufficient put some downward pressure on the exchange rate.

Another likely move is for the ECB to stop sterilising their 172 billion holding of sovereign bonds purchased in the Securities Markets Program (SMP) by stopping the reabsorption of the SMP cash.  That would have a similar effect to QE although it differs in the sense that the asset have already been purchased - in fact you could call it "delayed QE".

The next meeting of the Governing Council is scheduled for June 5th. 

Wednesday, May 7, 2014

The NZ labour market, the NZD and the RBNZ

New Zealand March quarter jobs growth came in at +0.9% for the quarter, stronger than the market consensus pick of +0.6%.   The annual rate of growth was a spectacular +3.7% for the year to March.  The strong jobs number supports our expectations of strong GDP growth in the period ahead and a broadening out of that growth across the economy.

Despite the strength of the jobs growth the unemployment rate remained unchanged 6.0% compared with market expectations of dip lower 5.8%.  That’s thanks to the 0.4pp increase in the participation rate.  We knew growth in the working age population would be strong over the quarter on the back of solid increases in net migration, but growth in the labour force exceeded even that. People starting to look for work is itself a sign of confidence in the jobs market.  That’s a good thing.

An unemployment rate of 6.0% suggests there is still plenty of slack in the labour market.  Indeed wage growth came in below expectations at +0.3% for the quarter according to the Labour Cost Index (private sector, all salary and wage rates), with the annual rate at 1.7%. 

Looking ahead we expect the pace of jobs growth to slow in the months ahead.  We have now had three quarters of employment growth of around 1% per quarter.  Unless productivity growth is zero (which we expect it’s not) it seems reasonable to expect some moderation.  However, we still think that growth will be strong enough to continue the trend decline in the unemployment rate which we still think will be closer to 5% by the end of the year.

So what does this mean for the Reserve Bank and monetary policy?  It’s all quite fascinating.  The employment growth numbers will give the RBNZ confidence that the economy is powering ahead.  That will in turn give them confidence that it is correct to be raising interest rates “towards a level at which they are no longer adding to demand” (from the April OCR Review press release).

But we also know the exchange rate is a complicating and frustrating factor in wanting to get interest rates higher.  That was made loud and clear again in a speech by Graeme Wheeler at a dairy industry function this morning in which he repeated the RBNZ’s view that the exchange rate is overvalued and unsustainable.  He went on to say that if the NZD were to remain high in the face of weakening fundamentals (i.e. declining export prices), it would become more “opportune” for the RBNZ to intervene in the currency market.

However to intervene in the currency and continue to raise interest rates would be inconsistent.  Such intervention would therefore require a pause in the interest rate hiking cycle.  In the meantime I’m still expecting 25bp hikes in June, September and December for an OCR of 3.75% by the end of the year, but much will depend on the trajectory of the exchange rate.  Watch this space.

Monday, May 5, 2014

Good jobs growth in America

April payrolls growth of +288k was better than expected.  Along with net upward revisions of +36k to the prior two months, this result took rolling 3-month average payrolls growth to +238k in April, up from +178k in March.
Jobs growth was broad-based with the biggest gains over the month coming from professional business (+75k), education/health (+40k), retail trade (+35k) and construction (+32k).

The real headline grabber was the large 0.4 percentage point decline in the unemployment rate which fell from 6.7% in March to 6.3% in April. However, the make-up of that result wasn’t as good as the headline result suggested.  The unemployment rate comes from the separate household survey which tends to be more volatile than the payrolls data with the labour force declining by 806k and employment falling 73k over the month.

The disappointment in the result was wages which were flat over the month after rising only 0.1% in March.  The annual rate of hourly earnings has now dropped back to 1.9%.  That said the strong gain in (payrolls) employment bodes well for overall income growth which will help underpin further growth in consumer spending.

While the labour market continues to recover it remains the case that the decline in the unemployment rate over-states the improvement.  Benign wage growth supports the case there is still slack in the labour market – but the question remains how much.  More on that later this week.

Thursday, May 1, 2014

US GDP and the Fed

There were no surprises from the FOMC today with a further $10 billion reduction in the pace of asset purchases to $45 billion per month.  The surprise was left to the March quarter GDP result, which despite the inbuilt expectations of weather-related weakness and a negative contribution from inventory investment, came in below expectations.

March quarter GDP came in at an annualised +0.1% rate.  The headline result was negatively impacted by a drop in inventories (expected) and large negative contribution from net exports (unexpected).  Together those factors detracted 1.4 percentage points from the quarterly result.

Exports and imports both fell over the quarter, but exports posted a large 7.6% decline.  The suggestion is that weather related disruptions to transport networks delayed the shipment of some goods – so I’d expect to see a reasonable bounce-back in the second quarter.

Domestic demand came in at a softer than expected 1.5%.  That’s despite consumer spending surprising on the upside at 3.0%.  Housing and business investment were the downside surprises.

March month activity indicators had already shown a degree of recovery from the weather-related weakness in the first two months of the quarter.  That gives us confidence we will see a strong recovery in growth in the second quarter.  I’ve bumped up my Q2 forecast to annualised +3.6%.  But with such a soft start for the year, my calendar year annual average GDP forecast now sits at 2.5%.

There were no surprises in the FOMC’s statement this morning.  There was no change to the Committee’s language regarding the economic or policy outlook.  Asset purchases were trimmed again and remain on track to be done-and-dusted by October.  The critical factor for markets now is the timing of the end of the FOMC’s zero interest rate policy.  We continue to expect that to mid next year with the critical question being just how much spare capacity there is in America…