Thursday, July 24, 2014

RBNZ: time for a cup of tea

As expected the Reserve Bank of New Zealand hiked the Official Cash Rate (OCR) 0.25% to 3.5% today.  Most interest today however was in the messaging around where to from here.   In that respect the RBNZ signaled a “period of assessment before interest rates adjust further towards a more-neutral level”.  In other words, it’s time for a cup of tea.

Recent economic data has been biased to the soft side.  Most recently we saw a further large fall in dairy prices in the global dairy auction and a softer than expected CPI.  That followed falls in business confidence, albeit it still at healthy levels by historical standards.  On the other side of the equation net migration has remained strong which is putting pressure on the housing market.

And of course all of this has been occurring at a time when the exchange rate has continued to be strong.  I have long been at the hawkish end of monetary policy expectations, but always acknowledged the key role the exchange rate would play in determining the phasing and ultimate extent of the interest rate cycle.

As I said last week we are now at a point where the softer data, especially commodity prices, along with the continued strength in the exchange rate does not fit with continued hikes in the OCR.  Something had to give.

While I am of the view that we have passed the peak in quarterly growth rates, I continue to expect growth to be stronger than our non-inflationary potential.  That means pressure on resources and upward pressure on prices.  I therefore still see a strong case for interest rates to be at least back to neutral in time.  And remember when the exchnage rate eventaully falls that will in itself contribute to higher inflation.

The key question now is how long a pause will this be?  At this point I expect the next hike in December, but that will be exchange rate and data dependent.   The risk to that view is the pause is longer.  The reality is we don’t expect sustained downward pressure on the NZD until we see upward pressure on the AUD and USD.  That needs rate hikes (or at least firmer expectations of rate hikes) in Australia and the US – and that’s a 2015 story.

Friday, July 18, 2014

Global growth outlook - July QSO

Global economic and financial conditions continue to improve and growth to gradually recover.  That is being supported by reduced fiscal drag and still highly accommodative monetary conditions given the absence, for now, of any sign of generalized inflationary pressures.  However, lack of structural reform continues to hamper any meaningful improvements in potential growth.

In the US a confluence of negative factors resulted in a sharp contraction of GDP in the first quarter of the year and while we expect a rebound, 2014 growth appears likely to come in below 2013.  In the Euro area growth continues to fail to gain any significant traction and make any dent in spare capacity.  Recent events in Portugal highlight the risk of complacency about the significant amount of work still required to put the economy on a firmer footing.

Japan is moving through the volatility created by the recent consumption tax hike.  We remain less than optimistic about the extent to which the economy will recover in the second half of the year given the decline in real incomes.  Some progress has been made on structural reform but it appears to us to still be insufficient to boost longer term potential growth in any meaningful way.

Sentiment has improved in the key emerging economies.  Growth in China appears to be stabilizing and current account deficits of the so-called ‘fragile five’ are at least stabilizing and in most cases improving following an abrupt adjustment process.

We continue to expect global growth will be stronger in 2014 than 2013, although the margin of that improvement has reduced since our last report, largely on the back of a weak start to the year in the US.  Global growth is forecast to come in at 3.3% this year, up from 3.0% in 2013 but lower than the 3.5% we were forecasting in April.  We expect further recovery over the next two years with growth of 3.7% expected in 2015 and 3.9% in 2016.

For the full story from the July issue of Quarterly Strategic Outlook, including asset class commentary from our Head of Investment Strategy Keith Poore, click here.

Thursday, July 17, 2014

China growth better than expected

The recent stabilisation of China activity data resulted in a better-than-expected GDP growth result for the June quarter.  The economy grew 2.0% over the quarter, up from 1.4% q/q in March.  Annual growth came in at 7.5%, better than market expectations of 7.4% and much better than my clearly overly pessimistic forecast of 7.2%.

Industrial production came in at 9.2% for the year to June, up from 8.8% in May.  Growth in Fixed Asset Investment increased in year-to-date terms from 17.2% in May to 17.3% in June.   That’s on the back of an acceleration of infrastructure and a recovery in manufacturing investment offsetting slowing real estate investment.  Infrastructure spending is likely to gather further momentum as the Government continues to fast-track rail investment.

Stronger external demand and the recent weakness in the exchange rate assisted stronger net exports while the recent series of policy “fine-tuning” measures including fiscal stimulus and the targeted easing in financial conditions supported domestic demand.  It’s no coincidence that growth in the money supply (M2) and new loans were stronger than expected in June.

The trajectory of the quarterly improvement and the factors behind it suggest continued solid growth into the next quarter at least.  At this point we think annual growth will continue at the current pace in the second half of the year with annual average calendar growth likely to come in either on or not far off the official target of 7.5%.  Residential property remains the key growth risk but as I’ve said before there is no shortage of measures the Government can adopt to stem that decline.

Wednesday, July 16, 2014

RBNZ: more cause for a pause

Today’s June quarter CPI came in a tad softer than expected at +0.3% q/q.  Average market expectations were for a quarterly increase of +0.4%.  The annual rate came in at +1.6%.

As expected the Housing and household utilities and Food groups provided much of the upward contribution over the quarter rising 1.2% and 0.9% respectively.  That said the increase in the former was a tad lower than we were expecting and was in fact driven mostly by an increase in electricity prices.  Indeed non-tradable (i.e. domestic) inflation came in at just 0.4% while the Reserve Bank was expecting +0.7% so this result isn’t going to spook the RBNZ.

And this data came in on the same day we saw another large fall in dairy prices in the global dairy trade auction.  Prices came off another 8.9% overnight, with the cumulative decrease since the start of the year now indicative of a dairy payout of around $6.00- 6.50 per kilo and a reduction in dairy farmer incomes of around $4 billion compared with last season.  While that’s consistent with our expectation that GDP growth has probably peaked, the dairy price decline is larger than we had expected to see.

What does this mean for the RBNZ?  The expectation has been they will tighten at the OCR review next week and then pause for a while.  We still think that’s the case.  The reality is we still expect growth to be running ahead of potential which will necessitate interest rates back towards neutral at some point so we think the Bank would prefer to get another one done before pausing.

That said the cause for a pause in the tightening cycle just increased.  We have said all along that it was particularly the trajectory of the exchange rate that would determine both the phasing and the ultimate peak in the tightening cycle.  That’s still the case.  The reality is the combination of dairy prices falling more than expected, continued strength in the exchange rate and continued interest rate increases just don’t add up.

So expect another 25bp hike next week and then a pause.  The only question now seems to be the length of the pause…

Sunday, July 13, 2014

Focus on Portugal

Concerns about the financial stability of the parent of one of Portugal's largest banks emerged last week.  Markets wobbled as fears rose about this being a sign of problems at other Eurozone banks.  That's too soon to tell but this latest event highlights the risk of complacency about the financial stability of the Eurozone and its banking sector in particular.

I've warned about this on numerous occasions, but promise not to say I told you so.  The challenge is the significant and ongoing private deleveraging that is playing out across the Eurozone in a low growth environment.  Until that process is complete there is the risk of the occasional wobble especially in economy's such as Portugal with still high levels of non-financial corporate debt.

That said, the risks of a return to the deepest darkest days of the Eurozone debt crisis are unlikely.  While I think complacency has been too high, significant progress has been made in restoring public finances and economic growth in many of the problem member countries.

Portugal itself has been doing an outstanding job.  The economy is growing on the back of gains in export competitiveness, private savings are rising and public finances have been restored so that a primary budget surplus is expected this year.  The economy is thus on a far firmer footing than it was during the depths of the crisis and is now in a better position to withstand shocks.

Such has been Portugal's success that it recently exited its bailout program, having met the harsh conditions set by the troika of the IMF, European Commission and the European Central Bank.  That means it no longer automatically qualifies for support through the Outright Monetary Transactions (OMT) program.  However, should push come to shove, the ECB's commitment to do whatever it takes to save the Euro will come to the rescue.  Portugal will not be penalised for having successfully met the troika's demands.

I expect this event, which followed an earlier profit downgrade from one of Austria's banks, will put renewed focus on the ECB's banks stress tests later this year.  Watch this space.

Friday, July 4, 2014

Solid US jobs growth

We saw another good piece of news out of the US today supporting the case for a solid rebound in growth following the disappointment of the first quarter.

Non-farm payrolls expanded +288k in June with broad-based gains concentrated in business services, manufacturing and construction.  The average work week was unchanged over the month but with more people in work aggregate hours worked are rising at around a 4.5% annual pace (3-month annualised), supporting the story of stronger growth ahead.

Employment growth was also strong in the household survey which when combined with an unchanged participation rate led to a decline in the unemployment rate from 6.3% in May to 6.1% in June.

Wages are quickly becoming the most keenly watched data as the market looks for any hints of when the Fed may start to raise interest rates.  There was nothing in this data to get excited about.  The 0.25% monthly gain in average hourly earnings was a touch higher than the recent average but the annual rate remains around 2%.

Our US growth forecasts for the remainder of this year are dependent on strong consumer spending.  While wages remain subdued, that combined with increasingly solid employment gains still leads to a strong increase in aggregate consumer income.  That in turn bodes well for GDP growth in the period ahead.