Wednesday, January 21, 2015

Data Insight: NZ CPI

Key points:

  • New Zealand’s December quarter CPI came in at -0.2% q/q and +0.8% y/y.  That was weaker than our expectations of -0.1% q/q.
  • As expected the fall in oil prices was the primary downside contributor with petrol prices falling -5.7% over the quarter.  Further petrol price falls will be reflected in March data with the CPI likely to fall -0.3% in that quarter.
  • The weakness in the quarter went beyond just petrol however with general weakness across the traded goods sector.  The high exchange rate remains the likely culprit.
  • The annual rate of inflation is now below the bottom-end of the RBNZ’s target band again.  It will head lower in March and on our current forecasts is expected to remain below 1% for all of this year. 
  • While this may be causing the RBNZ some discomfort, there is not much they can do about it.  They can’t cut interest rates given the strength in the housing market and signs of rising capacity pressures, even though that is not yet reflected in consumer prices. 
  • Nor should they do anything about it.  The dip lower on the back of weaker oil price will prove transitory.  The Bank should look through that in the same way they should look through price shocks to the upside.
  • That said, general inflationary pressures have been weaker than expected and the Bank is clearly ahead of the curve.  But we continue to believe the next move in interest rates is up although that now appears a 2016 story.
  • Where interest rates head from here will not be determined by the price of oil but rather the extent to which the New Zealand economy can to continue to grow at an above-trend pace without generating inflationary pressures.  That will largely be determined by the extent to which wages respond to continued falls in the unemployment rate.

Sunday, January 18, 2015

Data Insight: US CPI

Key Points:
  • The U.S. Consumer Price Index fell -0.4% mom in December as the sharp drop in oil prices continued to make its mark.  Petrol prices fell -9.4%in the month and are down 21% over the year.  This result took the annual rate of CPI inflation down to 1.2% yoy.
  • Central banks will focus on the extent to which lower oil price feed through into the prices of goods and services beyond the fuel pump.  The December data shows clear evidence of some flow through with core inflation flat over the month.  The annual rate of core inflation is now +1.6% although the last three months shows an annualised increase of just +1.1%.
  • The split of core prices into goods and services gives us some confidence the low core inflation result is fuel related.  Services prices showed a small rise over the month while goods prices declined.  Goods price seem more likely to be impacted by lower transportation costs and the recent strength in the USD.
  • We expect to see further softness in core inflation in the months ahead.  While a pickup in spending on the back of lower oil prices appears likely, businesses don't yet have sufficient pricing power to expand margins.
  • We know the FOMC won't wait for inflation to be at 2% before raising rates, but they will want to be sure there is a solid floor under core inflation before starting to tighten.
  • With likely further pass through of lower oil prices into core inflation in the months ahead, coupled with still low wage growth, it may be later than mid-year before the FOMC feels sufficiently confident that inflation is returning to target to increase interest rates.

Thursday, January 15, 2015

ECJ ruling opens the door to QE - but will it work?

For a quantitative easing program to be in any way effective in the Euro zone it must be large and unconstrained.  Up until now there have been two potential constraints to an effective asset purchase program – opposition from the German Bundesbank, primarily on the issue of risk sharing, and a pending ruling from the European Court of Justice (ECJ) on the legality of the earlier Outright Monetary Transactions (OMT) program.

Overnight the ECJ issued a non-binding opinion that, subject to a number of small conditions, the OMT is consistent with the EU Treaty.  Furthermore the opinion stated that the ECB should have “broad discretion when framing and implementing the EU’s monetary policy”.  Couldn’t agree more.

A final ruling from the ECJ is due in a few months but it seems unlikely will be substantially different from this opinion.  In the meantime this has removed any legal barriers to the announcement of a sovereign debt purchase program by the ECB on January 22nd. 

During the course of last year the ECB took a number of steps to support the flagging economy and to boost persistently low inflation.  They cut interest rates (including the introduction of a negative deposit rate) and launched the TLTRO, the take-up of which has been disappointingly low in the first two tranches.

Since then core inflation has continued to drift lower to a level that is uncomfortably low, a reflection of a persistently large output gap best indicated by an unemployment rate that remains chronically high at 11.5%.

The oil price fall has added to the disinflationary forces at play within the euro zone which is now in (technical) deflation.  While orthodox monetary policy suggests the ECB should look through the oil price shock, broader disinflationary forces are already well entrenched.  Furthermore it seems the oil price fall has greatest chance of spilling over into core inflation in countries where demand is weakest.  The euro zone fits the bill admirably.

The ECB rhetoric has stepped-up recently to the extent that a sovereign debt purchase program is now fully priced in by markets, thereby already delivering the decline in bond yields and a lower currency the ECB will be hoping will support growth and bolster inflation.  The risk for markets (and the euro zone economy) is the ECB underwhelms expectations next week.

So expect the ECB to announce a sovereign debt purchase program as part of its commitment to expand its balance sheet by €1 trillion, although some detail is likely to be unresolved.  A QE program in the euro zone is obviously more complex than it is in the likes of the US, the UK or Japan.

The ECJ opinion also reduces the effectiveness of opposition from the Bundesbank which fears the sharing of risk of sovereign bond purchases by the ECB will covertly lead to the introduction of Eurobonds.  I don’t have a problem with that as I still think some form of debt mutualisation is inevitable if the Euro is to survive as a common currency.   That concern can be mitigated if each national central bank to purchase its own sovereign bonds with no pooling of risk.  That seems to me to be a second best solution to large and unconstrained action by the ECB.

But will it work?  The ECB will be expecting the expansion of the monetary base, lower yields and greater liquidity to support rising asset prices to all contribute to stronger credit and GDP growth.  A lower exchange rate are will bolster inflation and add to competitiveness. In that respect it’s a necessary step along the path to higher growth and inflation.

But will it be sufficient?  Probably not.  Have a (re)read of Mario Draghi’s speech from Jackson Hole last year and you will see even he thinks monetary policy alone cannot fix what ails the euro zone.  Monetary policy needs mates in the form of growth enhancing fiscal policy and structural reform, especially in the labour market.

I’m often asked whether QE worked in America.  Apart from the obvious impact on interest and exchange rates, the important contribution it made was to buy time for the economy to heal itself.  But that was in the most flexible, nimble, innovative, dynamic economy on the planet.  The euro zone doesn't have that luxury.

Monday, January 12, 2015

Data Insight: US payrolls

Key Points:
  • December saw another solid US payrolls gain of +252k.  The twelve month rolling average now stands at +246k per month, its highest level since mid-2000.
  • The unemployment rate fell to 5.6%, the combined result of the increase in jobs and a decline in the participation rate which fell 0.2 percentage points to 62.7.
  • Jobs growth was broad-based with the construction sector posting a particularly large increase of +48k over the month.
  • Wage growth was weak with average hourly earnings down -0.2% over the month.  Following the large +0.4% increase last month a weak result was on the cards but the pullback was disappointing.
  • The improving labour market is a key part of our expectations of solid GDP growth this year.  The trend improvement in jobs growth supports that story.  Weak wage growth takes some of the gloss off that story but at the same time confirms the FOMC can remain patient in normalising monetary settings.


Friday, January 9, 2015

Oil, inflation and monetary policy

Oil prices have continued to fall since I first mused on the broader macro-economic consequene prior to Christmas.The price of West Texas Intermediate is currently under $US50 pb, a 55% decline since the peak of mid last year.We’ve had a couple of days now of relative price stability but it’s too soon to call the bottom.Being a predominantly supply-driven event we need to see a supply response before calling an end to the sell-off.

The conclusions about the economic impact remain the same. While tough for producers lower oil prices will ultimately prove a benefit for the major oil importers and the global economy on balance.The near-term inflation impact will be significant and will add to concerns of “low-flation” and even deflation.However central bank's will focus, and likely only act, on the extent to which lower oil prices feed through into more generalised disinflation – the so-called “spillover” or second round effect.

“Deflation”was the headline of the day yesterday as the CPI printed negative in the euro zone for the year to December.At risk of appearing unconcerned and potentially dismissive this is better described as negative inflation.The deflation epithet should be reserved for the more insidious problem of broad-based price falls and low inflation expectations that reflect weak demand rather than commodity price shocks.


That said, its the euro zone that remains at greatest risk of defaltion in its more meaningful sense. It’s that risk that is widely expected to prompt the European Central Bank (ECB) into taking further action at its next meeting later this month.(Note the Governing Council has a new meeting schedule this year. They will now meet every six weeks rather than monthly).The continued disappointing take-up of the Targeted Long-Term Refinancing Operations (TLTRO) means the ECB is looking for new ways to achieve its intended balance sheet expansion.

A move by the ECB to a more fulsome asset purchase program including sovereign bonds appears already fully priced in by markets.But challenges to the implementation of such a program remain including continued opposition from the Bundesbank and the upcoming ruling on the legality of the OMT. So the biggest questions right now are what happens if the ECB doesn’t deliver and, assuming they do, will it make any difference?More on that next week.

Meanwhile in the US the minutes of the December FOMC meeting were released this week and shed no new light on the monetary policy outlook there.At the post-meeting press conference Janet Yellen had already indicated an orthodox approach to the oil price fall by stating the impact would likely be transitory although there was some chance of spillover.I’m still picking June “lift-off”for interest rates in America, although risks remain biased to later.

Here at home calls for interest rate cuts will grow louder over the next few months as headline inflation heads well below the bottom-end of the Reserve Bank’s 1-3% target band and remains there for the duration of 2015.


Those calls will be disappointed.Continued low inflation has the Reserve Bank on hold for most if not all of this year, but I still think the next move interest rates is up, it’s just a question of when and by how much.

The answer to those questions will not be answered by the price of oil but rather the ability of the New Zealand economy to continue to grow at an above-trend pace without generating inflationary pressures. In my view that will largely be determined by the extent to which wages respond to continued falls in the unemployment rate as 2015 unfolds.

Wednesday, January 7, 2015

Greek angst

Greece is once again causing financial markets a degree of consternation.  The failure of the Greek parliament to elect a new President has resulted in the calling of a snap election scheduled for January 25th.  This has once again triggered concerns about the possibility Greece exiting the euro zone.

2014 saw relative financial market calm towards the euro zone.  That’s not to say there was nothing to worry about but market concern about weak output growth and low inflation was soothed to a significant degree by the pledge by the European Central Bank (ECB) to expand its balance sheet.

That relative calm largely ignored the growing unease, discomfort and possibly even rage against austerity that has seen the rise of anti-austerity and anti-Europe political movements across the euro zone in recent times.  For that reason 2015 was already shaping up to be an interesting year politically in the euro zone, even without an early election in Greece.  Elections are scheduled in Spain and Portugal for later this year.  It only seemed a matter of time before markets started to worry the far-left Podermas party in Spain is vying for the lead in political polls.

In Greece the (also) far-left Syriza party is ahead in the polls and seems odds-on to form the next Government, although it appears they will likely require coalition support from the centrist Potami and/or the centre-left Pasok.

During the previous election campaign in 2012 it was the (still) leader of Syriza, Alexis Tsipras, who promised to “tear up” the bailout agreement between Greece and the troika of the ECB, the International Monetary Fund (IMF) and the European Commission, an act that would have resulted in Greece exiting the currency union.  It was arguably that risk within an electorate that, despite austerity, preferred to stay in the euro zone that saw the current government led by New Democracy prevail.

Since then economic growth has turned positive (off a low base!) but the unemployment rate remains worrisomely high at 25.7%.  At the same time austerity measures have included cuts to pensions, reduced unemployment benefit entitlements and healthcare services and new levies on property investment.

In this election voters face a choice of more of the same or a change to a Government led by parties promising softer bailout terms, debt cancellation and the restoration of social benefits.  Syriza is promising higher pensions, free electricity for poor households, subsidised housing and free medicine and hospital care for the unemployed.  This is to be paid for by reduced “wasteful” spending and crackdown on tax evasion. They are also promising a near 50% increase in the minimum wage.  That must sound good to an electorate suffering austerity fatigue and where one in four is out of work.

There are, however, a number of risks for a new Government to manage.  The first is that 80% of Greek debt is held by official creditors.  Add to that the fact the government faces a financing requirement of €24 billion in 2015.  In the absence of an ability to secure that financing from global markets, the Government will remain dependent on those same creditors for that funding.  Default remains an option but that will result in exit from the currency union – a result that, despite austerity, is still not desired by the Greek electorate.

Should exit occur the Euro zone is arguably better placed to cope with it now than it was in 2012, although that won’t stop markets from fretting.  The European Stability Mechanism is stronger, the OMT (Outright Monetary Transactions) is in place, assuming the European Court of Justice doesn’t rule it illegal, and baby steps have taken towards banking union.

The likely post-election result seems to me to be the troika remains in charge and that some compromise will result.  Continued commitment to macro-economic reform and lower new spending than currently being promised will be exchanged for some debt relief in the form of a lengthening of debt maturities and further measures to lower debt servicing costs.

One can only hope, however, that an earlier than expected election in Greece may be the catalyst for a more meaningful conversation about the merits of austerity. It always seems somewhat simplistic to point out, as I have on many occasions, that there are two parts to a debt-to-GDP ratio – debt and GDP.  In the case of Greece and others in the euro zone austerity aimed at lowering the numerator ending up doing more damage to the denominator -  to such an extent that in Greece the ratio now stands at 174%, higher than the onset of the euro zone  sovereign debt crisis.

I also take little comfort from IMF forecasts indicating a drift lower in the ratio over the next few years.  That projection assumes Greece will be able to run primary budget surpluses averaging 4% of GDP over the next five years.  While few have little sympathy for the woes of the Greek populous given past profligacy, that forecast ignores the impossible political challenge of implementing such an austere program in the face of what the leader of Syriza correctly describes as a “humanitarian crisis”.  A different approach is required.