Friday, September 18, 2015

The Fed - No change

Concerns about recent global economic and financial conditions trumped further improvement in the labour market to see the FOMC take the cautious path and leave US interest rates unchanged today.   In the Press Conference Chair Janet Yellen signaled, unsurprisingly, that China and emerging markets are center to those concerns.

In July it seems the only thing that mattered to the Fed was the domestic labour market.  The key sentence in today’s statement was more global - “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near-term.”  The good news in that is the Committee is aware of its actions having global implication and that they are not going to do anything to derail the global economy.

Aside from that there were only minor tweaks to the Statement.  The Committee acknowledged the further decline in the unemployment rate, solid jobs gains, improvement in the housing market, modest gains in household spending and business investment, but also that inflation continues to run below the Committee’s longer-run objective.  In the Press conference Yellen continued to point to the recent downward pressure on inflation being largely due to factors that will ultimately prove to be transitory (the strong USD and commodity prices).

Changes to the Summary of Economic Projections lowered the median forecast for the Fed funds rate by around 25bp right across the projection period.  The median longer-run forecast was also lowered to 3.5% from 3.75% which is getting incrementally closer to our own estimate of 3.0%.  Changes in the median projections for growth, the unemployment rate and core inflation were all tweaked with no real surprises.  

So where to from here?  The Committee continues to see inflation rising towards 2% over the medium term so a rate increase is coming - it’s still just simply a question of when.  A rate rise this year is still favoured by the majority of FOMC participants, although one committee member favoured a rate cut into negative territory.  Yellen offered a wry smile when questioned about that in the Press Conference stating the Committee didn’t spend much time debating that option.

October and December are still live for lift-off.  Seems the only question now is when global uncertainty will be resolved…

Thursday, September 17, 2015

NZ GDP - weaker than expected, but where?

New Zealand June quarter GDP came in weaker than expected at 0.4% qoq.  Forecasts were for an increase of +0.6%.  Annual (+2.4%) and annual average (+3.0%) measures came in closer to expectation thanks to positive revisions.

The high-level breakdowns saw Primary Industries post a quarterly rise of +2.1%, the Goods-producing Industries rose +0.4% while Service Industries posted a +0.5%.  However, total GDP managed only +0.4%.  The reason lies in the usually innocuous and always mysterious “balancing item” which made a significant negative contribution over the quarter.  Make of that what you will. 

At a finer level of detail each of the sectors came in largely as expected.  The agriculture and mining sectors showed the expected bounce-back from the weak March quarter, construction posted a modest rise and manufacturing saw a modest contraction.

But there’s no getting past the fact that this is another soft GDP result.  The economy has expanded a relatively miserly +0.6% in the first six months of the year and on our current forecasts annual growth looks set to dip below 2.0% in the year to September. 

The good news is that financial conditions are significant easier than they were just a few months ago.  The exchange rate is 15% lower on a trade-weighted basis and the Reserve Bank of New Zealand has been reducing interest rates which will help support growth in the period ahead.  We expect the RBNZ will cut the Official Cash Rate again in October. 

Monday, September 14, 2015

China and the Fed

China activity and financial data for August was a mixed bag with some promising signs that policy easing is starting to have an impact but with the important activity indicators still on the weak side. 

In summary:
  • Inflation blipped higher to 2.0% for the year to August although this reflected higher food (pork) prices.  Non-food inflation came in at 1.1% and producer prices remain in deflationary territory at -5.9%.  Inflation is certainly no barrier to further easing.
  • Exports were a bit stronger than expected but imports were weaker.  The trade data is nominal so lower commodity prices helps explain the weakness in imports.
  • Monetary easing is having an obvious impact on money supply and credit growth.  M3 growth is well off its lows and credit growth came in stronger than expected.
  • However that is yet to be reflected in stronger real activity.  Industrial production came in at 6.1% for August, up on the 6.0% in July but short of expectations of 6.4%.  Weak industrial production is likely to reflect, at least in part, factory shut-downs for the Victory Day World War II commemorations.
  • Fixed asset investment slowed further with stronger infrastructure investment insufficient to offset further weakness in the property sector.  While residential property prices and sales have stabilised recently it will be some time before the existing oversupply is worked through, especially in the second and third tier cities.
  • Retail spending was a bright spot rising 10.8% over the year, up from 10.5% in the year to July.

So there are some signs that the policy easing to date is starting to have some impact but the transmission to the real economy remains slow, hampered by temporary factory closures and continued spare capacity.  That simply confirms once again that real interest rates remain too high and further easing is warranted.

So what’s the Fed to make of all of this?

Recent US labour market data has more than met the Fed’s requirement for some further improvement.  As I said last week, if the Fed’s decision was just about the labour market they would be hiking this week.

However it appears likely the Fed will delay the most anticipated US interest rate hike ever.  Global uncertainties are simply too high and the China data yesterday didn’t bring any clarity, either way.  And while the Fed will continue to see the dis-inflationary impact of lower commodity prices and the stronger US dollar as transitory, they do buy time.

That seems to me to leave three options for the Fed this week.  With their associated probabilities they are:

  1. No hike with a dovish commentary saying the outlook for the world has deteriorated and there is no chance of a rate hike anytime soon. (10%)
  2. A dovish hike i.e. raise interest rates but signal this is it until there is more certainty about the global outlook.  (30%)
  3. No hike but signal they are getting closer which leaves October and December on the table for "lift-off". (60%)

So it’s likely the Fed will delay lift-off.  But I have considerable sympathy for the view put forward recently by the Senior Deputy Governor at the Indonesian central bank that the Fed should raise rates sooner rather than later and end the uncertainty.   Looks like the uncertainty is going to linger a bit longer.

Thursday, September 10, 2015

RBNZ reduces the OCR to 2.75%

As was universally expected The Reserve Bank of New Zealand reduced the Official Cash Rate 25bps to 2.75% this morning.  Forward guidance indicated a further easing in the OCR is likely although this will remain dependent on the emerging flow of economic data.  The RBNZ’s interest rate projections suggest one more cut of 25bps which would take the OCR back to the historical low of 2.5%.  This is consistent with our own forecasts.

The RBNZ has significantly reduced its GDP growth forecasts citing the sharp decline in dairy prices, the plateauing of construction activity in Canterbury and the recent weakening in business and consumer confidence.  Those negative factors are offset to some extent by robust tourism, strong net migration, the large pipeline of construction activity in Auckland and other reasons, lower interest rates and the depreciation in the exchange rate. 

So like us the RBNZ sees weaker-than-previously-forecast growth ahead, but certainly not a collapse in growth.  That said the RBNZ flags an alternative scenario in which global growth is weaker than in their central projection which has obvious flow-on to weaker New Zealand growth should that transpire.  That indicates where the RBNZ sees the balance of risks. 

They are now forecasting GDP growth of 2.1% for the year to March 2016, down from 3.2% in the June Monetary Policy Statement and lower than our forecast of 2.3%.  The RBNZ sees growth of 2.5% and 3.1% in the March 2017 and 2018 years compared with our forecasts of 2.2% and 2.4%.  We are clearly less optimistic on the upside to growth in the back end of the projection period.  More on that in the upcoming issue of New Zealand Insights.

The RBNZ sees inflation back to the mid-point of the target ranger by the middle of next year (2.1% in the year to September 2016).  This is the combination of softer non-tradeable inflation being more than offset by stronger tradeable inflation on the back of the depreciation in the exchange rate.  As I’ve said before, and the RBNZ also acknowledges, the degree of pass through to inflation from the lower exchange rate is open to conjecture.  We will have to wait and see.

In terms of monetary policy I’m still happy with my forecast of one more cut in the OCR and I have that penciled in for the October OCR review.  In the meantime it’s back to watching the data.

Monday, September 7, 2015

Some further improvement in the US labour market

US August employment data was consistent with “some further improvement” in the labour market.  By itself that seems to meet the criteria for “lift-off” for US interest rates in September, but it’s not that simple.

The only disappointment in the report was the increase of 173k in non-farm payrolls which was below expectations of a +200k result.  But that disappointment is ameliorated by the observation that the initial estimate of August payrolls often undershoots the recent trend, only to benefit from upward revisions in subsequent months. 

Everything else in the report pointed in the right direction.  June and July employment growth was revised up by a combined 44k, jobs growth is increasingly broad-based, hours worked remains consistent with above trend growth and the average work week rose. 

Average hourly earnings rose 0.3% in the month although the annual rate of increase remains stuck at 2.2%.  Most importantly the unemployment rate fell to 5.1% - and is now bang on the mid-point of latest Fed estimate of longer run unemployment (NAIRU).  On its own this data fits the bill for some further improvement in the labour market and supports the case for “lift-off” in September.

That just leaves the Committee’s interpretation of recent market volatility.  As I said last week, market volatility by itself should not delay the Fed.  Indeed some volatility should be expected whenever the Fed starts any rate hiking cycle, let alone the first hike in nearly a decade. 

But it’s a different matter if the Committee views that volatility as indicative of factors that may impact the growth and inflation outlook in the US.  To the extent that recent volatility has been due to concerns about growth in China, this week’s release of the usual monthly plethora of Chinese activity data will add further fuel to the debate.  More on that later in the week.

Tuesday, September 1, 2015

So what does the Fed do now?

Last time I wrote about the Fed and upcoming decisions on monetary policy, domestic economic and financial conditions were of paramount importance.  All we were waiting on was “some further improvement in the labor market” before the Committee pulled the trigger on the most anticipated US rate hike ever.  Life was simple then. 

The US economy has delivered and more making September a done deal – that is if all that mattered was the domestic economy.  July labour market data was consistent with further improvement, second quarter GDP has seen a significant and broad-based upward revision and third quarter partial data appears, at least thus far, consistent with continued above trend growth.

But at the same time we’ve seen significant market volatility and heightened concerns of a hard landing in China.  This complicates things a tad.

Market volatility by itself will not delay the Fed.  Janet Yellen has previously warned that as we get closer to the first rate hike we could see “heightened financial volatility”.  Indeed that is simply an observation of history – previous rate hike events have seen similar degrees of equity market weakness.  If we wait till there’s no volatility, the Fed will never hike.

But a delay is likely if this volatility is indicative of factors that will have a direct impact on US growth and/or inflation.  It is the extent to which that volatility reflects fears of a hard landing China (and therefore weaker global growth) may see the Fed delay lift-off.

Recent Fed speeches have added colour.  Dudley was generally perceived as being dovish, although the most used quote from his speech was taken out of context.  Fischer’s speech from Jackson Hole was more non-committal and leaves the door open to a rate hike at any time, including September.  This reinforces the fact the FOMC has not yet decided when to hike and every meeting is “live”.

Lift-off has to happen at some point.  Market volatility was inevitable as we got closer and is not a reason to delay.  But the extent to which the FOMC considers the volatility to be China-slowdown related they may delay until clearer signs of stability in China emerge.  And of course watch out for the August labour market report at the end of this week.