Monday, March 21, 2016

Central bank stock-take

March meetings of the world’s major developed central banks are now behind us with one becoming less hawkish, one doing nothing and one firing a bazooka.  That combination has been enough to ease some of the concerns about the outlook for the global economy and has contributed to the recent rally in risk assets.  An important consideration however is with money policy already very easy, how much more effective can central banks be?

We thought the Federal Open Market Committee would drop one or at most two hikes from their interest rate track for 2016.  In the end they come in at the dovish end of the spectrum by taking two out and effectively removing any chance of an interest rate increase before June.   This is now closer to market expectations of around a 70% chance of one hike before the end of the year.

The issue for the FOMC was the extent to which they would balance upward momentum in key inflation indicators against the message about US and global growth contained in the market turbulence we saw at the start of the year.  In the end the message from the Committee is they are wary of doing anything that will undermine the outlook for economic growth, including the impact on the US economy of a stronger US Dollar if they continued tightening while the ECB and BoJ are still easing.

This now brings the FOMC into line with our thinking of two hikes this year with a risk profile that is somewhat more symmetrical, especially in the out-years. If growth disappoints they may do less; if inflation continues to move higher, they may do more.  In the meantime, markets have a chance to take a deep breath and time and space to reflect underlying fundamentals.

The Bank of Japan did nothing in March.  There are probably a number of reasons for that: they’ve only just done something, what they did backfired to some extent and they must also be concerned they may have exhausted their ability to be effective.  

The adoption of a Negative Interest Rate Policy (NIRP) earlier this year was probably aimed at increasing inflation expectations ahead of the spring wage negotiations.  For a sustained increase in underlying inflation, a sustained increase in unit labour costs is required.  The adoption of NIRP led to generalised concern about the health first and foremost of the banking sector and the economy.  As a result, wage claims this year are averaging around 0.4%, lower than last year’s 0.7%.   That seems likely to lead to a FALL in unit labour costs and downward pressure on inflation.

It’s inevitable the BoJ will revise down their growth and inflation forecasts at their April meeting. All else being equal, that would probably lead them to ease further at that time, but that is not guaranteed.  Further action from here will be most effective if it lifts inflation expectations.  The Bank may wait for the dust to settle on NIRP before doing more.  The answer to higher growth lies with the Government and fiscal policy – the most likely first cab off the rank in that regard will be postponing next year’s consumption tax increase.

The European Central Bank fired a bazooka earlier in the month, throwing everything except the kitchen sink at the problem of persistently low inflation in the Eurozone.   The ECB has similar issues to the BoJ in that they are missing their inflation target by a large margin.  Core inflation in the Euro zone is also 0.7%, the same level as Japan.

In March the Bank expanded their asset purchase program, cut interest rates and announced new Targeted Long-Term Refinancing Operations (TLTROs).  The good news is we think the ECB has a greater chance of impacting the real economy than the BoJ.  We’ve long stated the most effective of the ECB’s measures was their TLTRO programme which has been successful in helping unlock credit growth in the region, so we were pleased to see this component in their recent package of measures.

That said, with the unemployment rate still at 10.3% across the Eurozone, it will be some time before we see wage growth putting sustained upward pressure on inflation, which means there’s still a good chance the ECB does more.

Thursday, March 17, 2016

NZ GDP growth stronger than expected

December 2015 quarter GDP growth came in at +0.9% for the quarter, stronger than both market and RBNZ expectations that had gravitated to an expected increase of +0.7%.  Annual average growth for calendar 2015 was +2.5%.

The make-up of the result was largely as expected with construction and retail sales showing strong growth in activity.  The upside surprise over the quarter was mostly on the services side of the economy.

The outlook for the economy remains one of the degree to which some large positive and large negatives offset each other.  On the positive side of the equation population growth, construction and strong tourism activity are key supports for the economy.  However, the challenges in the dairy sector are a significant negative.  On balance we expect another year of modest growth in 2016 – our current forecast is for annual average growth of 2.6% in calendar 2016.

We see no implications for the RBNZ in this result.  While growth over the quarter was somewhat stronger than the Bank was expecting, we think their quarterly forecasts for the first half of 2016 (0.7% and 0.8% for March and June quarters respectively) look a bit on the optimistic side.  We are expecting 0.6% in each of those quarters.  We therefore see the Bank delivering their already-signaled interest rate reduction in either April or June. 

Tuesday, March 15, 2016

All eyes on the dots

With little or no chance of an interest rate hike from the US Federal Reserve this week, all eyes will be on the projections for interest rates as indicated by the infamous dots in the Summary of Economic Projections (SEP).  The March SEP will be released with the FOMC statement following their two day meeting this week.

It was only a few weeks ago that markets were pricing in the end of the world.  There was heightened concern about global economic growth and even talk of recession in the United States as economists raced to proclaim the highest probability of recession without actually forecasting one.
As it has turned out recent data has allayed concerns about growth and, in particular, the strength of the labour market.  Furthermore, key inflation indicators including the Committee’s preferred core personal consumption expenditure deflator are moving higher prompting Governor Stanley Fischer to recently observe the “first stirrings of an increase in inflation”.

At peak despondency, interest rate markets were pricing in no chance on interest rate increase in the United States in 2016, opening up a yawning chasm between the dots in the December edition of the SEP which had suggested four further steps towards interest rate normalisation were likely in 2016.

As the data has improved, the price of oil has risen and equity markets have recovered, interest rate markets have priced in a somewhat more realistic path for interest rates with a 50% probability of a hike in June and a 75% chance of one hike this year.

We expect much of the discussion at the meeting will centre on the market volatility seen so far this year and what that is telling the Committee about the economic outlook and the likely progress towards achieving their inflation and labour market mandates.  That seems to give the doves in the Committee the upper hand and will likely lead to a more gradual pathway to interest rate normalisation in the new SEP.

It always seemed to me the big gap in interest expectations between market pricing and FOMC projections would meet somewhere in the middle, but it will be an iterative process. I expect the FOMC will take only one or at most two rate hikes out of their projections for 2016, leaving a still sizeable amount of daylight between Committee and market expectations.  Right now I think two hikes is the right answer.  But only time...and the data...will tell.

Thursday, March 10, 2016

RBNZ takes path of least regret

While the case for further stimulus has been building, we didn’t think the RBNZ would cut again – at least not yet.  The Bank today took the path of least resistance, and probably least regret, and cut the Official Cash Rate (OCR) to a new record low of 2.25%.  

The RBNZ lays out the key reasons behind the cut being the deterioration in the global growth outlook, the difficult challenges facing the dairy sector, the strength in the trade weighted exchange rate, and the recent deterioration in inflation expectations.

The surprise is more about timing.  Today’s cut comes only a few weeks after the RBNZ Governor poured cold water on imminent interest rate reductions by cautioning against too great a focus on the low level of headline inflation.   Today’s surprise has seen a significant reaction in both interest and exchange rate markets.

Furthermore, while there are compelling reasons for the RBNZ to act there are also reasons to be cautious including whether further cuts to the OCR would make any meaningful difference to the domestic inflation outlook given the global nature of the disinflationary forces currently at play.  Also further interest rate cuts risk inflaming an already overheated Auckland housing market.

The key guidance paragraph is as follows:

“Headline inflation is expected to move higher over 2016, but take longer to reach the target range.  Monetary policy will continue to be accommodative.  Further policy easing may be required to ensure that future average inflation settles near the middle of the target range.  We will continue to watch closely the emerging flow of economic data.”

We did think that if they cut again they would do more than one.  The interest rate projections signal one further cut which could come as early as April or the next Monetary Policy Statement in June.