Thursday, April 28, 2016

Is this the bottom?

The Reserve Bank of New Zealand left the Official Cash Rate unchanged at its record low level of 2.25% this morning.  We had thought the recent strength in the exchange would be enough to see them pull the trigger.  Clearly not.

While most of the market expected no change today, many had expected that to come with an enhanced easing bias which was not for forthcoming either.  The Bank stuck to the line that further easing may be required, the same as the March statement.

In its statement the Bank acknowledged indications that house price inflation may be picking up and signalled their expectation that inflation will strengthen as the effects of low oil prices drop out and and as capacity pressures gradually build.  It was for these reasons we thought the Bank wouldn't cut in March and when they did, that the next easing would probably come sooner rather than later.

The overall positive tone to much of the Statement suggests we are likely at the bottom of the easing cycle.  We concur with the Bank that inflation heads higher from here and we expect the housing market to remain tight and problematic.

The one qualification to that remains the exchange rate.  While its wasn't enough for them to move today, we think that remains the most likely factor that could yet force the Bank's hand.

In that respect the Bank knows it's the against the Australian dollar where they can probably have most influence.  The interesting development on that front was yesterday's lower than expected CPI out turn in Australia which has our team in Sydney expecting the Reserve Bank of Australia to cut interest rates next week, so keep an eye on the NZD/AUD cross.

Tuesday, April 26, 2016

Four things the RBNZ will be thinking about in deciding whether to cut this week

When the Reserve Bank of New Zealand (RBNZ) surprised the market with its decisions to cut interest rates in March, it flagged another rate cut was on the way. Usually we would say “just do it”, but the decision whether to cut again this week appears more finely balanced. So what are the things the Bank will be thinking about in the lead-up to Thursday…?

Inflation: The March quarter CPI was bang-on RBNZ expectations, though the mix of tradeable versus non-tradeable inflation showed greater than expected pressure in the latter. In fact non-tradeable inflation has now risen 1.5% over the last six-months. Non-tradeable inflation (ie domestic inflation pressure) is more important for setting monetary policy. But at an annual rate of 1.6%, non-tradeable inflation was still lower than the 1.8% recorded in the year to December.

The exchange rate: At the time of March rate cut the Trade Weighted Exchange Rate Index (TWI) was around 72.5 and the RBNZ assumed an average of 70.9 for the June quarter.  So far it has averaged around 72.7.  All else being equal (and assuming the TWI stays at current levels for the remainder of the quarter) that would shave around 0.3% off inflation in 12-months time.   Part of the strength in the NZD/USD has been the recent weakness in the USD as the US Federal Reserve has recalibrated from four interest rate increases this year to two.  We think the Fed will raise rates again in June which will see some recovery in the USD and downside for the NZD, but we think we have seen already the highs in the USD for this cycle.

Housing: We weren’t expecting the RBNZ to cut interest rates in March. Our view was that given much of the reason for current low inflation was (arguably) outside the control of the RBNZ, the higher-inflation reward from lower interest rates wasn’t worth the risk to financial stability of inflaming the housing market. Indeed, household debt continues to rise, fuelled in part by record low interest rates. As it turned out, the Bank was reasonably sanguine about the housing market in March, no doubt reflecting a softening in both price and activity data following the introduction of measures to cool the housing market last year. The question is the extent to which they have been surprised by the recent renewed strength in the market, or are relaxed given their ability to deploy other (macro-prudential) tools from their tool-box.

Growth: GDP growth was stronger than the RBNZ was expecting at the end of last year, but there was probably nothing in that result itself that will alter the Bank’s forecasts for the period ahead. Some of the more recent partial data has been a bit stronger than we were expecting (migration, tourism flows, dairy prices), but then our 2016 GDP forecasts are lower than the Bank’s so these results might have been less of a surprise to them!! Add to this, the downside risks to global growth have diminished further since March, notably in China.

All things considered, it’s a close call as to whether the Bank cuts this week. But it’s the recent strength in the exchange rate along with consistency of approach that gets us just over the line in expecting them to cut the OCR to a new record low of 2.0% on Thursday. Furthermore, if they don’t cut this week, it will likely prove to be for reasons that mean there is a reasonable chance we may have seen the low in interest rates for this cycle. 

Monday, April 18, 2016

CPI bang on RBNZ forecast

The March 2016 quarter CPI came in a touch higher than market but bang on Reserve Bank of New Zealand (RBNZ) expectations.  Headline inflation rose 0.2% for an annual rate of 0.4%.  The annual rate is up from 0.1% in the year to December 2015.

The major contributors were broadly as expected with falling airfares and petrol prices keeping overall inflation subdued over the quarter while on the other side of the equation we are finally starting to see some flow through into prices from prior falls in the exchange rate.  There’s only so much margin pressure retailers can take!

While the overall result was in line with RBNZ expectations, the mix was a bit different in that tradeables inflation was a touch weaker than expected while non-tradeables was a bit stronger.  Non-tradeables inflation (i.e. domestically generated inflationary pressures) is more important for the setting of monetary policy.

That said this result shouldn’t derail the RBNZ from delivering its next already-flagged 0.25% interest rate cut.  The question is mostly about timing.  Slightly stronger domestic inflation along with recent data showing some renewed strength in the housing market may see the Bank choose to muse beyond next week’s OCR review and wait until they have rerun all the numbers for the June Monetary Policy Statement.  More on that soon.

Thursday, April 14, 2016

People rejoining the labour market in the US

There have been a number of mysteries in the evolution of the US labour market post the Great Recession.  Two that remain, and were only ever going to be resolved as the cycle matured, are the relatively low level of labour productivity growth and the significant trend decline in the labour participation rate.

There has been a significant trend decline in the US unemployment rate since the peak of 10% in late 2009 to the most recent reading of 5.0% as at March this year.  That has been the combined result of solid jobs growth but also helped by people dropping out of the labour force as indicated by the decline in the participation rate from around 66% prior to the recession to a recent low of 62.4% in September 2015.

 To be considered part of the labour market, a person must either be employed or actively seeking work.  Using 2008 as a base, that drop in the participation rate indicates around 8.5 million people have dropped out of the labour market over the last 8-years. 

There are a variety of reasons for a declining participation rate with some structural (i.e. permanent) and some cyclical (i.e. temporary).  Structural factors include the aging of the population and a greater proportion of young people staying in education for longer.  A typical cyclical factor is the so-called “discouraged worker” effect whereby a person may be out of work, is unsuccessful at finding a job and becomes discouraged, thus ending their job search and dropping out of the labour force.

Over the last six months we have seen a significant rebound in the participation rate which as at March was back up to 63.0%.  This is the equivalent of 1.5 million people returning to the labour force over that six-month period.  This is the beginnings of the unwinding of the cyclical component of the decline in the participation rate as jobs have become easier to find and as wages have started to nudge higher.

The extent to which the recent decline in the participation rate is structural or cyclical is an important issue for the Federal Reserve in determining the amount of slack in the labour market and the likely future inflation pressures that may emanate from wage growth as the labour market tightens.  People returning to the labour force have had the impact of stabilising the unemployment rate over the last few months.  In fact it ticked higher from 4.9% in February to 5.0% in March, despite continued solid jobs growth.

The big question is how much further the participation rate may rise from here.  As the decline has been debated over the years, the consensus has gravitated to the view that it has been mostly due to the large structural factors playing out, though with come cyclicality thrown in for good measure.  That seems intuitively sensible to me and means the participation rate that is consistent with full employment is now lower than it used to be.

So while the participation rate may continue to move up over the next few months, we don’t expect this to be the start of an extended trend higher.  That means the most prudent course of action for the FOMC is to continue the interest rate normalisation process.  We’re still happy with our call of two quarter-point interest rate increases this year with the first one in June.