Friday, May 20, 2016

June is still "live"

Markets have been shocked by the apparent hawkishness of the April FOMC minutes which indicated June is well and truly “live” for a rate hike.  Interest rate markets had priced in virtually no chance of a June rate increase with that probability having jumped to 30% since the minutes were released.  That seems to us to be an appropriate representation of the odds.

Our view has been that a June hike was unlikely unless we see some significantly better data following the weak March quarter.  The data since the April FOMC meeting has been OK - on average.   The April CPI came in higher than expected and April retail sales showed a pleasing bounce.  That result supports the case that March quarter weakness was temporary. 

April payrolls data was softer than expected but we are open to the possibility that this is a sign of a tightening labour market (see post below).  Contradicting that, however, is the recent lift in jobless claims. 

On balance we think June quarter GDP growth is likely to come in at around a 2% annualised pace, so not the usual strong above-trend bounce we have been used to seeing after weak March quarter data over the last few years.

So that leaves us thinking there is still sufficient uncertainty about growth and more specifically the degree of slack in the labour market to make a June hike unlikely but still possible, so a 30% probability appears about right.  That’s reinforced when considering the Fed’s new unofficial third mandate of global economic and financial stability.  Markets are currently rerating US interest rate expectations and the Fed may feel that’s enough for now.

The key point we need to take from the minutes is that the US Federal Reserve is determined to push on with the normalisation of interest rates and all that is up for debate is the pace and the eventual end point.  Markets had gone too far in pricing virtually zero chance of a hike in June. 

What’s changed for me is that regardless of whether the Fed hikes in June or not, the probability of two hikes before Christmas has gone back up.  I had thought that if they didn’t go in June that September was the next most likely opportunity and that if that was the case, only one hike was likely this year.  But July is now a distinct possibility, especially if the only thing holding them back in June is potential market volatility around the “Brexit” referendum.   Data will clearly still be important with the most critical being May payrolls released in early June.

Monday, May 9, 2016

Lower US payrolls growth: consistent with lower GDP growth or a sign of full employment?

Growth in activity in the United Sates has been disappointingly soft since last 2015.  The question is whether the slowdown is real or whether it reflects transitory factors such as continued drag from prior strength in the exchange rate and the market volatility and resulting uncertainty at the start of the year. 

Our view of continued solid US growth in 2016 is predicated on expectations of continued growth in aggregate labour income, a big part of which is expected to come from continued solid jobs growth.  In that respect lower than expected payrolls growth of 160k (market expectation +200k) was disappointing.   That disappointment was, however, offset by other components of the survey which showed an increase in hours worked and a tick higher in wage growth – both of which are consistent with a tighter labour market.

The unemployment rate remained unchanged at 5.0% despite a decline in employment in the household survey (payrolls growth and the unemployment rate are derived from different surveys).  That was a function of a lower participation rate which reversed some of its recent move higher.  We’re not concerned about the weaker household survey employment as that reverses some very strong results recently and brings the two surveys more into line.. 

The unemployment rate remains at the top end of the Federal Reserve’s 4.7 -5.0% range estimate of full employment.  As an economy reaches full employment, employment growth typically slows as labour becomes more difficult to find and wages start to move higher.  At this stage of the cycle sustained payrolls growth of +200k per month will be difficult to achieve with a move to lower levels likely.  It’s at this point we would expect to see productivity to improve as firms turn to labour-saving investment to resource the rising demand for their goods and services and to ameliorate the upward pressure on unit labour costs.

So to complicate things for the FOMC, lower payrolls growth is not necessarily a sign of a weaker labour market and weaker economy generally - it could be consistent with a tight labour market and rising wages and ultimately inflation.  
But while activity data remains soft and uncertainty remains about the degree of slack in the labour market it’s unlikely the FOMC will raise interest rates in June.  Indeed we would need to see some spectacularly solid data between now and the middle of June for the Committee to hike.  Realistically the most likely timing of the next interest rate increase in the US is September.

Wednesday, May 4, 2016

NZ labour market in good shape

As is usual with the plethora of data that comes with quarterly labour market releases, there was something for everyone in today’s data.  That is best exemplified by the seemingly contradictory strong rise in employment, combined with a rise in the unemployment rate.  The conclusion is, however, that the New Zealand labour market is in pretty good shape.

Most interest today was in the unemployment rate.  We made the point at the release of December quarter data that the unemployment rate can be volatile and that while we didn’t believe the sharp fall to 5.3% in December (today revised up to 5.4%), neither did we believe the September reading of 6.0%; somewhere in the middle was probably the more accurate picture.  While the March result of 5.7% was higher than average market expectations of 5.5%, it is probably closer to the true rate than either of the two previous estimates.

It’s also important not to take the rise in the unemployment rate as a sign of labour market weakness.  Indeed the underlying tone of the data was strong.  Employment rose 1.2% in the quarter a result that took the annual rate of growth back up to 2.0% from 1.4% in the year to December.  Full-time employment was up 1.0% in the quarter.  That’s undeniably non-shabby.

The rise in the unemployment rate was the result of growth in the workforce combined with an increase in the participation rate which rose to 69.0, reversing some of the decline of the last few quarters.  That saw the labour force rise a spectacular 1.5% in the quarter.  While that resulted in a move higher in the unemployment rate it is, at the same time, a sign of a healthy well-functioning labour market.

It’s the recent phenomenon of solid employment growth being roughly match with growth in the supply of labour that has kept wage pressure and with that, underlying inflationary pressures, in check.  In fact the Labour Cost Index (for private sector ordinary time wage and sales earners) has been trending lower recently. However the annual rate of increase blipped higher in March to 1.8% from 1.6% in the year to December.  That’s still lower than the level that would be consistent with 2% inflation, but it now appears to be heading in the right direction.  The question is whether it is sustained and only tome will answer that.

This result doesn't preclude further easing from the RBNZ but reinforces for us that whether they go or not will largely be determined by their level of (dis)comfort with the exchange rate.  In that respect yesterday’s EXPECTED (at least by AMP Capital) rate cut in Australia could have a more meaningful bearing on decisions at the June MPS.