This economic update is from Peter Munckton, Head of Markets Analysis at Bank of Queensland. Peter is BOQ’s resident expert in business economics and market strategy.
- After growing strongly during the mining boom, population growth has slowed in recent years;
- This reflected both a slowdown in the birth rate and the growth of immigration;
- Australia’s population growth is projected to be stronger than most developed countries over the next twenty years.
‘If you just focus on the smallest details you never get the big picture right.’
Leroy Hood, American biologist
Much of the news we get in economics is the details about how the economy is currently travelling, how many jobs are being created, how much money consumers are spending. And the recent published information suggests that the economy is moving along in the same gear. In short the Australian economy is doing Ok: not bad, but not great. Jobs growth is reasonable, although has slowed noticeably since the start of the year. Firms say that business conditions are around their long-term average, as do consumers. The unemployment rate is currently trending around 5.5-5.75%. Other labour market indicators (such as the underemployment rate, which measures the proportion of people working part-time that would like to work full-time) paint a less sparkling picture.
But by staying in the weeds of current developments it is easy to miss the big picture economic drivers. And one of those drivers is population growth. A larger population both boosts demand for goods and services (houses, shoes, movie tickets), as well as potentially boosting supply (increasing the size of the workforce). A larger population has other potential benefits (creating the scale for a larger domestic market), although there can also be potential costs (traffic jams, environmental problems). Overall, a strong economy typically exhibits a modestly growing population.
Up to the Second World War, Australia’s population growth exhibited wild swings. But a more stable economic and political backdrop has meant that the growth rate has been less volatile over the past 50 years, ranging between 1-2% annually. The two periods when the population growth was strongest (in the 1950’s/60’s and the 2000’s) were periods when Australia enjoyed standout economic growth rates (both helped by commodity price booms). Since the end of the mining boom, there has been some slowing in population growth although it is currently around the long-term average.
Growth of the national population essentially comprises ‘natural increase’ (births minus deaths) and net immigration (arrivals minus departures). After rising in the period up to the GFC, the fertility rate (the number of births per 1000 women) has moved back towards its 40-year average. There is some disagreement as to why there was a rise in birth rates around the GFC. Very strong labour market conditions might have encouraged women to have children because it was easy to get (or keep) a job. Another theory is that the higher birth rate reflected a rise of government largesse, whether in the form of higher government payments and/or greater tax incentives (baby bonus, child care rebates). A third is that the higher birth rate may have reflected decisions by a cohort of women to delay child birth back in the 1990s.
But it is immigration that is currently making the strongest contributor to population growth (55% over the past year). Since the start of the mining boom, Australia’s immigration growth has been very strong, with workers attracted by the strong local jobs market. Although below its recent peaks, immigration increased by a still strong 2% over the year to March 2016 helped by the improvement in the jobs market.
The number of permanent arrivals has declined from their peak levels around the GFC, while permanent departures have continued to rise. The biggest driver has been a fall in permanent arrivals from New Zealand, with the strength of the Kiwi construction market likely helping to absorb the job losses that have occurred in the Australian mining sector. There has also been a significant decline in permanent settlers from the UK, likely reflecting that the value of the pound has fallen by around one-third against the $A since that time. These large declines in permanent settlers has been only partially offset by the structural rise in settlers from India and China (as well as other Asian countries).
While population growth has been strong over much of the past decade, the number of people that have moved interstate has slowed. The number of people that have moved interstate has been broadly flat for the past decade, and has declined as a proportion of the total population. It is not entirely clear as to why this has occurred. Indeed, the big differences in the economic growth rates between the mining and non-mining states over the past decade should have encouraged greater movement. It is possible that the big rise in housing prices has reduced the ability of workers to shift interstate easily. And technology might have made it easier for workers to do their job without changing states.
While interstate migration is becoming a small part of overall population movements, people movements have impacted particular states. In recent times, Victoria has been the key beneficiary where interstate migration is at its highest level in over 30 years. A strong economy is an important factor, as well as a reasonably (at least relative to NSW) affordable property market. By contrast, after rising strongly during the mining boom net interstate departures is at a record level in WA.
Overall, economic growth rates does influence the growth of states population. The recent population growth has been strongest in NSW and (particularly) Victoria, but slowest in the mining states (including Northern Territory). Population growth is approaching its fastest pace of growth in nearly 30 years in Victoria. But it is close to its slowest pace in Queensland (and Western Australia) since the end of the Second World War.
Overall, Australia has enjoyed relatively strong population growth for a developed country in recent years, reflecting a higher fertility rate and its traditional status as an immigrant nation. Population growth has slowed in recent years, and the projections are for further slowing in coming years. Nonetheless, population growth in Australia is still projected to be amongst the fastest in the developed world (also including China and India) over the next twenty years.
A few years ago, the UK band, Blueprint, sang:
The future commin fast so I’m plannin for it
I’m thinking long term
I’m thinking long term …..
There are mixed emotions as to how the Australian economy is currently performing. But the Australian economy has a number of long-term positives, not the least a population growth rate that will be amongst the highest among developed countries. This will mean continue to mean there is plenty of demand for housing, furniture and ice creams at the movies.
And in other news: Some trending data
The RBA has recently noted that there has been some cooling in the housing market, noting indicators such as the slowing of housing credit growth and the reduction in the number of houses for sale. The looming big increase in the supply of units will also take some of the heat from the property market. But not all indicators suggest an imminent cooling down. Google Trends suggest the number of people searching for the term ‘house prices’ in Australia is near a record high. Admittedly the data appears to be skewed towards searches from Sydney and Melbourne, the two hottest markets. Nonetheless, it appears that auction results are still very much getting plenty of attention. So maybe heat in the housing market is going, going, but not yet gone.
We live in interesting times.
- As expected, the RBA kept the cash rate unchanged at its July meeting;
- The key short-term piece of data will be the Q2 CPI (released end July);
- The currency and the how the international economy evolves will also have important implications for the cash rate.
“There’s just this waiting game
And I don’t know how to play
It’s enough of a fight staying alive, anyway”
Parson James, Waiting Game
Parson James is a name that has relatively recently hit the charts, including for the above song. For the trivia buffs, the profile of the song Waiting Game rose when it was sung on American Idol at the suggestion of Keith Urban (according to Wikipedia). While the above lyrics might be new for most, for financial market investors their sentiment is not. This was most clearly demonstrated with the Brexit vote, where investors waited for the result only to find out that they were very much surprised by the end outcome. No RBA (or even a Federal Reserve) rate decision could ever have the impact that Brexit did. But some RBA rate decisions are expected to have bigger impact than others.
This was not the case with the July meeting. Partly that reflected that there was no compelling case for a rate cut from the domestic data released over the past month. The Q1 GDP numbers were stronger than expected, consistent with the general run of economic data. There has even been a nice run-up in iron ore prices. Other than for business investment, the RBA said in its June Statement that domestic demand and exports were growing at a trend to above trend pace. There has been no reason for them to change this view.
In the immediate aftermath of the Brexit vote, some were speculating this could have been a catalyst for a cut at this meeting. But the firemen knew where to point their hoses. Central banks (and the banking sector more generally) were well prepared in the event of a Leave vote. So there was no major funding disruption post the vote, even though there was some (modest) rise in pricing. Central banks made sure there was lots of liquidity available, and the Bank of England has made it clear that it is likely to cut rates. So like Shaggy (of Scooby Doo fame) post a brush with a ghost, financial market appetite (for risk) returned in a hurry. In its statement, the RBA mentioned that impact of Brexit remains to be seen, with its impact (outside of the UK) potentially hard to discern.
But it was not the state of the domestic economy that got the RBA to cut rates in May. Or even concerns about how the global economy is travelling. The key factor was that inflation was well under the RBA’s forecast, and they felt they needed to reduce interest rates to move inflation back towards their 2-3% inflation target zone. The RBA thinks inflation will rise. But despite the rate cut, the RBA is still only forecasting that underlying inflation will reach the bottom of its inflation zone in two years’ time. So the clear risk is that another rate cut will be needed.
To that extent, all eyes are focussed on the Q2 CPI result (released 27 July). Another low result (0.3% for underlying CPI) is likely to see a rate cut in August. A higher number (0.5%, or higher) would see the RBA keep rates unchanged. A 0.4% result would make for a more difficult decision. But such a result would be consistent with the RBA’s current forecast. Assuming the domestic and international economic outlook otherwise remains unchanged, rates would also likely remain unchanged for such an outcome. In a recent Reuters survey, over 80% of economists expect a rate cut by the end of September. Financial markets are pricing in a 50% chance for a cut at the August meeting.
But while all eyes are on the CPI, other events will also be important. If central banks globally are cutting rates, and the RBA does nothing, this would mean that Australian interest rates would rise in relative terms. This would likely see a rise in the $A towards the high 70c range. A currency at this level might be fine if the economy is firing on all cylinders. But a $A of that level would currently be more difficult to absorb, given the uncertain global outlook and too-low inflation. Significant changes to the international economic outlook would also have important implications for the cash rate.
Our view is that there will be another rate cut, but not in August. The economic data up to that meeting is likely to still be decent, and it will be too early to get a better understanding of the fallout from Brexit. Inflation will be the key, although at this stage I think that the number will not be low enough to justify lower rates. We will get more information prior to the CPI release to refine forecasts.
So today was a day for waiting. The action is still to come. In the meantime, investors will just have to follow another piece of advice from Waiting Game:
“I’ve been patient
Oh a change gonna come”
After all, financial markets rarely sit still for long.
- The financial market reaction to the Brexit decision on Friday was strong, but not panicked;
- The most likely scenario is that the implications of the decision are largely confined to the UK, and the fallout for the global economy will be limited;
- But risks to the global economy have risen because of the Brexit decision.
They say that breaking up is hard to do
Now I know
I know that it’s true
‘Breaking up is hard to do’ – Neil Sedaka
There are some songs made for dancing, and some songs for singing. And ‘Breaking up is hard to do’ is one of the later. Neil Sadaka originally released the hit song in 1962, and was on to such a good thing that he re-released it in 1975. And such has been the song’s popularity that at least 34 other artists (according to Wikipedia) have covered the song. So the song has never really gone out of vogue. But the recent Brexit decision means it may again get a new lease of life, at least for investors’.
Given the shock of the decision, the initial financial market reaction has been reasonably logical. Europe was hardest hit, with China and Asia the least. Emerging markets did sell off, but not aggressively. This suggests that (so far) markets are pricing a growth slowdown in the UK and Europe, with some (but limited) implications for the global economy. That there has been no GFC mark II (at least so far) is at least partly because Brexit was very much a known ‘unknown’ event. The firemen knew exactly where to point their hose in case of fire.
Theoretically, the Brexit vote is not legally binding. But practically the UK Parliament will have little choice but to follow the ‘will of the people’, no matter how narrow the outcome. Once the EU is officially notified that the UK is leaving (which will occur sometime in the next 4 months) then there is a 2-year window to negotiate a new treaty for trade and movement of people. This time limit could be extended if there is agreement to do so by both parties. Two years (even four) might seem a long time, but it is not given the number of different rules and regulations that would have to be negotiated.
The UK Government went at some length on the day to emphasise that all the current rules stay unchanged for at least the next two years. But it is the uncertainty thereafter that is the problem. It is very hard to see how the UK can avoid a tough economic period, although a substantial weakening of the currency may take away the worst of the economic pain. The UK does not know the rules and regulations of their future relationship with the EU, and even when those rules will be agreed. Society is split virtually 50-50 between young and old, wealthy and poor, London and the rest of England. The UK does not know who their future leader will be. And the UK may not even be the UK. Scotland seems almost certain to have an independence vote, one where leave will most likely win. At a minimum UK business and consumer confidence will remain weak for some time, which will hit business investment. Foreign investment is also likely to fall, given the uncertainty. Given that they are major trading partners, an economic slowdown in the UK will hit Europe. Markets are particularly worried about the implications for countries such as Greece, Italy and Spain that have only just been recovering from the GFC.
A period of weaker global growth is the most likely outcome, but one where the weakness is mainly concentrated in the UK. But other (gloomier) scenarios are possible. It is possible that the decision could lead to a European-wide recession which would be exacerbated if other countries followed the UK and held a referendum to exit the Euro. This is not our central case, but the risk of a Brexit in other countries has increased the chances. Particularly worth watching is a presidential election in France next year, where one of the parties has already made a call for a referendum. The other issue of wider concern is whether concern over Brexit leads investors to drive up currencies for other countries, hitting their economic outlook. This is already a potential problem for Japan. It could also be for the US if the $US rises too high. And a high $US would also be a problem for China.
The Australian economic implications will depend how the major global economies evolve over the next few months. Companies that export to Europe may in time find things a bit tougher, and we are likely to get a few less UK (and European) tourists in the next few years. The most likely scenario is that global growth will only modestly decline, something which the domestic economy should be able to largely absorb. Rate cuts will come if the RBA believe that international economic growth will decline substantially, or that the $A is rising too strongly (say, 78c-plus). Typically the $A would weaken in a risk aversion scenario. But the degree that the $A can weaken is limited by the reduction of the sterling (and possibly the euro). Providing that confidence remains in the global banking and financial systems (which is likely), domestic financial markets should be Ok albeit subject to a heightened level of volatility.
In ‘I wonder’, Chris Issak sang,
“I keep on praying for a blue sky, I keep on searching through the rain.
I keep on thinking of the good times, will they ever come again?
Now I wonder
Now I wonder.”
At times like these it is easy to think about gloomy times. But for the global economy while Brexit is important the good times will come again. And for Australia the times are currently not that bad. Indeed, the best forecast is that the dark clouds will soon go away. But just in case, make sure you have an umbrella.
We live in interesting times.
- A Budget deficit of around $37b is expected for the next financial year, around the same as this year;
- The Budget is likely to be a small boost for the economy next financial year;
- Company tax cuts and infrastructure spending should help boost investment.
Budget nights are always big news. After all, they influence how much money we have to spend and what goods and services we get provided (such as schools and medicines). Every year we get a list of Budget ‘winners’ and ‘losers’, those that either get more money (either directly in the pocket or in kind) or those that are likely to get less. In this Budget there is more money for schools, as well as health (dental and hospitals). There is greater spending to help the youth unemployed. The headline budget deficit for the next financial years is expected to be a bit under $40b (about 2.2% of GDP), around what was expected. While a surplus is projected for 2021, forecasted surpluses have had a history of vanishing in recent years. The economic forecasts look reasonable (for both GDP and the CPI), although the risk to the commodity price projections are to the downside. It is again possible that the budget deficit ends up being larger than projected, as has happened regularly in recent years.
This Budget does earn some economic brownie points. We live in a world where there is some uncertainty about economic growth, and interest rates are very low (particularly for governments) as highlighted by today’s RBA rate cut decision. We are also in an economy where there is discussion about improving infrastructure, not the least to help improve the productive potential of the economy. Government debt is also low. All this suggests that Government’s should be spending more on infrastructure investment. The state governments that have the most fiscal wiggle room (NSW and Victoria) are likely to be doing the most spending on infrastructure in coming years. The federal Budget announcement that it will be tipping in to help support infrastructure projects is therefore a plus.
Ideally, the economy would also like to see a boost of investment by the non-mining business sector, particularly given the looming slowing of residential construction activity and the ongoing decline in mining capex. The budget should help this happen, with the extension of the company tax cut as well as the depreciation allowances to firms up to $10m turnover (previously $2m). Ideally, all firms would receive the same tax treatment (otherwise there is a disincentive to become big enough to pay more tax). But given the federal government is hardly awash with cash at the moment, giving the incentives to smaller companies gets the maximum economic bang for buck given they are more likely to be cash constrained.
To keep the deficit under control, taxes have gone up to pay for the extra goodies. It helps that each of the major tax rises likely will receive bipartisan political support. It will be interesting to see how much tax each of these initiatives end up raising, notably the new tax on multinationals. There are also some spending cuts, including a further ‘efficiency dividend’ from the public service. Today’s Budget is likely to means that fiscal policy will make a (small) contribution to economic growth. That contribution will partially come from taking money from those that are more likely to save (high income earners and big companies) and give money to smaller companies and lower income earners who are more likely to spend.
But some of the important big picture fiscal questions remain:
- Improvements in the tax structure have only been partially addressed in this budget. The proportion of tax the government in Australia receives from income is amongst the largest of developed countries, and the company tax rate is relatively high compared to the rate in many countries. The Government would say that the cut in small company tax rates is the first installment of a general move lower in company tax. Indeed, the budget notes its ‘aspirations’ to reduce company tax more generally over time. The government would also point to the changes made in income tax rates (raising those subject to the second top tax bracket from $80,000 to $87,000). But more reform still needs to be done to improve the efficiency of the tax system. And the reform needs to get done while getting political agreement to tackle the size of the fiscal deficit;
- Budget deficits in recent years have been partially run to help support the economy. But the weaker (nominal) economy also causes budget deficits (eg, slower income and profit growth reduces taxes). My read of IMF estimates is that around 20-25% of the budget deficit of the past couple of years can be explained by the economy’s weak income growth. But while the deficits now and recent years are not a big worry, longer-term challenges remain. An aging population means higher health costs. And some of the fiscal presents we gave ourselves during the mining boom good times are now looking extravagant.
- Difficult structural fiscal problems were never going to be fully addressed in a pre-election Budget. But they will need to be an important part of the future economic debate. In fairness, that debate has started over the past year as to whether the reduction in the budget deficit should be done via lower spending or higher taxes. Of course, the end result will be some combination of both. So the debate will be as much around what the community expects the future size of the Government in the economy to be.
The Budget news was big as always, although getting all the answers to the long-term fiscal challenge remains. An old riddle is, what is always coming but never arrives? Tomorrow is the answer. Hopefully the answer never becomes solving our long-term fiscal challenges.
We live in interesting times.
- The jobs market has improved in line with the stronger economy;
- But some regions have done better than others;
- A sustained strong economy benefits most regions.
‘My dear girl, you cannot keep bumping your head against reality and saying it is not there.’
In a conversation the other day I was reminded of the greatness of Alfred Hitchcock as a movie director. Hitchcock was born in England, although he later became a US citizen. While making a number of films in England, his fame was entrenched when he moved to Hollywood. He was particularly productive in the 1950s and into the early 60s (most notably with the film that really boosted the horror genre, Psycho). The last Hitchcock film I watched was Rear Window, where a man (James Stewart) recovering from a broken leg spends most of his time looking out of his apartment window and starts speculating whether one of his neighbours has murdered his wife (I won’t give away whether he was innocent or guilty). What stood out about the film was that apart from one scene, the entire movie was filmed in one room.
While not achieving the sustained fame of a number of his other films, Spellbound was well received when it was released in 1945. I chose the above quote because while a lot of economic data can appear abstract, the numbers are just a summary of what is happening in ‘the real world’ (or at least that is the theory). And as we have noted before, there is nothing more ‘real’ than whether someone has a job. The national labour market picture has been unambiguously improving over the past year. Decent economic growth has meant that there are reasons for firms to want more employees. And the modest growth of labour costs means that more businesses are able to afford to take on more workers despite the low profit-growth environment. The result has been around 20,000 jobs a month created over the past year, enough to get the unemployment rate to fall by around a half percentage point. With plenty of jobs available, more people are out searching for work (in the jargon, there has been a rise in the participation rate).
But the national labour market comprises many sub-labour markets. And each labour market region has its own identity, influenced by factors such as industry composition and location. For example, while there have been job losses in areas of Perth caused by the mining downturn, more jobs have been created in a number of NSW regions reflecting that states’ stronger economy. While the unemployment rate in the Eastern Suburbs of Sydney is around 2.5%, it has averaged over 10% in (the much bigger area of) Outback Queensland according to the ABS in recent months. And although the participation rates in most of the inner city suburbs of the major cities are north of 70%, it is under 50% in Wide Bay (the national average is around 65%).
Of course, the key financial market variables (such as the $A and the cash rate) are driven by aggregate outcomes. After all, the RBA has only one interest rate that it can change. And in a market-driven economy, if one region is creating plenty of jobs in time that will attract workers from other regions with less work. That is currently happening, with a number of workers leaving WA as that economy slows to go and work in the stronger jobs markets. And at the end of the day, if an economy is strong enough for long enough that will (eventually) lead to prosperity spreading to most (but probably not all) regions. So the national economy matters no matter where you live. But the health of regions dominated by particular industries will fluctuate in line with developments in that industry.
Alfred Hitchcock was nicknamed, ‘the Master of Suspense’. While it is a bit of a stretch describing economic forecasting as full of suspense, there is always elements of uncertainty. And that is as true today as it ever has been.
It certainly is an interesting time.
Have a good remainder of the week.
3/2/2016 – Economic comment: The RBA has its say
- As expected, the RBA left the cash rate unchanged at 2%;
- They note that the Australian economy has entered the year on a solid footing;
- But low inflation and volatile international economy and financial markets means a rate cut remains very much on the agenda.
Traditionally this is the week of the year when the commercial TV stations unveil some of their ‘major’ rating series. This year that line-up includes ‘My Kitchen Rules’, ‘Australia’s Got Talent’ and ‘I’m a Celebrity, Get Me Out of Here’. No doubt each of the shows will at some stage get an airing at the fabled ‘water cooler’. This is also the week in the year that the RBA traditionally has its first monetary policy meeting. It gets limited marketing, but is an event that always rates high on the economic calendar and gains wide media attention.
There was a ‘feel-good’ factor about the Australian economy in 2015. The economy was confronted with a host of negatives, including an uncertain international environment, declining commodity prices and falling Capex spend. But the economy battled through all these negative to have a surprisingly good year. The most telling sign was the decline in the unemployment rate, which started the year at around 6.25% and ended it at 5.75%. Firms believe that conditions were a bit above average, while consumers are thinking the same thing about their finances. The lagged impact of past rate cuts and the lower Australian dollar worked their magic. So the economic momentum entering 2016 is good. And certainly good enough not to require an imminent rate cut.
So no surprises in this month’s episode that the RBA kept rates at 2%. But there is always the scope for a twist in the tale, and this month it is that there remains a distinct chance of more action in the months ahead. The low level of inflation provides a strong argument for lower rates. By some measures, underlying measures of inflation have been below the RBA’s 2-3% target band for the past two quarters. And too-low inflation is a global issue. We are likely to see that the RBA has marked down their inflation forecasts when they release their Monetary Policy Statement on Friday.
Further, the RBA has noted the uncertainty created by rising US interest rates and the slowing Chinese economy has led to a jump in financial market volatility. Commodity prices have fallen a long way, and we think that the clear risk is there will be further declines in 2016. And there are rising signs that residential construction might start subtracting from growth by year-end.
The key as to whether there will be any further rate cuts is whether the current momentum in the economy can be sustained. The lower exchange rate will continue to be a positive, and falling oil prices are starting to keep more dollars in consumer wallets. How the unemployment rate evolves is probably the one best indicator on whether there will be a cash rate change. But perhaps the key domestic data to watch this month is the December quarter Capex figures (released 25 February). Those numbers will give the first indication of how much firms intend to invest in the 2017 financial year. If those numbers do not provide any indication of a pickup in non-mining Capex then doubts may start to rise about whether the economic momentum can be sustained into the second half of the year.
We are not negative on the Australian economy, and think another reasonable economic year remains in prospect. But we think that continued low inflation and ongoing international economic uncertainty will mean there is a good chance that the RBA will look to take out some insurance rate cuts this year. Our read of today’s release following their meeting is that the RBA is closer to cutting rates than they were at their previous meeting in December of last year.
Overall, it looks like it will be an interesting year for those tuning into the RBA. Will ‘watch and wait’ be the winning strategy, or will a more action-orientated approach be necessary. It is likely that there will be more than a few economic ‘water cooler’ moments this year (well, at least if you are talking to an economist).
Have a good remainder of the week.
15/12/2015 – Elementary, dear Watson
- There was little change in interest rates in the second half of 2015;
- But that could change next year;
- We have yet to see the low of the $A in this cycle.
‘It is a capital mistake to theorize before one has data. Insensibly one begins to twist facts to suit theories, instead of theories to suit facts.’
One of the things I like to do when I get a spare hour (which is usually about once per week) is watch the British TV series, Sherlock. I loved detective stories as a kid. I enjoyed Hercule Poriot (written by Agatha Christie), but my favourite was Sherlock Holmes. There have been other Sherlock Holmes TV series, but the Benedicit Cumberbatch version has bought the series into the modern era. The aspect that I most enjoyed about Sherlock Holmes was that he looked at a range of incomplete evidence to come to the conclusion about what happened in a case. Maybe this is one of the reasons that I like financial markets. From a wide variety of data, the analyst tries to predict the future movement of interest and exchange rates. Unfortunately, most financial market analysts have less success than Holmes!
The easy prediction to make at the start of this financial year was that the cash rate would be unchanged for the remainder of 2015. As the year progressed, the momentum in the economy improved. Jobs growth rose, the amount of hours worked increased, business confidence improved, as has consumer confidence. The RBA was also concerned that the low level of interest rates was causing housing prices to go too high, but the income of savers too low. Even Sherlock Holmes would be struggling to predict what is currently happening with the global economy. But things had picked up from the start of the year when it seemed every second central bank was cutting interest rates (although there was a bit of a wobble around the time that China devalued its currency).
The sentiment on whether the RBA should cut rates again has waxed and waned. Expectations of a rate cut rose following the Chinese-inspired financial-market wobbles. The low inflation number in October also led to analysts to speculate of a lower cash rate, although that was largely unwound come the day of the November RBA Board meeting. At other times (typically following a strong run of local data), financial markets had essentially priced out the chance of any further rate cuts.
Currently, the good momentum in the economy means that most analysts are expecting no rate change in 2016. But with inflation low, commodity prices still falling and building approvals looking like they have peaked, a significant minority are forecasting 1-2 25bp rate reductions next year (with most expecting this action to take place in the middle quarters of next year). The earliest any analyst is speculating about a rate hike is the final quarter of 2016 (which still looks too early).
This looks about right. The RBA clearly would prefer not to reduce interest rates further. But that is the clear balance of risk, one acknowledged by the RBA themselves. Certainly, if the unemployment rate starts to dip under 5.5% then a rate cut becomes a far less likely scenario. But as long inflation remains low and uncertainty surrounds the global economy, a rise in the cash rate is a low probability event.
The movement in longer-dated interest rates was pretty benign in the second half of 2015, and so no Sherlock Holmes was needed to get those forecasts right. While markets have expected one rate hike by the Federal Reserve for the second half of this year (but have kept pushing back the timing), other central banks continue to keep interest rates low. The end result was a small fall in three- and five-year interest rates.
But Sherlock Holmes might be needed to predict interest rates in 2016. Most analysts expect interest rates to rise (and quite a few significantly). Partly this reflects expectations that the Federal Reserve will increase interest rates a further 2-3 times next year. And partly it reflects many people’s view that interest rates cannot remain this low forever. But the common forecasting mistake over the past couple of years was to expect higher inflation and higher (global) interest rates. Global inflation still looks low, and equity market volatility appears to be rising. So the risks around 3-5 year interest rates for next year are at least evenly balanced between a rise and a fall.
Dr Watson would have been able to follow the right clues to get the direction of the currency for this year. And the typical indicators (such as the direction of commodity prices and higher US interest rates) would suggest that we have yet to see the low for the $A. But plenty of the financial analyst detectives have followed that path, and the popular forecast is for the currency to be 65-70c this time next year. We have no particular problems with such a forecast (it is, after all, also our forecast). The only worry is that financial markets have a habit of following the path that the least people have trod.
So it was a little bit easier to solve the financial market riddles posed in the second half of next year. But that will not make it any simpler to solve the 2016 financial-market forecast cases. “There is nothing more deceptive than an obvious fact”, Sherlock Holmes said. I am hoping that “the facts” will end up agreeing with my forecast thesis.
This is the last report for the year. I have always believed in the rule that the less heard from economists around Christmas time, the better. So best wishes of the season to all readers (I think I have met both of you), and hoping that 2016 is both happy and prosperous for all of you.
8/12/2015 – It’s not where you start, it’s where you finish
- The GDP numbers suggest that the economy is doing Ok;
- The economy has decent momentum, but the economic risks are to the downside;
- Some combination of lower rates and exchange rate will still be necessary next year.
‘It’s not where you start, it’s where you finish.
It’s not how you go, it’s how you land.’
Dorothy Fields, ‘It’s not where you start’
Personally, I am not great fan of film musicals. It always struck me as a bit strange that someone when confronted with a potentially life-changing situation would all of a sudden break out in song. But singing on the stage is a bit different, as the performance of the actors and actresses is at least as important as the story. Miss Saigon is a case in point. The lyrics from the above song came from ‘Seesaw’, which was a major success on Broadway in the 1970s. Well-known singers of the song have included Shirley MacLaine and Barbara Cook.
And the theme of the lyrics fits in with how the economy has traveled this year. The year began with central banks around the world reducing interest rates, concerned about the global economic outlook. With the Australian economy struggling under declining commodity prices and a significant decline in mining investment, the RBA cut rates in February and again in May. Many forecasters expected that a sub-trend economy would see the unemployment rate pick up towards 6.5% over the course of the year. And at various points in time when concerns about the domestic or global economies became elevated, financial markets priced in a further the cash rate falling to 1.5% (50bp under the current level).
But the most recent GDP data confirmed that the economy is doing better than many feared at the start of the year. While growth is still not great, it has been good enough to ensure to ensure that the unemployment rate will end the year around the same level that it started. Indeed, jobs growth has been notably robust and has helped boost consumer confidence. And firms are saying that business conditions are around their long-run average levels.
Low interest rates and the lagged impact of strong population growth have played a role, boosting house building to very strong levels. The lower exchange rate has changed the competitiveness of a number of sectors, including tourism, education and accommodation. And the strong jobs growth has meant that consumers have been happier to run down their saving to spend in the shops, despite the modest rate of pay growth. So the momentum in the economy is better than envisaged at the start of the year. And with the exchange rate still acting to boost the economy, there are reasons to believe 2016 can be a better economic year.
But it is not all blue sky. Building approvals suggests that home building will not be boosting the economy much by the second half of next year. Falling commodity prices is continuing to constrain national income growth. And the global economic and financial backdrop still contains plenty of risks.
All of this means that the cash rate will remain at its current 2% level for at least the next few months. And the most likely outcome is that the cash rate will still be at 2% by the end of next year. But the economic risks, and the fact that inflation is low, means that there remains a real chance that there could be further rate cut(s) next year. One offset is that the $A is likely to resume its downward trend next year, a reflection of the fall in commodity prices. This year we have characterised the Australian economy as being C+; doing Ok but with the potential to be doing so much better. Next year, the economy has a chance to move somewhere into the ‘Bs’.
So while we might do a little bit better next year, long-term challenges remain. Notably productivity growth, the driver of sustained economic prosperity, has been slowing. For Australia to return to near the top of the global economic class will require a step up in productivity growth. The recently announced innovation package when fully implemented may end up being the first such step. So with some time (and maybe some luck) we can end up as the song finishes:
‘And you can be the cream of the crop;
It’s not where you start, it’s where you finish,
And you’re gonna finish on top.’
Have a good remainder of the week.
15/11/2015 – The Light on the Hill
- The employment numbers were unambiguously strong;
- And there are signs that decent jobs growth should continue;
- How the economy evolves will be the key in how low the unemployment rate falls.
The light on the hill was a famous catchphrase in a speech that Ben Chifley gave in 1949 towards the end of his term as Prime Minister. Chifley used the term as a symbol of the objectives of the labour party (‘the betterment of mankind’). The term had its origins in the Bible (‘city upon a hill’). The phrase subsequently entered Australian political folklore, and has been used on a number of occasions by politicians from both major parties.
For most people when they think about economics, the ‘light on the hill’ is plenty of available jobs (typically summarised in the unemployment rate). Sure, there are other major economic numbers (such as GDP) that gets lot of attention. And in other countries that have had a history of high inflation (such as Germany) price figures (such as the CPI) gain substantial attention. But for most people in most countries, how the jobs market is performing is the single best indicator of how the economy is travelling.
And for the Australian economy right now that light is burning particularly bright. The October rise in jobs (58,000) was the highest monthly increase in over 3 years. Individual employment numbers can be flukey. But the average monthly rise over the past year is typical of an economy charging ahead. Given the number of jobs created, it is no surprise that the unemployment rate is at its lowest level in over 18 months.
And the good news is that there is no reason to believe that the light will be dimming any time soon. The number of job vacancies point to further decent jobs growth in the months ahead (particularly in NSW and Victoria, although the news is not so good encouraging for WA). Businesses say that they are thinking about employing more workers. And consumers are becoming less fearful about not getting a job. So the combination of a decently-performing economy and low wages growth has meant that employers have been happy to add more workers.
But that light on the hill unfortunately cannot be currently seen by everyone in the economy. Although there has been a fall, the unemployment rate remains well above the level consistent with a full-employed economy. And while they have become less fearful, consumer are still worried about the jobs market. One reason for this is that the underemployment rate (the unemployment rate plus those unable to find a full-time job) is still at a high level. And there must be some doubt that the recorded jobs growth is consistent with the current modest strength of the domestic economy.
At the end of the day, the one sure way to get plenty of jobs created is to have a consistently strong economy. In that regard, probably the single most important domestic piece of economic inflation to be released for the remainder of this year is the Capex data (due 26 November). With signs that growth in residential construction is likely to slow next year, the RBA is looking for business investment outside of the mining sector to become of a new pillar for economic growth. This will be important as falling commodity prices will mean that mining capex will continue to decline sharply over the next couple of years.
The ‘Light on the Hill’ is not the only famous Australian political catchphrase. ‘Life wasn’t meant to be easy’ was a well-known phrase from Malcolm Fraser (although it originated in a George Bernard Shaw play). For the sake of the economy, we hope that ‘Light on the Hill’ provides a better indication of the direction of the economy.
Have a good week.
4/11/2015 – The RBA and the ‘Sliding Doors’smoment
- The RBA has become more confident about the economic outlook;
- But low inflation provides the scope for a further rate cut;
- The Capex numbers released at end November will be important.
‘Sliding Doors’ was a late 90s movie, It was a decent ‘rom-com’, but the film’s fame came from the plot which showed the central character (Gwyneth Paltrow) living two parallel lives, which were divided on whether she caught a train. Although not a massive grossing film, it has been embedded within popular culture with the saying a “Sliding Doors moment”.
I was reminded of the film when considering yesterday’s RBA decision. Either course of action (no move, or a rate cut) could be justified (although clearly the no move argument was stronger). The economy has been growing at around ‘trend’ pace this year, as evidenced by the fact that unemployment rate is likely to finish the year at around the same level as it started. But the participation rate (the proportion of people in the labour force) is picking up. Both business and consumer surveys are reporting that conditions are around, or a little better, than average (although clearly better if you are living in Sydney than Perth). Further, the full benefits of the lower exchange rate will only be felt throughout the economy over the next couple of years. While concerns remain around China, the US economy is doing well enough and Europe is having a better year.
The other issue for the RBA is the level of interest rates. There are growing signs that the Sydney (and Melbourne) property markets are cooling. But the RBA would be understandably reluctant to rekindle that fire with another rate cut, particularly as they have recently highlighted the risks around the residential property market. More generally, the very low level of interest rates has already cut incomes of savers (particularly retirees).
So the ‘real’ economy is doing Ok. The key reason to think about there could have been a rate cut was last week’s CPI numbers. The past 3 underlying inflation numbers have been 0.7%, 0.5% and 0.3%. Annualised, that suggests that underlying inflation is running around 2%. This is at the bottom of the RBA’s 2-3% target zone, and below their August CPI forecasts (2.5% by end December). Having an economy doing Ok is alright when inflation is within the RBA’s target band. But a stronger economy is needed when the CPI is around the bottom of the band.
On top of this, borrowing rates have risen in recent weeks as a consequence of major banks decision to increase mortgage rates. Global central banks have also been reducing rates in recent months, including China, Canada and New Zealand. The ECB has also made it clear that it is contemplating further quantitative easing.
Clearly, on balance the RBA Board felt the no change arguments were stronger. But there was a comment in the statement that read, “Members also observed that the outlook for inflation may afford scope for further easing of policy, should that be appropriate to lend support to demand.” In other words, if the economy does not pick as the RBA expects, then a rate cut is on the cards. On Friday, the quarterly Monetary Policy Statement will be released. That publication is likely to show that the RBA has modestly revised up their economic forecasts (or at least their confidence in an economic pickup has improved), but revised down their near-term inflation outlook.
At the time of writing, financial markets have largely priced in a rate cut by early next year. Prior to the December RBA meeting, the capex numbers released on 26 November will be crucial in determining whether the RBA’s view that the economy is strengthening has any legs. Last quarter, there was (a modest) upward revision to non-mining firms capex spending plans. A further upward revision will be looked for this quarter. And before the February meeting, GDP, two employment and the Q4 CPI data will all be released. International development will also be worth keeping an eye upon, particularly the Federal Reserve meeting in December.
Most ‘rom coms’ end well (although Sliding Doors was a little different). The RBA has made it clear that it stands ready to cut rates again if they think it is necessary. This year looks like it will end up a bit better for the Australian economy than most forecasters expected at the start of the year. The best forecast is that 2016 might be a little better again for the economy.
Have a good rest of the week.
27/10/15 – Country road take me home
- The Dubbo economy has had a decent run over the past couple of years;
- The town is reasonably diversified, and should be able to absorb any slowdown in the construction industry;
- Part of the agriculture industry has done OK, but maintaining productivity will be important.
For the third week in a row I was on the road, this time a visit to the wonderful NSW town of Dubbo. For those not in the know, Dubbo is around 400kms north west of Sydney. The town itself has around 40,000 people, but is also a major regional hub for around 130,000 people (according to Wikipedia). Given its weather and facilities, it is no surprise that Dubbo is a major producer of sporting talent (including a number of rugby league stars, while Glenn McGrath was born in the town). ‘The Reels’, a rock band of the late 1970s and early 1980s, was also from Dubbo. Dubbo is famous for the Taronga Western Plains Zoo, where attendees can walk, ride and cycle around the animal exhibits. And from a visitor standpoint, the dining scene is a step up from when I first visited the town almost 20 years ago.
It is always good to get out of the major city CBD’s to gain an understanding on how the wider economy is travelling. And the short answer is that Dubbo is not doing too bad. Dubbo’s status as a city that services a wider region is highlighted by the composition of its labour force. The four largest industries (by employment) are health, retail, education and government. This diversification will be important as the nature of economic activity in the town changes over the next year. The low level of interest rates has seen Dubbo benefit (as has many other regions) from a construction boom over the past couple of years. But there are increasing signs that construction activity may fall over the next year, or so. But the diversified nature of Dubbo’s industries should keep the town in reasonable stead.
Indeed, there are reasons for optimism, The Dubbo economy has done pretty well in recent years, with an unemployment rate under the national average. There has been a modest decline in job vacancies in recent months. But two of the other major employment sectors in Dubbo are the accommodation and manufacturing industries, both of which should benefit from the lower $A. More generally, Dubbo should benefit from the continued strong performance of the NSW economy.
An issue for Dubbo (as with many other areas of regional Australia) is the outlook for agriculture. In recent years, many agriculture prices (as with commodity prices more generally) have risen to relatively high levels. The low level of interest rates has played a role. But the increasing importance of the Chinese wallet has played a prominent role in agriculture, as it has for other industries. It is recognised that as China (and other emerging economies) continue to grow they are likely to demand more protein, which should be a significant plus for sectors such as meat and dairy. Australia as a major agriculture exporter and with a good reputation should be well-positioned to make the most of this opportunity.
The evidence to date supports this view. Chinese consumption of meat (such as beef and sheep meat) has increased consistently for the past 30 years. Such has been the rise in demand, Chinese local production has not been able to keep up. The result has been a rise in Chinese imports, including from Australia.
This rise in demand should be a positive for the domestic agriculture industry for some time to come, and by extension should benefit regional towns such as Dubbo. But despite the stronger demand from China and the higher prices, the profitability of the average Australian farm remains modest (although the range in profitability varies from quite reasonable to a reasonable proportion of farms making losses). Partly that reflects weather. The size of the farm is also an important determinant of farm profitability. But the overall modest level of profitability also highlights that farmers will need to continue to work on boosting their productivity levels. This is particularly the case given that Chinese agriculture productivity is currently quite low, and is likely to improve over time.
Reflecting the state of the local economy, the room on the night of the function could be described as cautiously optimistic (although the possibility of a dry summer was a real concern, and some of the smaller regional towns are unlikely to be doing as well). “The future will be better tomorrow”, was one of ex-US Vice President Dan Quayle’s more memorable quotes. With a diversified industry base, the lower exchange rate, and a decent run with the weather and commodity prices, that may also be the case for regional centres such as Dubbo.
Have a good remainder of the week.
20/10/15 – Economic and financial market weekly: Infrequent trip notes – New Zealand, more than just the All Blacks
“New Zealand rugby is a colourful game since you get all black … and blue”
- The NZ economy has many of the same characteristics as Australia;
- The NZ economy is undergoing a cyclical slowdown, but it should be manageable;
- NZ does a great job in keeping experienced employees in the workforce, but needs to improve its infrastructure.
Last week, one reader (I did not have time to ask the other one) suggested that I write a note on the (infrequent) trips that I make. As it turned out the suggestion was good timing as last week I was in New Zealand speaking at a Conference at Ashburton, just south of Christchurch. The Conference itself was originally to be held in Christchurch, but was moved as there remains a lack of hotel facilities. Downtown Christchurch largely remains a big building site. But the rebuilding plans are impressive, and the timing of the completion of the overall project remains on time.
Unsurprisingly, the Rugby World Cup was the focus of conversation (for some reason, there seemed to be a strong consensus that the All Blacks would win). But the economy was also top of mind. For Australia, how the New Zealand economy evolves matters for several reasons. It is Australia’s 7th largest trading partner, and a country with which Australia runs a trade surplus. Global investors place Australia and New Zealand in the same investment basket. Economic developments in one country are often taken as a sign of what might happen in the other country.
And the current New Zealand economic story is very similar to that of Australia. High commodity prices helped boost New Zealand national income growth (for NZ the important price is dairy instead of iron ore for Australia). The tragedy of the Christchurch earthquake does mean there is a multi-year construction boost to the economy.
And with the economy performing well, high levels of immigration underpinned strong population growth (which in turn means more homes to be built, roads constructed, etc).
The other similarity with Australia was that high house prices was a prime topic of conversation. As soon as I got in the car, the first thing the driver mentioned was how high Auckland house prices are, and how difficult it is for young people to buy their own home. As with Sydney, Auckland house prices have been driven up by strong population growth and limited supply (and also a high level of investor activity). The extent of the rise in Auckland house prices in recent years has certainly caught the local regulator’s attention.
My casual observation, and also discussion with Conference participants, was that NZ is still doing Ok but is slowing. The decline in commodity prices is now acting to crimp income growth. Business confidence has declined across NZ, but most sharply in the rural areas. One of the talks at the conference I attended highlighted that the Christchurch rebuilding still has a number of years to run. But the peak in the growth of rebuilding has been reached. And with economic growth showing signs of slowing this will lead (in time) to a slowing in population growth. The slowing in growth has already been felt by firms who have been marking down their capex and hiring intentions.
These developments have had a couple of significant financial market implications. First, there has been a significant decline in the value of the $NZ (similar to the Australian dollar). The $NZ has fallen from around 0.88 to as low as 0.62 by end September. Given the global economic risks (and the possibility of further falls in commodity prices), analysts expect the $NZ to decline by around a further 10% over the next year. Second, the New Zealand central bank (the RBNZ) concerned about the economic outlook has already cut rates by three-quarter percentage point this year. Financial markets are predicting there will be at least one more rate cut in coming months.
The most likely outcome is that the New Zealand economy will continue to do Ok. It has one of the higher developed country interest rates. So unlike most developed countries, there is ample room for further rate cuts. Like Australia, the lower $NZ is already helping to boost tourism and education and this trend has further to run. And low government debt means that the NZ Government (if it feels the need) has plenty of capacity to spend to support the economy. One thing that New Zealand does better than Australia is that it has a good track record in keeping experienced workers in the labour force. Participation rates for 55-64 year olds in New Zealand are amongst the highest in the world. But New Zealand does need to improves its infrastructure, which is rated relatively low by global standards.
But while I spent a lot of time talking economics, I probably ended up spending more talking rugby. There is no doubt that the All Blacks dominate in New Zealand. And the Kiwi’s are rightly proud of their rugby team. The AB’s have a very impressive 75% win rate through their history, and that rate has not changed since the advent of professionalism. They also have a winning record against all countries, although that record is least impressive against the two countries they are most likely to play in their next two games (South Africa and Australia).
But the more interesting sporting result may end up being the cricket. Typically, Australia starts as a heavy favourite in any cricket match with NZ, particularly when it is played in Australia. But currently the Black Caps have better batting, and a more experienced captain and team. Australia probably has the better bowling, although NZ does have two fine opening bowlers.
Typically, this would mean that the Black Caps would be favourites for the upcoming series. The key to the series will be how the NZ team handles Australian conditions. Many of the current players have either not played in Australia, or do not have strong records in this country. If they can adapt to the conditions, the Black Caps could be more than very competitive.
Have a good rest of the week.
6/10/15 – Economic and financial market weekly: Consumer health check
- Growth in household spending has been reasonable in recent years;
- Low interest rates has played a key role;
- Consumer spending is unlikely to reach pre-GFC heights again anytime soon;
- But consumers will remain an important part of the economic landscape for some time.
‘Never bet against the consumer’ is an old saying in financial markets. It has been around since the Depression, and reflects that regardless of the economic ups and downs the US consumer generally keeps on spending. There are differences between what happens in Australia and the US. For a start, while the consumer accounts for around 70c in every dollar spent in the US economy. In Australia the figure is a lot closer to 55c. And the growth of consumer spending in Australia is a little more volatile than in the US reflecting greater volatility in the growth in national income (because of Australia’s greater reliance upon commodity exports such as wheat, wool, iron ore and coal).
Indeed, it has been the low level of wages growth and higher unemployment rate that has meant there has been some pessimism surrounding the consumer’s role in the economy in recent years. But the Australian consumer remains the largest player in the domestic economy, and consumer spending has grown at a reasonable rate in recent years.
Household dollars are still being directed towards health, education and stuff for houses. ‘Bad habits’ are out, with wallets/purses opening up less for alcohol and tobacco.
Low interest rates is a key factor. Low interest rates have boosted asset prices (houses and the sharemarket). Together with (surprisingly) strong jobs growth, this has allowed consumers to run down their rate of saving. Another way interest rates are working is in the way people save. Low interest rates is starting to make bank deposits less attractive, but buying real estate has become more attractive. Sustained price rises, however, has meant that parts of the NSW and Victorian housing markets have become less affordable to many households. But consumers’ have better feelings about Queensland and Tasmanian homes.
Another way that low interest rates is helping the consumer is that it has encouraged people to borrow more money (partly because their assets are now worth more). Stronger borrowings has played an important role in the strong house building boom we have had in recent years (together with a reasonable economy and strong population growth). Very low interest rates has also meant that less of consumers’ incomes are being spent servicing debt so more can be spent buying goods and services.
There are always risks. Despite the strong jobs growth of the past year, households remain concerned about the labour market. The high level of household debt might be playing a role. High household debt also means the consumer might be more vulnerable to higher interest rates than in the past. Banks (and their regulator) have been conscious of this possibility, and include tests of the impact of higher interest rates when determining how much consumers can borrow.
Even here there are mitigants. If the jobs market does deteriorate, this is likely to be a signal to the RBA to cut rates further. Alternatively, if interest rates do begin to rise this is likely to be in an environment that the unemployment rate is declining and there is a rise in wages growth. It is unlikely that consumer spending will reach the heights of the pre-GFC years any time soon. But decent levels of consumer spending will likely remain an important part of the economic landscape for some time.
Have a good rest of the week.
14/9/15 – Economic and financial market weekly: Jobs, jobs, jobs
- The number of jobs created continues to surprise;
- The strength of the labour market highlights the economy is doing Ok;
- The level of the unemployment rate remains a key indicator for the RBA.
One of politicians’ great loves is to spruik the benefit of some program they have announced in terms of the number of jobs it will create. This is understandable as employment always rates highly with voters, almost regardless of the state of the economic cycle. This is one of the reasons that the monthly jobs numbers always grabs the headlines.
A couple of weeks ago we received information indicating that the economy was growing at around a 2% pace, with income growth even slower. Taken at face value that would have been consistent with a meek number of jobs on offer, and typically a rising unemployment rate. By last week we found out that jobs growth continues to be (surprisingly) resilient and the unemployment rate has been unchanged for the past year. Why the information mismatch? As we mentioned last week the GDP numbers contained some ‘noise’ and therefore overstated the degree of weakness in the economy. The very low level of wages growth has also played a part, making it affordable for employers to hire new workers. It is also true that the unemployment rate overstates how well the labour market is doing. Alternative measures (such as the underemployment rate which measures those who are unemployed and those working part-time who would like to work full-time) suggest a somewhat softer jobs market.
The good news is that firms are still looking to hire. But unsurprisingly given the current state of the economy, not at the levels seen pre-GFC. That there will be more jobs around will be good for consumers who remain very concerned about the labour market. This is particularly the case for the young (who are worried about who to break into the employment market) and the over 45’s who are concerned about what happens if they lose their job, particularly if they still have debt.
The hope is that the decline in the currency will lead to increased activity in sectors such as accommodation, retail trade, education and manufacturing. And this is starting to happen. Job prospects have improved in the accommodation industry, although so far remain soft in the retail and manufacturing industries. The current state of the jobs market is also mixed across the country. There is a decent number of jobs available in both NSW and Victoria. But the slowdown in the mining and construction industries in WA and SA has seen a notably softening in both states’ labour markets.
The importance of having a decently-paying job is likely to remain an important part of our society. “All I’ve ever wanted was an honest week’s pay for an honest week’s work” (Steve Martin as Sergeant Bilko in the movie of that name) was one of many examples of the importance of work in popular culture. Over the next year, the Australian economy is likely to see a reasonable number of new jobs created, although unlikely to be enough to lead to a major fall in the unemployment rate. And if there was to be a clear rise in the unemployment rate, that would be a signal to the RBA that they have more rate cut work to do.
Have a good week.
7/09/2015 – Economic and Financial Market Weekly: C+, but must work harder
- There was a reasonable amount of pessimistic commentary post last week’s GDP numbers;
- But the underlying economy performed better in Q2 than what last week’s headline figures suggested;
- Developments in China remain the key risk to the domestic economy.
Who are you going to believe, me or your lying eyes?
The true test of greatness of an entertainer is whether their work stands the test of time. Groucho Marx passes this test as he was responsible for some of the most memorable quotes of all time (including the one above). That particular quote came to mind when thinking about last week’s GDP figures. The economy grew by just 0.2% in the quarter, boosted by a surprisingly strong quarter of government spending. The consensus following the numbers was that the economy is weakening.
And there are reasons to be concerned. Income growth in the economy remains anemic, constrained by the continued decline in key commodity export prices. This is the reason why wages and profit growth in the economy is modest, and the federal government is struggling to balance the budget. Declining commodity prices is also the reason why there is a lot less mining investment happening in the economy (although the big increase in supply from the mines we have already dug in a major factor behind the fall in commodity prices).
But it is not all bad news:
- Exports were weak in the quarter, hit by poor weather. From a longer standpoint, exports are at an all-time high when measured against the size of the economy. And they are likely to rise further when the major gas projects all come on line;
- Residential construction was also weak, despite the building approvals data indicating there is plenty of homes that will still be built;
But more importantly, the headline GDP numbers are inconsistent with other indicators that paint a picture of the economy:
- The amount of hours worked in the economy over the past year is typically consistent with an economy running close to 3%, not the 2% indicated by the GDP data;
- The unemployment rate has been broadly unchanged for the year, indicating an economy that is performing closer to its ‘normal’ level which is somewhere in the ‘high 2s’;
- Similarly, the level of business and consumer confidence is consistent with an economy doing OK, and not at the below par pace indicated by the GDP figures.
The weak income growth in the economy means that Markets are right to be concerned about the risk for the Australian economy. But the level of pessimism of last week probably at least as much reflects developments in China and the jump in financial market volatility. Indeed, up until last week the economic data in Australia was typically surprising analysts with strength.
What does this all mean for how the Australian economy is going? For some time now we have marked the Australian economy performance as a C+: doing OK but with the potential to do much better. After last week, we have kept our mark of C+ unchanged, but have changed our commentary to the Australian economy will need to work harder if it wants to at least keep the same mark.
Yes, the lower currency will be an increasing plus for the economy over the next couple of years. But that may not be enough if the global economy does disappoint. In that event, fiscal policy will have to make a bigger contribution, as well as a more action to improving productivity (which admittedly is doing Ok at present). And lower interest rates come very much back on the agenda.
‘Statistics are used much like a drunk uses a lamppost: for support, not illumination’ is a well-known quote by Vin Scully, a high-profile US sports broadcaster. So it is with economic data. No one piece of data highlights how the economy is going. It is what those numbers say in conjunction with all the other available economic information. There might come a time when we need to be very worried about the Australian economic outlook. But that time has not yet arrived.
Have a good week.
31/08/2015 – Economic and Financial Market Weekly: The future is now
- Capex spending is an important part of sustainable economic growth;
- But modest profit growth means modest capex spending;
- There are some positive signs, but China remains a wildcard.
To be an investor you must be a believer in a better tomorrow
Many people have heard of Warren Buffett, the famous American investor who has a peerless track record of being able to make good investment returns in both good markets and bad. While Benjamin Graham’s name might be less well recognized, it was his work that inspired Warren Buffett’s investment philosophy. And his quote highlighted above is an important question for how the Australian economy will develop over the next couple of years. The Capex numbers released last week highlighted that a large decline in mining investment is continuing. The Government and the RBA are looking for the non-mining sector to pick up at least some of this economic slack. But for this to happen Australian firms must believe there will be a better tomorrow.
What happens to investment matters. Investment in productive assets is an important drive of sustainable economic growth. That certainly has been true for the Australian economy, which has been one of the better performing economies for some time helped by a relatively high investment rate (by developed country standards). The short-term investment outlook does not look good, although there is the clear potential (in time) for more investment into machinery and by the public sector. It is the modest growth in profits that is the major constraint on investment in many industries, although capex spending in some sectors (such as telcos and wholesale trade) is looking more positive. Because of the uncertain outlook, firms are delivering relatively high dividend payout ratios.
But there is good news. While firms are not getting the price rises they want, and forward orders are no better than average, productivity growth is assisting firm finances. The other plus is that firms are becoming increasingly confident on the export environment. And it is the improvement in productivity growth and better export environment that might be leading firms to revise up their views about capital spending (particularly outside of mining). The other big plus is that age of the capital stock is relatively old in sectors that should benefit from a lower $A (such as accommodation and manufacturing).
Of course, a reasonably positive outlook for capital spending comes down to a having a reasonably positive outlook for the domestic economy. The benefits of low interest rates are being felt through the economy, and the biggest bang from the lower Australian dollar buck has yet to be felt. Events of last week, however, highlight that it is external events that should be of most concern. The US economy is doing well, but is it doing well enough to absorb an interest rate hike? Both the European and Japanese economies have had a decent run, but doubts about whether the economies can grow strong enough for long enough to repay their high debt levels.
And then there is China. Last week was about markets growing doubts about the outlook for the Chinese economy and the Government’s ability to deal with any economic downturn. As we noted last week, there are still plenty of positive chapters to be written on the Chinese economic story. The harder chapter to write is how Chinese economy will travel over the next 3-4 years, one that is likely to include a big Chinese government spending package. How this Chinese economic story develops will have a major influence on the tale of the Australian economy.
‘Someone is sitting in the shade to today because someone planted a tree a long time ago’ is one of a number famous Warren Buffet quotes. The Australian economy is in need of a few more of the ‘trees’ that come from Capex spending. Overseas developments will be a major influence as to when they are planted.
Have a good week.
25/08/2015 – Economic and Financial Market Weekly: A bump in the road
- China increasingly matters for the Australian and global economies;
- There is growing uncertainty as to how the Chinese economy will perform in the short term;
- But the medium term positive Chinese economic story still has chapters to be written.
Can’t slow down, won’t back down, too far now
Won’t turn around not now for just a bump in the road
Johnny Lang, “Bump in the road”
Johnny Lang is a well-known US blues singer, originally from Fargo, North Dakota. He has played in bands since he was 12, and played for a President (Bill Clinton). He also won a Grammy for an album which included the above lyrics.
The lyrics are appropriate to describe the current progress of the Chinese economy. Over the past twenty years, the Chinese economic success story has become increasingly well-known. One measure of its success is that China has moved from being the 8th largest economy in 1995, to currently being the second largest (and by some measures already the largest).
But more recently, doubts have been raised as to how the Chinese economy is progressing. The latest GDP numbers suggested that the economy grew by over 7% in the past year, a figure that would make most countries green with envy. But a wider range of indicators suggest that the story under the headline is not so rosy. The manufacturing sector is struggling, as is the export sector. Business confidence is declining, and the construction industry is facing tougher times.
So the Chinese economy has been in need of some assistance. Its central bank has been cutting interest rates, and making it easier for banks to make loans. This is helping activity in some of the major cities, but over building in other areas and high debt in parts of the property sector is a constraint. Chinese Government’s should be spending more money to help the economy, but some local governments are also constrained by high debt levels. And after years of complaints that the Chinese exchange rate is too low, it now looks too high given the state of its economy.
And then there is the structural challenges. The ‘law of big numbers’ says that the Chinese economy could not keep pumping out the growth rates it has achieved for much of the past two decades. The Government recognizes that the economy has reached a size and level of sophistication where it needs to become more market-orientated, one that is more driven by domestic consumption. But moving from a highly-regulated economy to a de-regulated one is a difficult transition, one where there are bound to be a few bumps until the government understands what mixture of rules and regulations best serve the economy. And all of this is happening at the same time that the size of the Chinese workforce is declining, and rising wages growth means that Chinse firms have become less competitive in producing low-priced goods.
The medium-term picture of the Chinese economy is still fine. Household and (central) government debt is still relatively low. The economy is becoming more market-based, and Chinese consumers are already one of the biggest buyers (and increasingly largest travellers) in the world. There still remains ample scope for China to substantially increase productivity as more people leave the countryside and move to work in cities.
But there is more uncertainty about the short term. Like a teenager transitioning to adulthood, moving from a regulated to a de-regulated economy is full of learning experiences. The good news is that the Chinese Government has studied these lessons as well as anyone. But that does not necessarily make the path to be travelled any less bumpy.
In 1990, in its song ‘Heading for tomorrow, Gamma Ray said “We are heading for tomorrow, but we don’t know if we are near.” So it is with China. The success that China has on its journey will have important implications for how the Australian and global economies evolve in the coming years.
Have a good week.
17/08/2015 – Economic and Financial Market Weekly: One man’s meat is another man’s poison
- Modest national income growth means modest wages growth;
- This has implications for consumers, business and government;
- When national income growth rises again, wages growth will get stronger.
This week we have fine-tuned the publication to provide a more thematic look at a particular issue, as opposed to a roundup of the major pieces of data released in the preceding week. As always, all feedback (particularly if its positive) on the new approach is welcome.
This week, we begin with a look at wages growth. It is an important issue as it is not only the prime source of income for most households, but is a major cost base for firms, a key source of taxation for governments and important driver of inflation in the economy. Often the strength of wages growth is seen as a win-lose situation. Or as the old saying goes, “one man’s meat is another man’s poison” (a saying that was first used in the 1st century BC, and then revived in 1604 by the English playwright, Thomas Middleton). Of course, this is not necessarily true as there are scenarios when wages can be win-win. For example, if productivity growth is strong then the employer can afford to give bigger pay rises.
Last week we found out that wages growth in Australia remains near the lowest on record. The main reason is that if income growth in the economy is only modest (as it is right now), then wages growth in the economy is also likely to be modest. For firms, this has been important. A few years ago, Australian firms (particularly in the non-mining space) were becoming increasingly uncompetitive as a result of a high exchange rate, relatively low productivity and reasonably strong wages growth. This did not matter when Australia was receiving big prices for the commodities it was exporting. But once the mining boom was over, a sharp improvement in competitiveness was required in order for the Australian economy.
The good news is that is happening. Wages growth has been modest, and firms have concentrated upon improving productivity in recent years. The substantial decline in the exchange rate has been important, allowing the tourism and education sectors to increasingly successfully compete internationally.
Another economic plus is that the low level of wages is helping to keep inflation low. This has allowed the RBA to cut rates, and is a reason why the RBA can still reduce interest rates further if they believe the economy remains sub-trend. And the combination of low wages growth and decent productivity has played a role in the (surprisingly) strong jobs growth of recent months.
Of course, low wages growth is certainly not all good news. It has constrained spending in the shops. Spending would have been even lower if households had not run down their saving, which they have been happy to do because very low interest rates have increased the value of their house and the value of their super portfolio. And one reason that the government has been facing budget deficits is that the modest level of wages growth has reduced the amount of income tax that it collects.
As Australia’s export prices stop declining there will be an increase in Australia’s income growth. In turn, this will mean that firms will be able to be able to afford bigger pay rises, particularly if productivity remains around current levels. Such a development will clearly help the economy. But this may not happen quick enough, or soon enough, and is the reason why we still believe the economy is in need of some further assistance from some combination of lower rates/weaker exchange rate.
In 2011, Frank Turner in his song ‘Peggy Sang the Blues’ said ‘Cause better times are coming, Better times ahead’. For the Australian household, there will be a time when things get better, and wages growth will be stronger again.
Have a good week.
10/08/2015 – Economic and Financial Market Weekly: Jobs, jobs, jobs
- The jobs numbers have been pretty strong for the past 9 months;
- The unemployment rate has been steady for the past year, and is probably providing a better read of the jobs market
- The risks still remain tilted towards some combination of lower rates/weaker currency.
Had me a job til the market fell out. Tried hard to borrow but there was no help; now I’ve got nowhere to go. I need a job for these two hands. I’m a workin’sman with nowhere to go.”
By the Nitty Gritty Dirt Band
Concern about getting a job typically waxes and wanes, depending upon how the economy is purring. Right now, the tune that the economic data is playing about the jobs market is a little out of sync. One verse tells a story of a below trend economy, high consumer concerns about getting a job and mixed sentiment from business about hiring. But the next verse tells us about very strong jobs monthly jobs growth. No wonder the RBA (amongst others) are puzzling a little about the sound of the jobs song.
Instead of puzzling about those lyrics, perhaps we should keep our ear tuned to the labour market chorus. This is typically the level of the unemployment rate, which often is the best single measure of labour market performance. The unemployment rate has essentially been between 6-6.25% over the past year. If this tells us the right story, then the labour market tune becomes a below trend economy employing a reasonable number of people, with employers adding workers partly a result of the very low level of wages growth.
How the labour market plays out matters to the RBA. If the RBA is not concerned about inflation (which it currently is not), then the outlook for the unemployment rate becomes a significant factor for interest rates. At the start of the year the RBA downgraded its growth views, and upgraded its unemployment rate forecasts. The result was that interest rates are now half percentage point lower. Last week, RBA forecasts indicated that they remain unconcerned about inflation, but revised up their views on the economy and (modestly) reduced their forecast for the unemployment rate. At a minimum this means that the RBA will be in no rush to cut rates quickly, particularly as they have expressed concerns about property prices (notably in Sydney).
But this does not mean we have seen the last rate cut of this cycle. Commodity prices generally have been falling. This will impact the Australian economy through slower income growth, particularly if key export prices (such as iron ore) head lower and the $A does not decline. This week we will receive an update on wages growth, which is near record lows.
More generally, last week there were signs that the building approval cycle may have peaked. This is a very volatile series, and the peak in these numbers has been called more than once in recent times. And even if it is the peak, the amount of work in the pipeline suggests that the residential construction industry will continue to be a plus for the economy this financial year. But if approvals have peaked, then this will in time remove one of the key props for the Australian economy over recent years.
The good news is that the weaker currency is helping, whether that be through more tourists, more overseas students, or helping manufacturer’s to sell more into offshore markets. But the risks of the problems associated with any further falls in commodity prices, and the lack of signs that non-mining firms are investing more, means that the risks remain tilted towards some combination of lower rates or a lower currency needed for the domestic economy. We continue to look for the currency to do the work, with the $A moving down to 70c (and into the 60s next year). But if the RBA feels that the currency is not helping enough, and revise up their unemployment rate view again, rate cuts very much come back on the agenda.
Have a good week.
RBA August Monetary Policy Statement – getting more comfortable with the level of the $A
- The cash rate remains at 2%;
- The RBA has revised up its view on the jobs market, and look like they are more comfortable with a currency of 72-73c;
- But if commodity prices fall further (the clear risk), then the currency has further to fall;
- The cash rate is likely to remain unchanged, but if there is to be a move in the next year it remains down.
As expected, the RBA left the cash rate unchanged this month. Much of the accompanying statement remains unchanged. They still believe that the economy is operating below trend, and that inflation is not a concern. That suggests that the RBA has a bias to ease policy further. But that rates are already low, and causing some issues in (Sydney) property prices, means that the bar to any other move is high. Also, the low currency is clearly helping the economy.
The two key changes this month to the RBA statement are an upgrade to their view of the jobs market, and the removal of the segment from the Statement looking for a lower $A. The market has (rightly) picked up on both, and given the market has been a little negative on the Aussie, we have seen a bit of a rally. The RBA (like us) is probably a little curious as to the strength of the labour market given the relatively weak state of the wider economy. However, that the jobs numbers have been strong now for about 8 months means that they acknowledge that the labour market may be stronger than they had previously thought. Next week an RBA official is giving a talk on this subject so we should know more about their views then. Meanwhile, the RBA is likely to be more comfortable with a currency at 70 than 75, so they would not want to see any substantial rise in the $A. And if commodity prices continue to decline (the clear risk), then some combination of lower rates/currency (the RBA would prefer it to be the later) will still be required.
The bottom line is that the economy is doing OK and the RBA is currently comfortable with the level of the currency and the pricing of some chance of another rate cut. But given the economic risks, particularly if commodity prices continue to trend lower, means that we have not yet seen the bottom of the $A. The market should also continue to price the risk of a further rate cut (even though we do not believe it will need to be delivered). The larger Monetary Policy Statement will be released Friday, and will provide further detail.
4/08/2015 – Economic and Financial Market Weekly: Delicate China
- The volatility of the Chinese stock market is getting plenty of attention;
- But it is the underlying weak performance of the Chinese economy that matters more;
- What happens in China impacts Australia’s export prices, currency and (potentially) interest rates.
Many years ago to remind everyone of what was important during an intense election campaign, Bill Clinton’s strategist (James Carville) came up with a saying, ‘it’s the economy, stupid’. Earlier that year, the then President George (H) Bush had a 90% approval rating after invading Iraq. But the economy was in a recession. So by keeping the team focussed upon economic performance, James Carville helped Bill Clinton became President by year-end.
And when thinking about China, again it is the economy that should be front of mind (although that is the type of thing an economist would say!). The sharp fall in the Chinese equity market has captured attention of global investors. But the Chinese financial system remains highly regulated. This means that global investors currently play only a small role in China, and Chinese investors only a small role in global markets (although this is starting to change) and even in the Chinese economy.
In contrast to its modest global financial system status, China has been playing an increasingly big role in the global economy. It already is the second largest economy in the world, the largest exporter in the world and the predominant buyer in most commodity markets. It has the fastest growing number of tourists, a number which will only grow as Chinese income continue to rise. And Chinese students are an increasingly common sight in many developed country universities. So the shifting of gears of the Chinese economy matters to the world.
A shift down in the speed of the Chinese economy was inevitable. Partly that reflects that the size of the Chinese economy means it is now more like a truck, than a zippy little sports car of yesteryear. But the aging of the population means that the number of Chinese workers is falling. This means that as the Chinese population continues to age, further slowing in the trend rate of growth is inevitable.
But there are also cyclical factors. A good portion of the growth in China in recent years has been in construction, particularly associated with the building of cities. The highly regulated nature of the Chinese economy has meant that some of this investment has gone in the right areas, but others in the wrong ones. In any event, there are only so many bridges that you need to build. The regulated nature of the financial system means deposit rates are currently too low. This means savers look for other places to achieve better returns, whether that is in the ‘shadow banking’ system, or the equity and property markets. This can cause “bubbles” to appear (although that also happens in countries that have less regulated financial markets). There has also been a substantial run-up in debt in China.
All this means that the Chinese economy is currently struggling more than the Government would prefer. The Government wants the consumer to become the new driver of the Chinese economy, but they currently do not have the spending power to completely take over the drivers’ seat from the construction industry. Ideally, government spending would rise more but a number of local governments are struggling under high debt. Monetary policy has been eased (lower interest rates, relaxed regulations on borrowing), but the concern is that this could lead to more borrowing for speculative investment. And the high exchange rate means that exporters are becoming more uncompetitive (although in time it will lead to Chinese firms to look to its large domestic market for growth).
The medium-term Chinese story remains positive. Chinese consumer wallets will soon become thick enough to become the new economic kingpins. And they will continue to be an important buyer for our iron ore and gas exports. But the short-term outlook is a little cloudier. For Australia that could mean even lower prices for our commodities, and so potentially lower income growth for Australia Inc. And this would lead to a weaker currency. Also, if the world’s second largest economy continues to slow, it will be hard for global interest rates to rise significantly.
Another famous James Carville quote was ‘I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.’ There is an element of truth about that statement. But for now watching Chinese economic developments matters more than ever, even if it is the volatility of the financial markets that catches the eye.
Have a good week.
20/07/2015 – Economic and Financial Market Weekly: The dashboard warning lights
- No flashing came from the inflation bulb last week;
- But the Chinese economy light is blinking;
- It underlines that the $A has further to fall over coming weeks.
We all know the importance of the flashing dashboard light. The blinking petrol light gets us looking for the nearest service station. And all good Hollywood space films have a scene set in the control room where a blinking light gets people grabbing phones and looking worried.
One of the major economic dashboard lights is inflation. High inflation distorts prices, and creates a high level of economic inefficiency. This is the reason the RBA has an inflation target when setting interest rates. Investors when they lend money are interested in inflation as (at a minimum) they want the return on the money they lend to be higher than the prevailing inflation rate.
For these reasons, the quarterly CPI data are always one of the most closely watched pieces of economic data. But the numbers released last week did not light up the inflation bulb on the dashboard. It was not low enough to get the RBA thinking that an imminent rate cut is needed. But nor was it high enough to remove any thought of lower interest rates. In short, the CPI is around the middle of the RBA target band so it will neither stop any rate cuts but is also not currently a catalyst for lower interest rates.
But if inflation lights are not flickering, others are. In particular, the Chinese economy light is blinking insistently. While the GDP numbers released a couple of weeks ago looked Ok, a number released last week highlighted that the manufacturing sector is under stress. And it has been concern about the Chinese economy (as well as strong supply) that has been a factor behind the recent drop in commodity prices.
The reduction in commodity prices means we are getting paid significantly less for our major exports. This means lower income growth for Australia Inc, which has been a principal cause of the weakness in economic growth (as well as federal government budget deficits). It has been a factor behind the reduction in domestic interest rates. And the weaker economy is also a reason why the $A has declined, and has further to decline.
Where does that leave things for the cash rate? The renewed fall in commodity prices means Australia’s income is still being hit. The RBA is worried about the impact of lower interest rates on property prices, but some major banks have both increased interest rates and tightened lending criteria to investors. The Chinese economy is by far our largest trading partner, so if its economy continues to slow this would be a cause for concern. But the lower currency is clearly helping the economy, stimulating the tourism and education industries and helping the manufacturing sector. And given that the full benefits of a lower currency are not typically felt until 1-2 years following a decline, the best for the economy from a lower $A has yet to come.
In short, the domestic and Chinese economy lights are blinking on the economic dashboard and are catching attention. For the RBA, ideally the lower currency comes to the rescue and they do not have to reach for the rate cut button. But the blinking lights do highlight that if there is to be a move over the next 18 months it will be down.
Have a good week.
20/07/2015 – Economic and Financial Market Weekly: The Days of our Economic Lives
- Greece and China do not look to have significantly impacted the global economy;
- But there is still plenty of uncertainty;
- Financial market volatility will remain part of the landscape.
Like quite a few people, there was a period of my life when I snuck a peek at Days of Our Lives. The long-running soap opera started in 1965, and recently had its contract extended until next year. My peeking was done some years back during Uni Exam Study, when to give myself a break from ‘high-powered’ thinking I made a sandwich and tuned into the goings-on in Salem. The great thing about Days of Our Lives was that even though it was quite often months between my viewing, I could tune into an episode and could feel like I had missed nothing.
I felt a little this after looking at financial markets this morning following my flu-driven enforced break. Over the past few weeks there has been plenty of headlines about the Greek crisis and the ups and (mainly) downs of the Chinese stock market. The currency is a little lower and the domestic stock market a little higher. But interest rates are around where they were at the beginning of May.
One reason why the market has not changed significantly is that neither Greece nor China looks to have sustainably hit the global economy. The Greeks and their creditors appear to have reached an agreement. And the Chinese Government has got out the cheque book to support the equity market to ensure that financial market volatility does not push the Chinese economy into recession.
But while the recent news has been better, financial markets still face plenty of challenges. The Greece problem will not be ‘fixed’ until there is meaningful debt reduction. It looks like the creditors will be happy to extend the maturities of the Greek debt and reduce the interest rate charged. How much this will help will be determined by the final agreement. But the amount of debt reduction that Greece needs to become a fully functioning economy again is significant.
By itself, the trials and tribulations of the Chinese equity market is unlikely to be a major concern. Although it is of growing importance, the Chinese financial markets are not (yet) an integral part of the global economy. Of more importance is the Chinese economy which has been struggling against a high exchange rate, slowing construction sector and areas of high debt. Monetary policy has been helping, and the central government will need to spend more money to support the economy. The medium term outlook (5-10 years) for the Chinese economy remains sound. But there is uncertainty about how the Chinese economy performs in the short term.
All of this uncertainty, and we have not yet mentioned the growing likelihood of rate hikes in the US and the UK. Financial market volatility will remain part of the landscape, which will keep interest rates domestically low and be a factor in pushing the $A lower. If China continues its struggles this could hit commodities, and weigh on the local equity market.
Even Days of Our Lives has had to evolve. New characters have been introduced. And in 2011, the series underwent a ‘reboot’ to drive lacklustre ratings. Lacklustre is unlikely to be a description of financial markets over the next year.
6/07/2015 – Economic and Financial Market Weekly: Ashes to Ashes
- Big week in financial markets with the Greece ‘No’ and the declining Chinese stock market;
- The Australian economy remains sub-par, but growing signs the $A is helping;
- Australia is the Ashes favourites, but England have a significant home ground advantage.
Each week financial markets looks at the major events of the week: central bank meetings, major pieces of data, government budgets. These events provide a running commentary on how the economy is travelling. While still having plenty of capacity to surprise, the regularity of such events means they can be forecastable.
And this week we have a couple of those big regular events. The jobs number has traditionally been the single most important monthly economic indicator. Jobs growth has been surprisingly strong over the past 6 months given the underlying strength of the economy. Low wages growth has made it more affordable to hire, although the number does look a little strong given other labour market indicators. The RBA Board meeting is the other key event. There will almost certainly be no rate change, leaving the focus on the monetary policy statement that is released on the same day. While still forecasting sub-trend growth, the RBA will be happy with the recent fall in the $A and pleasantly surprised with the strength of jobs growth.
But the RBA’s biggest immediate concern will be developments in the global economy and financial system. The Greece ‘No’ means that the Greek Prime Minister has been representing the wishes of his people at the negotiations. The question now moves to whether the creditor countries are happy to relax the terms of their lending to Greece. More pressing will be whether the ECB provides more support to Greek banks given the high demand for funds that is coming from depositors. If the ECB does not provide more help, the Greek financial system will have a problem.
Meanwhile, the Chinese stock market is having some tough times following an amazing run in 2014. There is no doubt that there was a speculative element to the buying last year, not the least represented by the large amount of margin lending that took place. The Chinese Government announced support for the equity market over the weekend. The early signs have been good (the Chinese market started up 5% this morning) but it is unclear whether it will be enough to calm the market long term. More generally, the Chinese economy is slowing and will need further support from either lower interest rates or more government spending. How the Chinese economy performs obviously has major implications for Australia. Moderating demand from China played an important role in the fall in the iron ore price last week.
It is a lot harder to predict the outcome for events such as what is currently happening in Greece and China. Investor confidence plays a big role, and this is something that no one can forecast. As noted last week, one obvious outcome is a rise in market volatility. Another is that central banks are more likely to provide support to the economy and financial markets. That is already happening in China. In the US, the best performing economic region, recent events means that the Federal Reserve is unlikely to be increasing interest rates in the immediate future. For the RBA, it means no change in the cash rate but the maintenance of an easing bias. The combination of volatility and central bank support have been the principal drivers of the fall in interest rates over the past week.
If the headline news is not great, the back page news is more up lifting. For those in NSW and Queensland there is plenty of focus on the State of Origin on Wednesday. But for cricket-lovers across all states, the key focus this week will be the beginning of the Ashes series. The evidence suggests that Australia has the better team, and a history of greater success over the past couple of decades. But England has a significant home-ground advantage, with few of the Australian players having a great track record on English tracks. All this suggests that Australia should start slight favourites.
‘Ashes to Ashes, dust to dust, if Thomson does not get you, Lillee must’, was a popular saying following a mid-1970s Ashes series. For the sake of financial markets and the wider economy, let’s hope that the most interesting news over the next couple of months will be on the back page!
Have a good week,
29/06/2015 – Economic and Financial Market Weekly: Grease is the word
- Events in Greece and China are a reminder of the level of uncertainty in the global economy;
- This suggests that interest rates should remain low for much of the remainder of the year;
- We also believe it could be a factor to drive a lower $A.
Grease is the word
They think our love is just a growing pain
Why don’t they understand, It’s just a crying shame
Their lips are lying only real is real
We start to find right now we got to be what we feel
We take the pressure and we throw away
Conventionality belongs to yesterday
There is a chance that we can make it so far
We start believing now that we can be who we are
Excerpts from ‘Grease’ by Frankie Vallie, from the movie ‘Grease’
Anyone who is of a certain age can remember the movie ‘Grease’. The movie had plenty of attitude and catchy tunes. Many movies strive to be iconic, but it is fair to say that Grease was and made a lasting impact on western culture. To this day, parties and discos still blast out some of the old Grease tunes.
Well this week, Greece is again the word. The soap opera that has been their debt negotiations with Europe and the IMF appears to be nearing a critical juncture. Europe does not seem to want to recognize that Greece is unlikely to be able to repay their current level of debt. And the Greeks do not seem to want to make the adjustments necessary to run a sustainable economy. At the time of writing, a Greek bankruptcy has become increasingly likely, potentially leading to Greece leaving the Euro.
The consensus view is that Europe should be able to survive a Greek exit, reflecting the size of their economy and that the bulk of the debt is held by other governments or central banks. Maybe. But Lehman Brothers was a reminder that in the modern sophisticated world no-one can be aware of all the linkages if one part of the economic eco-system has a problem. There has been some financial market reaction to the news on the weekend (interest rates, Euro, Aussie dollar and stock markets all lower), but the moves are more consistent with a modest reduction of investor risk appetite. In the event that Greece does leave the Euro and leads to widespread consequences, the financial market reaction will be significantly bigger.
Of course, none of this may happen. It seems that every other year since the GFC some problem in Europe has popped up, which has been addressed (by that increasingly stale phrase of) ‘kicking the can down the road’. But in the case of the Greek debt problem, it appears increasingly to be (as those financial market strategists , the Talking Heads would put it) a ‘road to nowhere’.
More importantly, events in Greece (and China) over the past week are a reminder of the level of uncertainty that exists in global economy and financial markets. This suggests that there will be an increase in financial market volatility, which can lead to a lower Aussie dollar, the maintenance of lower interest rates but wider borrowing spreads.
Recent events (and the calendar) has also led us to do a review of our financial market forecasts. In the plus column has been our cash rate view (since January) of two rate cuts in the first half of this year, and our Aussie dollar forecast of 77c. Less accurate has been the 3- and 5-year swaps forecasts, as we (and many investors) were surprised by the sharp jump in yields that corresponded with improved confidence about the European economic outlook.
So much for the history. Looking out, our view remains that the cash rate is likely to be at its low. Interest rates are doing its bit to get the economy going, as evidenced by the number of cranes building apartments. But the economy does need more help, and our forecast is that will come from a lower currency (which we forecast will eventually move down to the mid 60c mark). But if the currency does not move as we forecast, then the help will need to come from lower interest rates (which would not the RBA’s preferred option). We also look for longer-term interest rates to remain low over the next 6 months, or so, reflecting the uncertainty surrounding the global economy and financial markets. Thereafter, we predict a modest step up in rates in line with an expected improvement in the global economic backdrop.
Overall, this week reminds us of the uncertainty surrounding the outlook. So perhaps the best advice in these conditions comes from the Bee Gees, “Feel the city breakin’sand everybody shakin’sAnd we’re stayin’salive, stayin’salive.”
Have a good week.
23/06/2015 – Economic and Financial Market Weekly: Turn up the vol
- There are a number of identifiable economic and financial risks;
- This makes the outlook uncertain;
- But it does suggest that there might be a rise in financial market volatility.
“Because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.”
Donald Rumsfeld was by nature a polarising figure. But the above quote is widely used as it neatly sums up the range of possibilities when thinking about the future, including the economic outlook. The known knowns are that Australia economy Inc is currently facing an income squeeze, the result of the big decline in commodity prices. This income squeeze is the cause of modest wages and profit growth, as well as hitting many government budgets. Lower commodity prices is also the cause of the marked slowing in mining investment, something that will continue to be a feature of the Australian economy for at least the next two years.
The good news is that low interest rates and a fall in the exchange rate are providing some soothing economic balm. Builders are busy putting up new homes, the mines we have dug are shipping out record export volumes and the consumer is visiting the shops.
But it is the known unknowns that are posing the key questions. Domestically, the key unknown is when will firms outside the mining sector start to invest? The answer is when national income growth starts to pick up again. And that (amongst other things) will depend upon what happens to the exchange rate and commodity prices (which are more known unknowns).
But there are also two important international unknown knowns. One is what will happen to financial markets when the Federal Reserve starts to increase interest rates. Financial markets have been thinking about the potential for higher rates in the US for some time. But the clear risk is that when the Federal Reserve does eventually move there will be a spike in market volatility.
The second unknown known is Greece. There is a lot of speculation as to what might happen but no-one truly knows. The news overnight that Greece might reach a compromise with its creditors was treated as good news. But the level of Greek Government debt will remain high for some time, as is the likelihood that the Greek economy will remain vulnerable. All this means that even if a ‘deal’ is reached in the next couple of weeks, Greece will remain a potential cause for concern.
It is thought that as much of the Greek Government debt is held by other governments (or central banks such as the ECB) any default by Greece would not have widespread ramifications. But Greece has been an integrated part of the European economy for a long time which means that there are likely to be links that not everyone can know. And there is always the potential for financial markets to become concerned that what happens to Greece could happen to other countries.
But as that great international economist, Eminem said, “the truth is you don’t know what is going to happen tomorrow. Life is a crazy ride, and nothing is guaranteed”. It is hard to know how these events will turn out, and what they will mean for financial markets. And we have not even begun to explore the unknown unknowns (which by definition are unknown). The one clear implication is that financial markets are likely to become increasingly volatile.
Have a good week.
15/06/2015 – Economic and Financial Market Weekly: America
- The Federal Reserve shifts into the spotlight;
- No rate change will happen this week;
- But global markets will be looking for any signs that Federal Reserve action is imminent;
- Potential US rate changes are likely to have a significant impact on the value of the $A.
‘Everywhere around the world
They’re coming to America
Every time that flag’s unfurled
They’re coming to America
Got a dream to take them there
They’re coming to America
Got a dream they’ve come to share
They’re coming to America’
From ‘America’, by Neil Diamond
Personally, I was never a big Neil Diamond fan. ‘Sweet Caroline’, of course, is a bit of a banker in terms of getting the feet tapping (and is also played at the end of the eight innings of every Boston Red Sox game). But for a boy bought up on the lyrics of Midnight Oil, much of Neil’s material was a bit sedate.
But for a long time, America was the song of the world economy. This was reflected in that old saw of financial markets, ‘when the US sneezes, the world catches a cold’. Twenty years ago the US economy was one-third of the global economy. And more importantly, the world focus on the US reflected the predominant role played by the US financial system, and by extension, the Federal Reserve.
The rise of China has meant that the US is now a little less important for how the global economy evolves. The highly regulated nature of their financial system means that China has less direct less influence on global capital markets (but that is rapidly changing). Still, developments in the US have had to take back stage to Europe and Japan over the past year where it has been central bank buying (and surprisingly low inflation) that has had the major influence on interest and exchange rate markets.
But you can’t keep a good (and big) economy down. The US is about to have a bit of time back in the spotlight. The US economy is doing well, or at least well enough for the Federal Reserve to believe that the current level of the cash rate near zero is too low. The consensus view is that the Fed will start raising rates in September. Where the debate really starts to become interesting is how far, and how fast, the Fed will move rates thereafter.
And the outcome of this debate is of immense interest to global financial markets. Potential changes in rates by the Fed always move markets. But the impact could be even larger this time. Financial market expectations of the amount that interest rates will need to rise are currently less than that of Federal Reserve members themselves (we will get an update on their views this week). The extended period of very low interest rates in major economies has encouraged capital flows into a number of smaller countries.
Closer to home, the RBA will also be eagerly watching how the Federal Reserve acts. A US rate increase would be a sign of greater confidence about the US economic outlook. Importantly, signs of higher interest rates in the US could also be the signal for the $A to decline down into the low 70c range. A lower currency would be very helpful in getting the economy to shift up a gear. It would also mean that the RBA may not have to reduce rates again, something they would prefer given the strength of the housing market (notably in Sydney).
Of course, economic developments often do not go to plan. How developments in Greece will play out remain a wildcard. This time last year the US economy was performing well enough for the popular pick to be that the Federal Reserve would begin increasing interest rates at the start of this year. The most likely outcome is that the US economy will perform well enough to require higher rates.
But if the global economic data is modest, the probable outcome is that US interest rates would stay where they are. And that would mean that the outlook for the global economy would be for only modest growth. It would also mean that the $A is more likely to stay around current levels, and force the RBA to contemplate another shift lower in interest rates. And if this was the case, the popular Neil Diamond tune might change to become ‘Song sung blue’.
Have a good week.
9/06/2015 – Economic and Financial Market Weekly: An updated report card
- The GDP numbers released last week were a little stronger than expected;
- The strong bits of the economy remain strong and the weak bits weak;
- An economic growth rate a little below trend is the most likely outcome for the remainder of the year.
Four times per year we get a report card on how the Australian economy is performing. For much of the past decade the Australian economy has earned top marks, which has been particularly impressive given the performance in the wider global economic classroom. But more recently we have characterised the Australian economy as a C+ economy: doing OK but with the potential to do better. The most recent quarterly economic report card that we received last week justifies a similar mark.
The good news on the report card was that the headline quarterly increase in GDP was larger than expected. But it did follow a couple of quarters when economic growth was quite soft. Overall, growth over the past year has been in the low 2’s, well under a what we have come to expect from a ‘normal’ Australian economy of something in the low 3’s.
The strong areas of the economy remain strong. There is plenty of houses being built. The volume of exports being shipped overseas is also increasing substantially, and is now at its highest-recorded level as a proportion of GDP. The other bit of good news is that the number of hours worked in the economy jumped sharply in the March quarter. This measure can jump about a bit. But it is a good sign that firms are happy for their employees to work longer hours to meet demand.
Unfortunately, the areas of weakness that have been evident for some time are still noticeable. Business investment declined again, driven by the large decline in mining capex. The other area of concern is that the nominal economy (the value of actual spending and income in the economy) has grown by just over 1% over the past year. This has been driven by the substantial decline in commodity prices. And it is this factor that is constraining wages and profit growth, as well as a principal cause of budget deficits. Consumers are still spending, financed by reducing the amount that they are saving (their saving rate is at its lowest level in almost five years). But consumer spending growth is well down from pre-GFC levels.
What does all this mean for the future? The strong areas (home building, exports) will still be strong for much of this year. And shop owners can still expect householder visits (even if it is happening more by virtual means). But the weak area (mining investment) is likely to remain a major economic negative for the next 1-2 years.
A key factor is what will happen to income growth in the economy. If commodity prices remain where they are and the $A depreciates further, then income growth in the economy should in time rise from current levels. This would help support both stronger consumer and business spending. But if commodity prices fall further (and without an offsetting reduction in the $A), income growth will remain a negative factor. Either way, the economy is still likely to need some help from some combination of a weaker currency (ideally) and lower interest rates.
Those days of the Australian economy achieving straight A’s is unlikely to be repeated this year. But with some more work, good economic marks can be again achieved in the future.
Have a good week.
1/06/2015 – Economic and Financial Market Weekly: Fitting together the pieces of the puzzle
- This week we are likely to find out the Australian economy grew modestly in the March quarter;
- And there are few signs that a significant pickup in the economy is on the horizon;
- This will result in some combination of lower rates/currency over the next year.
Growing up, my family used to watch a lot of ABC, particularly British-produced TV. Partly that was based on my parent’s view that there was nothing they liked on the other stations. It might have also reflected that when I was growing up in Perth there was only 3 TV stations. Regardless, one of the shows we watched was ‘Whodunnit?’, where a panel was presented with a series of clues and had to guess the identity of the killer(s) of a dramatised murder.
Each quarter, economists are presented with their own little puzzle, less a ‘Whodunnit’ and more a ‘Whatisit’. Every week, a few bits of economic data are released and economists try to guess what they mean for the strength of the economy. And then every 3 months the ABS reveals the answer when it releases the National Accounts (the equivalent to Company annual report). This week we get the latest report.
What have the clues told us? We are likely to find out the economy is currently moving at a sauntering pace, comfortably less than a canter. An Australian economy moving at normal speed would typically grow at a bit over 3% annual pace. We are likely to find out that the economic pace was a lot closer to 2% in the March quarter. The economic pluses will be the large amount of iron ore and coal we are shipping overseas, as well as all the homes we are building. The tourism sector is also helping. Consumers are spending, albeit not at the rates typical of the pre-GFC times. Each of these factors are likely to remain in the plus column for the next year.
But the minuses are big ones, and are also likely to impact the economy for some time. The large decline in commodity prices means that Australia Inc has faced a significant price cut. It means there is less income growth to go around in the economy, which explains the very moderate pace of wages and profit growth. It is also the reason why the federal and many of the state governments are confronted with budget deficits. And as with any business when confronted with falling prices, Australia Inc is cutting costs. This is particularly the case with mining firms, where significant cuts to capital spending is taking place.
This is also the reason why last week’s business capital spending numbers were so important. We always knew that a further significant fall in mining investment was on the cards for 2016, although the further downward revision was a bit of a surprise. Given the strength of the boom, it was always likely that mining capex activity would decline significantly, and this is something that is likely to continue for some time to come. But it was the downward revision to non-mining investment that has got analysts surprised. The hope was that low interest rates and reasonable levels of profit growth would encourage firms to invest. But at the end of the day it is returns that firms are chasing, and the low level of national income growth means the average level of returns available across the economy is low. Together with excess capacity in many industries, it is no wonder that firms are keeping tighter control of their cheque books. It will be interesting to see what the RBA makes of the Capex data when the release announcing the interest rate decision is released on Tuesday.
Of course, the clues can always mislead. There is relatively little economic data released for the services sector, for example, so forecasting for that sector comes down to an educated guess. Even with business investment, the data released last week did not cover a number of sectors (such as education, health, government), or types of investment (such as R&D). This means that while economists are usually pretty good at using the clues to get the right answer, sometimes there can be a big miss.
Regardless of what is revealed this week, the bottom line will be that the national economy is running sub-trend and will need further assistance. This is likely to come from a lower exchange rate, but if that does not happen lower interest rates come very much back on the agenda. An important part of the puzzle as to how much help the economy will need is when there will be stabilisation in commodity prices as this will take out a major factor weighing on national income and firms investment decisions. But the evolution of commodity prices in recent times has been as much a mystery to analysts as the best episodes of ‘Whodunnit?’
Have a good week.
28/5/2015 – Economic update: Business capital spending still looks soft
- Firms have marked down their capital spending plans for next financial year;
- The RBA will sit back to see what impact the May rate cut and Budget announcements will have on the economy;
- But the sub-trend economy means that if the currency does not fall further, rate cuts come back on the agenda.
Of all the economic releases, the quarterly business capital spending survey by the ABS is one of the most complicated but important. Important because it is a key leading economic indicator, providing a guide on the future of business investment spending. Complicated because it is full of terms such as ‘realisation ratios’ (the proportion of forecast capital spending that actually takes place), which can make it difficult to determine what the numbers actually mean.
But not this time. The release provides three pieces of information: what has happened, what is just about to happen and what will happen in the long term. In terms of what has happened, firms indicated that capital spending (particularly on building and structures) was even weaker in the March quarter than economist forecasts. Overall, expected spending in the 2015 financial year is around what firms told us three months ago; it is likely to decline by over 8%, driven largely by less spending by mining companies.
The most important part of the release, however, is the outlook for 2015-16. A large reduction in mining investment is widely expected, and the hope of the RBA (amongst others) is that investment in the non-mining sectors (particularly outside of manufacturing) would start to increase. No such luck, at least in this report. Not only has the non-mining, manufacturing sectors marked down their capital spending intentions (from being broadly flat to 10% fall), but the mining sector has further cut its planned spending (from a bit under 20% decrease to over 30% fall). There have been cuts to planned capital spending on both plant and equipment as well as building and structures across industries.
It is not all bad news. Capital spending plans have been revised up in the utilities, wholesale trade and finance industries (although these sectors only account for around 10% of total spending). And the survey has not captured the full benefit of either the May rate cut or from the Budget (which will certainly lead to an increase in plant and equipment spending). Finally, the survey does not cover all capital spending in the economy (eg, it does not cover the education, health, government or superannuation sectors).
Nonetheless, the outlook for business spending is even weaker than originally anticipated. The combination of an low income growth in the economy and excess capacity in many industries means many firms are in no rush to invest. The RBA is unlikely to want to do anything in the short term, content to sit back to see how much the rate cut and the Budget announcements impact the economy. Their hope will also remain that the $A falls further (US economic developments will be important). But the continued sub-trend pace of the economy means that if the currency does not fall in coming months, then additional rate cuts very much come back on the agenda. Today’s release confirms that if there is to be a rate change in the next year, it will be down.
25/5/2015 – Economic and financial market weekly: The search for economic growth
- Data on business capital spending plans are released this week;
- This is currently one of the important indicators for the Australian economic outlook;
- The risks are that firms have marked down their capital spending plans for the 2016 financial year.
The legend of the holy grail is part of popular culture, most obviously in the movie “Indiana Jones and the Last Crusade”. The Holy Grail was said to be the Cup from the Last Supper for Jesus Christ, and the search for the Cup became the principal quest of the knights of King Arthur. In everyday usage, the search for the holy grail has come to mean trying to achieve an ultimate goal.
For the Australian economy, the holy grail right now would be a boost in investment from the non-mining business sector. For about a decade, high commodity prices (and the associated boom in mining investment) helped drive a strong economy. But those good times are now well and truly in the rear-view mirror, and the search is on for an adequate replacement. All the mines we have built means we are shipping big volumes of resources overseas. But from a national economy standpoint this has been more than offset by the large cuts to commodity prices. Consumer spending is currently helping to drive the economy. The growth of spending at the shops typical of the pre-GFC days, however, is unlikely to return any time soon. Growth in pay packets is modest and high household debt levels is crimping spending. Fiscal policy is an economic plus, but concern about deficits is limiting the scope of government support.
So the hope (including from the RBA) is that the non-business sector starts to boost capital spending. And there are reasons to be positive. Interest rates are very low, and there has been some fall in the exchange rate. The capital stock is aging in a number of industries, which means firms at some stage will need to replace old equipment and structures.
But like those searching for the holy grail, signs of a pickup in non-mining business investment have so far been more hope than fact. Business confidence has been mixed, constrained by the modest state of national income growth. And in a number of industries (such as mining and manufacturing) there is plenty of spare capacity meaning firms have no need for substantial capital spending.
We will get an update on business investment plans for next financial year from the ABS this week. The risks are that the investment outlook will be further downgraded, particularly given the movements in commodity prices since the last survey. Surveys also indicate that business confidence continues to be mixed. Certainly, the Budget will help boost spending by small firms (although this will not be captured in the survey released this week). But the question of whether the Budget measures boosts economic spending on a sustainable basis is an open question.
Where the analogy ends is that King Arthur and his knights never did find the holy grail. That will not be the case with business investment, which will eventually rise as firm’s confidence in the economic outlook improves. The timing of that pickup in business confidence, however, is the tough thing to predict.
Have a good week.
18/5/2015 – Economic and financial market weekly: Three Budget questions
• Politically, the Budget has been reasonably well received;
• There has been greater debate about the economics;
• The Budget is likely to be a modest plus for the economy this financial year.
There are some things in life that are guaranteed to attract a lot of attention. The new Star Wars movie is one, Prince Harry’s latest movements another. A third is the Federal Budget, which always gets acres of analysis and detail. A lot of the work is focussed on the ‘what is in it for you’ type of analysis. Plenty of the media discussion is also centred around what the Budget means for the Government. But there is also the odd article on what the Budget means for the economy.
Interestingly, one of the issues that attracts least attention is what does the Budget mean for economic growth this year. Back in the day, monetary and fiscal policy was looked at through an economic growth lens. But in recent times, the economic philosophy has changed, with monetary policy set for the state of the economic cycle and fiscal policy for longer term objectives. The exception in recent times was when there was great concern about the economic outlook around the GFC, and fiscal policy was shifted to a higher gear to get the economy moving.
In this Budget, the focus has been on the incentives provided to small business to invest (and the tax cuts), together with the announcements that should boost disposable income for middle- to lower-income earners. There is no doubt that small business policies should lead to higher investment. Not only have most of the press reports been positive, but history would suggest that changes to depreciation allowances do lead to higher business spending. For example, a temporary Investment Allowance in 2009 led to an increase in spending on equipment by 13% in real terms in the December quarter of 2009.
But overall, the Budget impact on the economy next financial year is likely to be modest. One measure of how the Government influences total spending in the economy is to examine changes in the size of the Budget balance. In this case, the underlying deficit is forecast to narrow modestly from a bit over $40b this financial year to around $35b in 2015-16. In a $1.6 trillion economy, such a change is small beer. The higher spending and tax incentives need to be funded from elsewhere in the economy. Concern about the size of the deficit constrains the Federal Government’s ability to materially increase spending without lifting tax receipts.
Of course, the Budget does have greater influence on the economy than just the dollars and cents. Its impact on business and consumer confidence is important, and the early signs are that it has been well received. But there are plenty of other factors that will matter for the economy over the next year, including the outlook for both interest rates and the exchange rate.
A bigger focus of all the discussion has been what will the economic outlook mean for the Budget. One criticism of the Budget is that the economic forecasts are too rosy, and could mean that the budget deficits will end up bigger than current forecasts. But concern about the credibility of the economic forecasts has been a feature of a number of past Budgets. As Niels Bohr (and Yogi Berra) said, “its tough to make predictions, particularly about the future”. In this case, the Government’s economic forecasts are not too different from that of many economic analysts (including the RBA). And if the forecasts end up being too optimistic and the budget deficit ends up being bigger, that is what is supposed to happen.
The Government should be running budget deficits when the economy is running sub-trend (as it currently is) to support economic growth. When the economy eventually gets up and running again, the Government of the day will have to do a bit more to reduce the size of the deficit. How much work will be required will partially depend upon how much of this Government’s policies it will be able to get through the Senate.
From an economic standpoint, there are a few longer-term issues that are more important:
- An aging population will add to the Budget deficit in future years. How this will be dealt with (what combination of higher taxation and/or lower spending elsewhere) is not completely clear;
- One way an aging population increases the budget deficit is that it potentially reduces economic growth (by reducing the size of the workforce). So policies that maximize productivity growth and workforce participation will become increasingly important;
- In this respect, it is worth noting that the Government’s impact on the economy (as measured by the combination of the level of taxation and the size of the deficit) is nearing levels last seen in the 1980s. The size of the Government in Australia is still relatively modest by international standards. But it does say that governments spending and taxation decisions are having an increasingly greater impact on economic and productivity growth;
- One of those decisions is how much government spending is directed towards infrastructure investment. That proportion is currently quite low, although that partially reflects the impact of privatisations (eg, investment by Telstra is now a private sector decision not a government one) and that there was a lot of Government investment spending around the GFC (“education revolution”). But infrastructure spending needs to be maintained to support economic growth. That a lot of the infrastructure spending is the responsibility of the states makes the politics more difficult.
It is these longer-term questions that need to be debated further and getting more air time. Or at least until the next Star Wars movie come out in December!
Have a good week,
11/5/2015 – Economic and Financial Market Weekly: The tide is high but I’m holding on
- Interest rates are currently at historically low levels;
- This is helping the economy, but growth is still sub-trend;
- Despite last week’s move, the economy is still likely to need some combination of lower interest rates/weaker currency
‘Plans were laid
Plots have thickened
Today’s the day
How long you waited’
Deborah Harry and Blondie were one of the iconic bands of the late 1970s/1980s. To this day, songs such as ‘Call Me’ are still played and have moved on to become a ‘classic’. And the above lyrics (from the song ‘School for Scandal’) summed up market analysts prior to the RBA rate cut last Tuesday. Most had been expecting a rate fall at some stage, and the RBA (eventually) duly delivered. But following the decision, a number of analysts came to the view that the bell had been rung and that the cash rate had hit its low. Maybe it has, and that would be good news. It would mean that either the $A will depreciate further, the domestic and global economies will improve, or some combination of the two. This is our forecast, as we believe that the currency will head towards 70c (and maybe even into the 60s) at some stage over the next 12-18 months.
But for the currency to head lower will likely reflect developments in the US economy. The RBA will most probably now sit on its hands for at least the next 6 months to see how lower interest rates are helping the economy. If the US economic data becomes stronger (as we expect), market attention will again start to expect imminent Fed rate hikes and this is likely to be the catalyst for the $A to test 75c. If, however, the US data remains weak financial markets will continue to push out expectations for higher US rates. In this scenario, the $A again tests 80c.
Another factor to watch is how the Chinese economy develops. The Chinese economy has been slowing over the past year, as the Government looks for consumer spending to take over driving economic growth from investment spending. This will likely happen over the next 5-10 years. But the uncertainty is how this transition will go over the next 2-3 years. Moderating Chinese demand has played an important role in the decline in commodity prices over the past couple of years (although many analysts think that higher supply has played a greater role). And Chinese Government concerns that the economy is slowing too quickly have led them to reduce interest rates on a number of occasions over the past few months.
China is important not only from an export standpoint, but also for the currency. The value of the Australian dollar is typically heavily influenced by commodity price developments. It is therefore no surprise that the Australian dollar has risen in the past few months at the same time that commodity prices have increased. But we believe that unless there is a substantial rise from current pricing (not the consensus view) the level of commodity prices is consistent with a lower $A.
Which brings us back to the Australian economy. While there are clear areas of strength (residential construction, export volumes, Sydney economy and increasingly tourism), there are also clear areas of weakness (mining, manufacturing, while the WA economy is clearly slowing). More importantly, in last week’s Monetary Policy Statement the RBA marked down its growth views over the next year, as well as pushing out the time when they expect the Australian economy to strengthen significantly. With that as background it is clear as to why the RBA felt the need to cut rates. And it is why if the $A does not fall as we expect over the next 6-9 months, rate cuts can return to the agenda.
One of the other famous Blondie lyrics was ‘The Tide is high but I’m holding on’. The hope is that the tide will eventually go out on $A strength which will help the Australian economy to do more than just be ‘holding on’.
Have a good week.
4/5/2015 – Economic and financial market weekly: The truth is out there
• Last month’s jobs and CPI data were not sympathetic to a near-term rate cut;
• But the longer-term trend of declining commodity prices and weak business investment is;
• The result is that at least one more rate cut is likely, with a move this month a ‘live’ possibility.
Scully: ‘Why is it so dark in here?’
Mulder: ‘The lights aren’t on’
Back in the day I was a bit of a fan of the X Files (or at least the first five series). By the end of each show the viewer was both a bit closer, but also a little further away, from finding out the answer. In a number of respects, following Australian monetary policy in recent times has been a little like following the X Files. Each month we have been waiting to see whether the RBA is going to reduce interest rates again. And after each meeting we find out that interest rates may decline again, but just not this month.
Each X Files episode also touched on the possibility that things were happening that we did not quite understand. A similar observation could be made as to how the economy is evolving. What is not a mystery is that not for the first time, the Australian economy is being hit by a large decline in its major export prices. Historically, this has resulted in slower income growth in the Australian economy, meaning slower wages and profit growth and wider government budget deficits (as highlighted once again in today’s headlines). One difference on this occasion is that the investment during the ‘mining boom’ was (mainly) spent well, and inflation remained tame. This meant that interest rates could fall quickly, helping to boost home building, allowing house prices to go up and household and government interest payments to come down.
But there are some things that are a mystery. For a long time it was believed that interest rates could go no lower than zero. After all, why would you lend a borrower any money in the expectation that you would get less money back. No longer it seems. German Government bonds out to 4 year’s maturity are currently trading on negative yields. This is because of European Central Bank action (and similar policies undertaken by the Bank of Japan) are driving down interest rates to get the European economy going.
The actions by the European and Japanese central banks have worked to an extent, with some better signs surrounding both economies (at least for the short term). But their actions have meant that the Australian dollar is higher than what it normally would be given the extent of the decline that has taken place in Australia’s export prices. And offshore central bank moves have helped drive Australian interest rates lower than what the RBA would prefer.
This is where the mystery remains. When will record low interest rates start stimulating both the domestic and global economies like they did in ‘the good old days’? The answer to that question will determine where interest and exchange rates head over the next 1-2 years. Unlike the X Files, most mysteries are (eventually) resolved. Negative interest rates are unsustainable, and an eventual cyclical upswing in the domestic and international economies will take place. But in the meantime, the Australian economy will require some combination of lower interest rates and a weaker currency. It is which combination that is uncertain. The most likely combination will probably include at least one more rate cut, with the meeting this week remaining a live option of action.
Have a good week.
27/4/2015 – Economic and financial market weekly: The real story
‘Who are you going to believe, me or your lying eyes’. This was one of Groucho Marx more memorable quotes (one of many). But it could also be a summary of the key bits of economic data released over the past couple of weeks, and what they say about the state of the domestic economy.
First, the CPI numbers. The quarterly inflation numbers are always important, not the least because it is the key benchmark the RBA uses when setting interest rates. The headline figure was always going to be low (only a 1.3% increase over the past year) reflecting the big drop in petrol prices. Importantly for the consumer, other regular spending items (such as utility bills) have also fallen over that time. But when setting interest rates, the RBA does not use the headline number as it could be overly influenced by a change in price for 1 or 2 items (as falling petrol prices did this time). They use various measures of ‘average’ price changes, and these suggest that inflation is only a little below the middle of the RBA’s 2-3% inflation target.
The jobs numbers released the preceding week also created a surprised. They showed that employment is trending up, while the unemployment rate fell in the month. At face value, the two reports suggest little urgency to have lower rates.
But both numbers were a surprise given the other information that is available. The key drivers suggest that inflation should be heading lower. The domestic economy has been a little soft, wages growth moderate and the major concern in the world economy over the past year has been that inflation is too low. Meanwhile, the other indicators suggest a soft labour market. Consumers remain worried about jobs. Employer hiring intentions are picking up, but from a low level. Ditto for job ads and vacancy data. The ratio of long-term unemployment has also been moving up.
The big picture remains that income growth in the economy is being subdued by the significant fall in commodity prices. And the economy is struggling to fill the ‘growth hole’ caused by the ongoing fall in mining investment. The GDP data also paint a picture of an economy running sub-trend.
So the economy is still in need of some assistance. The RBA would prefer that this assistance comes from a lower exchange rate, at least partly reflecting their concern that lower interest rate is leading to rising (mainly in Sydney) house prices. But the actions of global central banks (or in the case of the Federal Reserve, possible inaction) has meant that the $A has remained stubbornly high.
This means that lower interest rates remains very much a live option. The two CPI and jobs numbers give the excuse for the RBA not to move in May. But it would be surprising if the RBA was still not forecasting sub-trend economic growth and a sanguine inflation outlook. And if this is the case, a move in May still remains a distinct possibility.
Have a good week.
20/4/2015 – Economic and financial market weekly: Death, taxes and monthly jobs numbers
Some years ago, I made a forecast that there would be a large rise in a monthly jobs numbers report. Everything came together for that forecast, from my reading of the forward job indicators to how the general economy was travelling. It was one of the few times I have ever had strong views about the jobs data. It tuned out that I was right there would be a big change in the monthly number – the only problem is that it ended up being a large fall. The lesson I took away from that experience was that any monthly number contains a substantial amount of ‘noise’, but particularly the jobs figures.
Which brings us to last week’s numbers. At face value, the data was strong. Not only was there a big jobs increase in the month, but with significant revisions the average increase in monthly jobs over the past 6 months is now (apparently) around 25,000 (the long-term average is closer to 15,000). The unemployment rate (6.1%) fell for the second month in a row and suggests that the unemployment rate has stabilized around 6.25%. And the participation rate rose to its highest level since July of last year. All up, the picture painted was one of an economy starting to travel pretty serenely.
The problem is that they do not appear consistent with all the other economic information. Job ads and firm-hiring intentions are picking up, but slowly and they are both at a low level. Despite the (apparent) jump last month, business confidence remains mixed, and consumers are still worried about the jobs market. The bigger picture is that the Australian economy far from travelling serenely, is having a bumpy ride caused by declining mining investment and falling commodity prices. This picture is suggestive of lower job increases in the month ahead, and a higher unemployment rate.
Beauty as they say is in the eye of the beholder, so how are the RBA likely to be viewing these different pictures? Their forecast is still probably for sub-trend economic growth over the next 6-12 months (we will get an updated look at their forecasts next month). And sub-trend growth typically leads in time to a higher unemployment rate. At the same time, the RBA is unlikely to have any concerns about inflation (to be confirmed with the release of the CPI figures this week). So they will still be thinking that the economy needs further help. Their preference is that this help comes from a weaker currency, but they also realize that this it is also likely to mean an even lower cash rate.
What does all this mean for interest rates over the next few months? A literal reading of the jobs numbers suggest that the RBA will not be changing interest rates. But then the RBA has not been following the data playbook this year, cutting rates in February when the data suggested no change but then keeping them unchanged in March when the information suggested reduced interest rates. The RBA is far more likely to be keeping their eyes on the bigger picture of modest national income growth, declining business investment and a stubbornly high currency. That picture tells the story of lower rates.
So May remains very much a live possibility for lower interest rates, particularly given the recent move of the $A to north of 0.78c. Given the weighting the RBA puts on them, things could change after the release of the CPI this week. But more likely is that the inflation numbers will be benign and allow the RBA to cut rates again when they see fit.
Have a good week,
13/4/215 – Economic and Financial Market Weekly: The Australian economy headwinds
‘Plus ça change, plus c’est la même chose’
Jean-Baptiste Alphonse Karr from his journal, Les Guepes
The above is one of the most used quotes of the modern age. Don’t recognise it? In English, it is translated as ‘the more things change the more they stay the same’. Another example of the many advantages of Google.
The quote highlights what is currently happening with the Australian economy. In 2008, Australia’s unemployment rate snuck under 4% (at least when taken to 2 decimal places), the lowest rate since the glory days of ABBA and Sherbet in the early 1970s. In 2008, commodity prices were boosting Australia’s income, leading to decent wages growth, rising taxation (which led to tax cuts) and high company profits (notably for mining and related sectors). In time it led to a huge mining investment boom, which boosted activity in mining-related regions.
But now, as highlighted by the significant fall in iron ore prices, commodity prices are falling. The result is sluggish income growth, which is why there is modest pace growth in wages and profits. And it is why governments are now struggling with budget deficits.
This is the change that is currently impacting the economy. The RBA has responded to developments with an aggressive series of rate cuts, taking interest rates down to multi-generational lows. The retail sales data released last week highlighted the impact. Although the headline monthly number looked strong, smoothing out the monthly noise still points that spending in shops has been softish over the past year reflecting modest wages growth and household fears about the jobs market. But spending has been stronger on household goods reflecting the impact of low interest rates on the property market.
This week we will get the latest read on the unemployment rate. It has been slowly drifting up over the past year, the surest sign of an underperforming economy. The number of job ads is picking up, and firms are saying they are looking to hire people. But it will not be enough to stop the unemployment rate heading higher over the second half of this year.
‘The more they stay the same’? This is not the first time the Australian economy has felt the large swings in commodity prices. The impact of past episodes of commodity price downswings on the economy has varied, depending upon the level of exchange and interest rates and how the economy ‘spent’ the proceeds of the ‘good’ times. How the Australian economy fares over the next couple of years is uncertain. To borrow another well-known quote, ‘it is tough to make predictions, especially about the future’. What is more certain is that the Australian economy will require some combination of lower currency and interest rates. Next month, we are likely to see the next step down in interest rates (always remembering that it is tough to make predictions …..).
In the medium term, the Australian economy should do OK. For example, population growth in Australia is expected to be stronger than most developed country peers. So if not quite da ja vu all over again, we have been somewhere near here before.
Have a good week.
7/4/2015 – Economic and Financial Market Weekly: Curiouser and curiouser
“My dear, here we must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that.”
From Lewis Carrol’s ‘Alice in Wonderland’
Most people know the story of Alice in Wonderland where a girl falls through a rabbit hole to enter a parallel universe, one in which logic is turned on its head. To many observers that is how financial markets currently appears. Globally, interest rates are at extraordinarily low levels and in a number of countries (notably in Europe) they are negative. Like Alice before her journey into Wonderland, negative interest rates was once considered impossible. Fund managers are scratching their heads thinking about what is value in such a low interest rate world. Only the Mad Hatter would be comfortable as an investor in this world!
But this is the world that the RBA is now inhabiting when it is considering setting interest rates. The Australian economy is currently facing big price cuts (falling commodity prices). Some fall was expected and the RBA hope was that they could reduce rates, and together with a substantial decline in the exchange rate, this would cushion much of the economic pain.
And some of this has happened. The $A has fallen by nearly 30% from its peak against the USD, helping sectors such as tourism. Lower interest rates have helped stimulate house building, as well as putting many households in a better financial position (but not first home buyers in Sydney or those reliant on their saving for income).
But still it has not been enough. Partly that is because the extent of the fall in commodity prices has been substantially more than analysts had thought possible (but then analysts are always surprised by how quick commodity price changes can happen). But it is also a reflection of the power of negative interest rates in many European countries, which has meant that the AUD has hardly declined against the Euro (and other currencies such as the yen).
And it is also becoming increasingly apparent that there is a point where cutting rates from very low to very, very low just does not pack the same economic punch. As the Mad Hatter said to Alice, ‘You used to be much more…”muchier.” You’ve lost your muchness’. Modest levels of domestic business confidence is playing a role, something which can be helped by greater clarity in government policy. But very low interest rates is also a sign that globally there is too much saving and not enough investment. And that is something that may take some time to correct.
All this is background to today’s decision by the RBA not to cut rates. The RBA acknowledged that the economy is likely to remain sub-trend and that inflation will not be a problem. They are still looking for a lower exchange rate (“a lower exchange rate is likely to be needed to achieve balanced growth in the economy”), something that today’s decision has not helped to achieve. The bias for lower interest rates remains very much in place.
The decision this month to keep rates on hold is likely to be as much about tactical decisions about when the RBA believes they will get maximum impact from rate cuts than the economics. In February the RBA got significant traction from both the financial markets and the domestic economy from its decision to drop the cash rate. The RBA will want similar traction from future decisions. The economics argues that interest rates should be at least one quarter percentage point lower. In that light, a move next month remains a distinct possibility.
Nothing lasts for ever, even in Wonderland. Alice eventually woke up and found herself back home. Very low interest rates will also eventually be a thing of the past, a story that can be passed on to (disbelieving) future generations. In the meantime the cash rate is heading lower, most likely in the next month or so. How much longer we spend in the Wonderland of low rates, however, remains the topic of much debate.
Have a good week.
30/3/2015 – Economic and Financial Market Weekly: The rate cut arguments are clear
A lower Australian dollar is crucial for the Australian economic outlook. The sectors that rely on being internationally competitive (such as manufacturing and tourism) struggled when the Australian dollar was high. The fall in the currency that has taken place so far has seen a pickup in the tourism industry, something confirmed to me from a visit to Cairns a couple of weeks ago. It is helping, but not enough and a further fall in the $A is needed.
All of this is why financial markets expect another rate cut by May. The timing of which month the RBA moves will come down to tactics. But there is no obvious reason to wait, meaning April is very much a live option. Probably more important than which month the RBA next moves is how low the cash rate may go. After cutting rates to 2% sometime over the next couple of months, the RBA is likely to sit back and hope the global economy will pickup and the $A falls further. But in the event that ends up being more hope than fact, further rate cuts could take place before year-end, potentially taking the cash rate down to at least 1.5%.
The Clash posed the question but did not provide the answer to the RBA’s conundrum. We will not know for sure for some time, but the end result will be some combination of a lower cash and exchange rate than we currently have.
Have a great week.
These articles contains general advice which has been prepared by Peter Munckton without taking account of your objectives, financial situation or needs. The content of these articles is for information only and is not an offer by Bank of Queensland Limited ABN 32 009 656 740 (BOQ) to provide any products and services. BOQ makes no representations or warranties about the accuracy or completeness of the content contained in the article. BOQ recommends that you do not rely on the contents of the article, that you consider the appropriateness of any advice before acting on it and that you obtain independent professional advice about your particular circumstances.