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Analysis

• The sharp improvement in the labour market has important implications for the budget outlook with the labour market improving much more quickly than projected back in December’s MYEFO. The unemployment rate at 5.8% is well below MYEFO’s forecast of 7¼% in Q2 2021, while employment is back to pre-pandemic levels, something not expected to happen until mid-2022 according to MYEFO.
• The automatic stabilisers are already starting to reflect the sharp improvement. The Monthly Financial Statements show budget revenues running $6.1bn ahead of YTD forecasts and expenses running $9.8bn below, a net $14.5bn improvement to the underlying cash balance (equivalent to 9.8% of the forecast underlying cash deficit YTD). Further improvement is likely given the ongoing recovery with aggregate payroll wages back to pre-pandemic levels and an iron ore price of $160 a tonne being well above MYEFO’s assumption of it falling to $55 a tonne by Q3 2021.
• It is conceivable the run-rate of a 10% improvement in the cash deficit is sustained for the rest of 2020-21, which would equate to the underlying cash deficit being $20bn better off (possibly cutting the deficit to $177bn from the current $197.7bn projected). That would likely continue into 2021-22 given revenue timings around a higher iron ore price and that employment is already back to pre-pandemic levels, well ahead of MYEFO’s projections for mid-2022. The expense profile may also see some improvement with unemployment already at 5.8%, below the 6¼% forecast for 2022.
• Automatic stabilisers will see some narrowing in the deficit on top of the MYEFO path. It is worth noting that MYEFO forecasts already forecast a sharp fall in the deficit given the end of JobKeeper in March 2021 and the JobSeeker Supplement with the underlying cash balance set to fall from $197.7bn in 2020-21 to $108.5bn in 2021-22. A $20bn improvement in both would see those numbers fall to $177bn in 2020-21 and $88bn in 2021-22, broadly bringing forward the improvement in the deficit by a year. The risk is to a faster improvement given the rapid recovery in the economy to date.

The week ahead

• Australia: A quiet week with no top-tier data or RBA speeches scheduled. Accordingly, domestic markets are likely to take their lead from offshore.
• International: US: Fed Chair Powell is appearing before Congress with Treasury Secretary Yellen on Tuesday (House) and Wednesday (Senate). Inflation pricing is lifting given the Fed’s pledge to keep rates on hold through 2023 despite full employment begin forecast to be reached in 2022 (Fed’s unemployment forecast is 3.9% in 2022 compared to the longer-run pegged at 4.0%). There is also a host of other Fed speakers. There is also plenty of data, though the severe winter storms will mean some volatile reads. Durable/Capital orders are on Wednesday, Jobless Claims on Thursday and PCE Inflation on Friday. CH: a quiet week with no data scheduled. EZ: flash PMIs on Wednesday the most market moving, with consensus looking for a modest softening. The rise in new virus cases has seen more countries tighten restrictions, while the vaccine rollout continues to lag that seen in the US and the UK. UK: Labour market data is on Tuesday and inflation on Wednesday.

Chart 1: Budget deficit is narrowing quickly from the lows of the pandemic

Chart 2: Unemployment is falling much more quickly than MYEFO projected

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