Fed a step closer to lift-off as RBA mulls outlook

The week opens with two conflicting pieces of economic news for markets, the strong US payrolls report and weak China trade data. NAB has also revised lower its $A forecasts. Friday’s US non-farm payrolls report for January surprised on the high side, re-assuring those prosecuting the case for the Fed to increasing rates by mid-year. Not only did payroll growth surprise on the high side but average hourly earnings bounced back with a vengeance. Average hourly earnings growth in annual terms picked up to 2.2% y/y, an economy-wide piece of evidence of still diminishing slack in the US labour market. The market is now pricing rate increases by late Q3/early Q4.

That report was a stark contrast to China’s trade report for January that played to the view of continuing softness in the economy. Export growth slumped to -3.2% from +9.9% in December while the annual change for imports fell to -19.7% y/y from -2.3% to December, the wider contractions signs of weaker growth and falling imported commodity prices, even allowing for large and shifting seasonal Lunar New Year effects. Iron ore imports fell 50.3% y/y and coal imports by 61.8%. The spot price of iron ore has more than halved over this period.

RBA Developments

It certainly was a big week for Australian interest rate markets, with the RBA easing monetary policy for the first time in 18 months. The Bank then published quite weak economic forecasts in the near term, notwithstanding the combined stimulus of the low $A, much lower oil prices and the technical assumption of a further interest rate cut at some stage in the next few months and finally, considerably stronger than expected US labour market data on Friday night.

The text of the RBA statement reveals: (i) the Bank appears to have been frustrated by the continued failure of the non-mining economy to accelerate as expected. This is not to say that the economy is getting a lot worse, just that it isn’t getting much better. This extended period of below-trend growth has been underpinning a continuing 0.1 percentage point per quarter increase in the unemployment rate (the latter will likely be a useful metric by which to calibrate future RBA actions).

Coupled with a better inflation outlook courtesy of much lower oil prices, this allowed the Bank to act to seek to stimulate the non-mining economy a little further; and (ii) the latest forecast appears to have greater uncertainty attached to it than normal, given the multitude and size of the diverse forces currently impacting on the Australian economic outlook. This agglomeration tends to argue against a quick follow up rate cut, with at least a few months of incoming data required to assess the Bank’s revised view of the world.

Usually when the RBA cuts rates, it moves rates at least twice in relatively quick succession. On this occasion, however, given the uncertainties described above in the forecast outlook, not to mention the continuing concern notwithstanding APRA’s recent actions over house price developments along with the implications for savers, it seems more likely that the Bank will hasten slowly and be guided by incoming data. This suggests that no further interest rate reduction will occur before May at the earliest [NAB: current forecast -25bps in August].

The construction of the Bank’s forecast also suggests some risk of greater upside surprises in coming months, given the forecasts are relatively timid on the near-term growth outlook in spite of stronger US growth, much lower oil prices, a lower $A and the recent interest rate reduction. Again, the story in Australia is not about no recovery in the non-mining economy, but about a slower-than-expected recovery. This suggests a more cautious approach, than when the economy is developing rapidly in a certain direction.

AUD/USD forecasts revised lower

Today we also issue updated AUD FX forecasts, now showing the AUD/USD falling to a low of 0.74 this year and 0.73 in 2016 before recovery commencing in H2 2016 and into 2017. The scale of the AUD’s drop in January, when liquidity conditions were seriously impaired by the Swiss National Bank’s shock decision to lift the cap on the Swiss Franc and at a time when markets were rapidly pricing in a resumption of the RBA’s easing cycle, meant that our original end-2015 forecast of 0.78 was met before the month was out. From here, increased confidence in a mid-year start to the Fed’s tightening cycle, alongside the likelihood of at least one more RBA rate cut in this cycle and expected further falls in Australia’s terms of trade, justifies lower forecast levels both versus the USD and in broader trade weighted terms.

The week ahead

It’s another big week for the RBA and key data risk. The week is book-ended by the RBA Governor. After today’s “Remarks” from the RBA Governor at a RMB Clearing bank launch event, it will be his semi-annual Parliamentary testimony on Friday and the extensive question and answer session before the House Economics Committee that will garner most attention. That’s at 9.30. We also have a speech from Guy Debelle, the RBA’s Assistant Governor (Financial Markets), who is speaking to the FX Week Conference in Sydney on Wednesday.

Today’s ANZ Job Advertisements (+1.3%) comes before Thursday’s labour force report, with the NAB Business Survey for January tomorrow, and the monthly W-MI Consumer Sentiment Wednesday. Tuesday sees the ANZ-Roy Morgan Consumer Confidence index, surveyed last week when the rate cut and Federal politics were getting enormous airplay so this reading will get more attention than usual.

Tomorrow’s NAB monthly Business Survey for January was polled in the last week of January, so confidence was surveyed before the RBA rate cut. In December, Business Conditions and Confidence were a little below their long term averages, Confidence at +2 and Conditions at +4.

The monthly Westpac-Melbourne Institute Consumer Sentiment February reading for February will be released Wednesday morning, under the same post-RBA rate cut prism as the previous day’s ANZ-Roy Morgan measure. In January, consumer sentiment was at 93.2, up 2.4% in the month but still languishing below its long term average. Housing finance approvals for December are also released on Wednesday and we look for a solid 3% rise in the number of owner-occupied loans in the month. There’ll be a lot of interest too in the investor lending space with approvals having eased a touch in November, down 2.2%.

For Thursday’s labour force report, after the unexpected 37K jump in employment last month, coming on top of the large 45K gain in November, some payback from either a somewhat lower level or much-reduced growth is expected. Leading indicators of employment still point to employment growth in coming months, but December’s result looked a little too strong to us. NAB expects to see employment up a muted 5K; the market is looking for the same fall in quantum with an unemployment rate of 6.2% the pick for both assuming an unchanged participation rate of 64.8%.

Offshore this week, it’s another big week in the US, with the NFIB Small Business Survey, Retail Sales, the Fed’s Beige Book and CPI key releases in a busy data week. Yesterday’s China trade data for January looked weak, seeing some selling of the AUD/USD at the start of trading this morning. China also releases their January CPI/PPI inflation data this week.

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