Below trend growth to continue
This week we look at: •The latest US FOMC statement and its implications; •The RBA Minutes, which reveal the Bank considered further reducing rates in March, but decided against moving at that meeting. How much longer might they be patient?; •The latest industry employment data to see how this fits with our view of the Australian economy; and •The main events coming up this week.
This week we look at:
As had been widely expected, the Fed altered its forward guidance to remove the guidance that it could remain patient in terms of changing monetary policy. Previously the Fed had explained that being patient denoted no increase in US interest rates at the next two meetings. Reflecting both the Fed’s improving view on the US economy but also its concern to manage potential market volatility from the first rate rise in nine years, it:
Market moves were wild in the 24 hours after the Fed announcement, even though the statement was carefully crafted to minimise its impact on markets. Share markets soared and bonds rallied. However, the biggest moves and greatest volatility was in currency markets, with the US$ easing sharply (with the EUR and $A rallying sharply in the aftermath, $A up 2 US cents and EUR up 4 US cents. The market then proceeded to completely unwind the moves over the following 24 hours reportedly due to renewed concerns over Greece, though on Friday night, the US$ was again weaker and the $A and EUR stronger.
For us, the most interesting aspect of the Fed statement was the increased focus on international developments in its decision making at the current time, including in the concluding paragraph that “The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”.
While it’s clear that the Fed is now data dependant, with both trends in the labour market and medium-term inflation key, the Fed seems to be also saying that the impact of other central bank policies will constrain its ability to return US interest rates to neutral levels. Our strong suspicion is that this is for fear of causing an overly-strong US$ response, though it would seem that if there is one country in the world that could accommodate a stronger currency at the present time, it is the US economy, which has benefited from a low currency over the years since the financial crisis. Medium-term, our expectation remains that the US$ will continue to appreciate (and the $A depreciate – toward the low US$0.70s by end 2015). The Fed’s concerns could suggest the US$ may not adjust that significantly, which could mean the $A stays higher than desired, which in turn could have implications for Australian interest rates at the margin. In all likelihood, however, the risk remains of an ultimately stronger US$ and weaker $A, before and after the US raises interest rates, with the US likely to be the only major economy to offer rising interest rates. The prospect of significant currency appreciation, however, would likely be a constraining factor on the extent to which US rates might rise.
It remains NAB’s forecast that the Fed will commence raising interest rates in June, however, the cautious nature of this week’s statement does raise the risk of a slightly later commencement to rate rises.
Meanwhile, the Minutes of the RBA’s March Board meeting left no doubt that the RBA has a strong bias to ease Australian interest rates further. A number of statements in the Minutes seemed to indicate that such a move was less likely to be forthcoming in April. “Nonetheless, on the basis of the current forecasts for growth and inflation, members were of the view that a case to ease monetary policy further might emerge. In considering whether or not to reduce the cash rate further at this meeting, members saw benefit in allowing some time for the structure of interest rates and the economy to adjust to the earlier change. They also saw advantages in receiving more data to indicate whether or not the economy was on the previously forecast path. Further, they noted the greater degree of uncertainty about the behaviour of borrowers and savers in a world of very low interest rates. Taking account of all these factors, members judged it appropriate to hold the cash rate steady for the time being, while recognising that further easing over the period ahead may be appropriate to foster sustainable growth in demand while maintaining inflation consistent with target”.
At face value, these assessments would normally tend to take a few months, quite possibly even if the Bank had already decided that the economy required two interest rate cuts (which is normally how it would operate – any policy adjustment likely requiring at least a half a percent move over a relatively short period of time). The many considerations reported above highlight the wide variety of influences currently impacting upon the Bank’s policy making (think the $A, whether the Bank’s forecasts for the economy continuing to record sub-trend growth are correct, the strength of housing lending – especially to investors, what the Fed does (and when) and what that means for the $A, the efficacy of Australian monetary policy in the current circumstances (and how still lower rates might impact on housing), not to mention the low starting point for interest rates and the anticipated beneficial impact on the Australian economy of lower oil prices, a lower $A and a stronger US economy).
These uncertainties, in the context of an economy that is sub-trend but not clearly developing quickly to the downside still appear to be consistent with a generally cautious stance toward further easing. The RBA’s main game remains to try to return growth more quickly to a trend rate (while also remaining cognisant of financial stability issues). On balance, while this is consistent with a further easing in the months ahead, we tend slightly to favour a further month’s delay (and data monitoring) before the Bank eases in May (or still later). After a further move, we would expect the RBA to be on hold for an extended period assessing the impact of its prior moves.
The ABS also released its detailed February employment data this week, which provides estimates of employment growth by industry. While the data is not generally focused on by markets, we like to check it to see that it conforms to our understanding of the economy. Just over 150,000 net new jobs were created in Australia over the past twelve months (1.3% growth, which is not that far below trend if productivity growth is in the order of 1-1.25%). The industry breakdown fits extremely well with the broad picture of the economy as most economists currently perceive it: greatest weakness has been experienced in mining and manufacturing, though a number of service sectors have also been soft. Strength has been most noticeable in construction (the housing recovery) and broader services industries (professional, accommodation and food, and information media).
While the March labour force data will be released after the April RBA Board meeting, it will be very interesting to see if the recent trends for both employment and unemployment are maintained. Both have been more favourable in recent months, with employment growth now around 14,000 per month and the number unemployed rising at only 3,000 per month, the slowest rate for some time.
A light data week in Australia this week, with most domestic interest likely focused on the RBA’s six-monthly Financial Stability Review on Wednesday. The September 2014 Review highlighted the strong growth in lending for investor housing and it is likely to again be a key theme in this week’s report. Sydney house prices and Melbourne apartment construction will likely again get special mention, while the RBA’s commentary on commercial property and the business sector will also be scrutinised.
Otherwise there is little domestic news for markets. The weekly consumer confidence data are out on Tuesday, while February skilled vacancies are released on Wednesday.
For markets the highlight of the week will be the numerous US Fed speakers. In Sydney on Tuesday, San Francisco Fed President Williams will speak (via videoconference) to the Australian Business Economists Luncheon. Meanwhile Chair Janet Yellen is speaking on monetary policy in San Francisco on Friday. The Fed’s Evans, Bullard, Lockhart and Fischer are also speaking during the week.
On the data front, the Chinese manufacturing PMI and Eurozone PMIs tomorrow and German IFO on Wednesday will also be closely watched by markets.
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