• The RBA left cash rates unchanged again in April. The NAB business survey and April employment data this week are likely to be important for market pricing and expectations for May ahead of RBA April Minutes and Q1 CPI next week (NAB expects headline flat/0.2% q/q and underlying 0.3/0.4% q/q – final forecast to be released later this week).
• Recent reporting of Australia’s labour market data somewhat pessimistic – while unemployment has risen, that’s due to Australia not creating sufficient jobs to absorb immigration and school and university leavers. In fact, Australian employment is at a record level, with 151,000 jobs created over the past year. This isn’t the same impact on the economy as rising unemployment when many jobs are lost.
• For markets, the main challenge remains working out when the Fed will begin to raise interest rates and when it does, the pace of subsequent moves and the impact on equity and bond markets. NAB continues to expect the US$ to strengthen moderately and the $A to weaken a little further as the market prices the Fed raising rates in the June to September timeframe. This is likely to provide for modest upward pressure on term borrowing yields.

Two big pieces of Australian data this week ahead of next week’s RBA Minutes and the Q1 CPI. Both have the ability to influence market thoughts about whether the RBA cuts again at the May Board meeting, following the decision last week to hold rates steady but to retain an easing bias. In general, with the exception of iron ore prices, Australian data have not developed significantly to the weak side in recent months, as the markets have been expecting and pricing. Markets for the most part over the past week continue to reflect a stronger US$ and weaker EUR in particular, with bond yields relatively stable and equity prices strong, including a near 10% rise in the Hang Seng index since the end of March!

The Australian labour market

Thursday sees the release of the March labour force data. Current reporting of the Australian labour market frequently suggests the labour market data reflects a very weak Australian economy, by referring to the 6.3% unemployment rate. However, it’s worth noting the following points about the current Australian labour market data. First, Australia currently has a record level of employment, with some 11.7 million persons employed, 151,000 higher than in February 2014. As chart 1 shows the rise in Australian unemployment is quite different from that which occurred in other countries around the world. In Australia, employment growth has remained positive in recent years, meaning the rise in unemployment reflects Australia not producing sufficient jobs to accommodate newly-arrived migrants and school and university leavers.

This type of unemployment, while certainly a policy and potential social issue, is not as damaging for the economy as unemployment caused when there are large job losses (such as overseas in the wake of the Global Financial Crisis). In the latest labour market report, employment growth was around 14,000 per month in trend terms, just shy of the 17,000 per month currently needed to keep the unemployment rate stable. The market is forecasting the unemployment rate to remain stable at 6.3% in March and for a further 15,000 jobs to have been created. If this expectation is realised, it would likely see a modest further reassessment of the likelihood of the RBA reducing the cash rate at the May meeting and of two further cuts by the end of the year, particularly as weekend auction clearance rates in Sydney and Melbourne remained elevated (Sydney had the second highest clearance rate ever recorded).

The other trend we should be expecting to see confirmed in the labour market data is relative strength in NSW, Victoria and Tasmania (based on job advertising trends and business conditions in recent months), restrained by relative weakness in WA, Queensland and SA (with WA likely to be the weakest of these three regions, again given recent trends in job advertising and business conditions). This is effectively the reverse of the mining boom: the non-mining states are showing greater strength, albeit restrained by weakness in the states most exposed to mining.

NAB Business Survey

While we obviously can’t comment on the actual survey results just yet, we can point to what we should be looking out for. First and foremost, the February survey outcome was a little disappointing in not recording any significant improvement in conditions or confidence in spite of the further reduction in interest rates by the RBA in February (though beneath the surface conditions improved across all states but were held back by weakness in Queensland following that state’s somewhat unexpected election result). Any improvement in conditions would be welcomed by the RBA, as would any more encouraging trends for forward orders, capacity utilisation, capital expenditure and employment.

RBA Minutes and Q1 CPI

With last week’s RBA Interest Rate Decision giving few additional clues as to why the Bank’s Board held rates steady again in April, we anticipate strong focus on the April Minutes next week. The March Minutes gave a number of hurdles for a further cut in interest rates, namely:

• Allowing some time for the economy and interest rate structure to adjust to the February move; and
• Confirmation (from the data) that the economy was indeed on the new (sub-trend) forecast track predicted in February, and upon which the February rate cut was predicated.

These caveats suggested that it was unlikely that the Bank would reduce rates at either its March or April meeting and while the Bank maintained its easing bias, these hurdles likely remain in force. We will look for further guidance from the April Minutes and while we retain a forecast of a further cut at the May meeting as our central case, if the data were to improve, the risk of a later cut would rise. In any case, we remain of the view that the market is overly eager in pricing an official cash rate of around 1.75% by the end of the year.

Next week also sees the publication of the Q1 CPI, which somewhat unusually is not quite as important for monetary policy expectations as normal given the broad expectation that Australian inflation remains very well contained at the present time by low wages growth and falling petrol prices, even though the $A has fallen. NAB forecasts are for a flat headline CPI and an underlying rate of 0.3%/0.4% q/q. The headline rate is not quite as low as originally expected since petrol prices retraced a significant amount of the initial decline from around $1.45 a litre to $1 a litre and spent much of the quarter at around $1.35 a litre. More recently, prices have again fallen to around $1.23-$1.25 a litre, suggesting a further beneficial impact on the headline CPI next quarter. However, your author’s shopping trolley is beginning to notice some increased prices for imported items along with anecdotes to the same from importing companies, so these forces will likely be in play over the next few quarters in the CPI.

Market themes

The biggest challenge in markets remains trying to ascertain when the Fed will begin lifting interest rates and when it does, how fast will rates increase and how will other market react. Our team has recently pushed back the expected timing of the first Fed rate rise to September and now expects only two rate increases by the end of 2015. Recent Fed speakers have reiterated that the Fed remains “data dependant” meaning non-farm payrolls reports remain extremely important for US interest rate pricing. Furthermore, Fed speakers have been at pains to stress that tightening will be gradual, likely reflecting a desire to limit the potential for either destabilising impacts on the bond or equity markets but also to seek to avoid a potential further sharp rise in the US$.

NAB retains the following broad market outlooks:

• The US$ to continue to benefit moderately from the stronger US economy and expectations of the Fed beginning to raise interest rates in the June to September timeframe;
• The $A/US$ exchange to remain under further moderate downward pressure as the US$ increases further, though much of the adjustment may have already occurred in the near term;
• Australian short term interest rate markets are more vulnerable to stronger data this week than weaker data, given market pricing. It remains NAB’s forecast that assuming the RBA does deliver a further interest rate cut in the next month or two, that the Bank will then keep rates on hold for an extended period. Term yields are expected to be under moderate upward pressure over the medium term from higher US yields.

For further analysis, download the full report:

• Australian Markets Weekly:  Record employment and the NAB survey (PDF, 235KB)

For further FX, Interest rate and Commodities information visit nab.com.au/nabfinancialmarkets

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