Better than it looked

Today’s Australian Employment report for January 2019 was good — but it was actually better than it looked. The reason is the sample rotation actually biased the results down. The incoming group was a weak group (Low employment and high unemployment) and the outgoing group was a strong one (high employment and Low unemployment).

Despite this we had strong jobs growth, strong full time jobs gains, an increase in the employment to population ratio and a decline of the underemployment rate.

Here’s what the ABS had to say about the matter:

In original terms, the incoming rotation group in January 2019 had a lower employment to population ratio (63.6% in December, down to 61.0% in January 2019) than the group it replaced, and was lower than the ratio for the entire sample (61.7%).

The full-time employment to population ratio of the incoming rotation group was lower than the group it replaced (43.6% in December, down to 42.6% in January 2019), and was lower than the ratio for the entire sample (42.8%).

The unemployment rate of the incoming rotation group was 1.0 pts higher than the whole sample (6.4%, compared to 5.4%), and it replaced a group with a lower rate (4.1%). Its participation rate was below that of the sample as a whole (65.2%, compared to 65.3%), and below the group it replaced (66.3% in December 2018).

Posted in AUD, economics, Labour Market | 1 Comment

The RBA’s neutral bias

The RBA went back to an explicitly neutral bias at their Feb’19 policy window — via an interesting bit of subtlety.

The central forecast remains for a gradual decline of the unemployment rate and a very modest acceleration of core inflation, but the weight on the downside risks were increased. Thus, the official line was nudged to become “the probabilities of these two sets of scenarios have shifted to be more evenly balanced than previously”. So the next move could be up or down …

The market focused on the removal of the “next move is up” language, and priced in more cuts … notwithstanding that the RBA’s *modal case* is for stable policy, a falling unemployment rate, and gently accelerating inflation.

So what changed? After all, inflation has been too low for years, and they haven’t seemed to care. They might have justified a cut at any time since 2016 by reference to inflation — but they didn’t.

What changed is growth. There’s less of it, so they are less sure that inflation will accelerate back to their 2.5% target.

The most obvious change was to the current assessment of Australian growth. Recent history was sharply changed by the annual benchmark revisions to the National Accounts that were released with the Q3’18 report. This publication revised away the H1’18 GDP boom, with the consequence that the economy was both operating with a bit more spare capacity and carrying a bit less momentum into 2019.

The second change was to the housing market assessment. The housing market hit the skids in Q4’18. Price declines worsened from ~50bps per month to ~100bps per month. Consistent with this, lending finance approvals cratered (lending to households for dwellings ex-refi was -20%y/y). The most optimistic thing that can be said is that the council of financial regulators are aware of the problem and are trying to do something about it.

The third change was slowing global growth — and in particular the softer Chinese economy. Trading partner growth was nudged down a little — but it was small. The RBA said so in the SOMP.

It’s worth noting that Australia’s real trading partner problem was the prior tightening of Chinese policy — this was hurting steel demand. Thus, policy loosening in the Chinese property space and increased infrastructure spending may ultimately help Australia via the terms of trade.

This last point is worth dwelling on a little. Australia’s macro fortunes are largely determined by movements in the terms of trade. The transmission from higher terms of trade to wages and inflation has been broken since 2008, because prior excesses in mining investment and fiscal policy were being worked off … but these prior excesses have now been worked off. Mining investment has probably bottomed out, and recently high Iron Ore and Coal prices mean that we’re likely to see a budget surplus in the 2018/19 financial year. The budget assumption for Iron Ore is USD55, so the present 160% premium over the assumption will be very helpful.

Of course, none of this will matter if house prices continue to fall by 1%m/m — but the RBA won’t react to this until they see the consequences in consumption. That’ll take time.

Before that happens, we’re likely to see PM Morrison boost the size of income tax cuts when the 2019/20 budget is handed down on 2 April budget … and mining investment might even respond to the signal from higher spot prices!

Posted in AUD, economics, monetary policy, RBA | 10 Comments

Aussie GDP boom revised away

The annual revisions to GDP, and a weak 0.3%qoq in Q3 , mean that the GDP boom of H1’18 has been revised away.  The chart below shows what we thought was true (the red line) v. the new information (black line).  The bottom line is that the economy wasn’t so bad in 2016, and hasn’t been so good in 2018.  We’re stuck at or around trend. 

The RBA wasn’t really planning to do much anyways, but it should have some impact on their forecasts.  GDP had been expected to be 3.5%y/y in Q3 … so we are looking at a 75bps downgrade when they next make their forecasts in Feb 2019. 

Posted in Uncategorized | Tagged , | 2 Comments

Another perspective on Aussie Jobs

The ABS handed us another puzzle yesterday — the September jobs report told us that employment growth wasn’t keeping up with population growth (you need about 15k jobs per month to keep up) but that the unemployment rate fell to a 6yr low of ~5%. 

So which is it? Is the labour market tight, or is it flaking out? 

Perhaps it’s both.  Perhaps the truth was that the participation rate was never really so high — so the true unemployment rate was a bit lower.  This makes some sense: GDP growth has been meaningfully above trend in H1’18, so we might have expected the unemployment rate to fall.  So what we are seeing is the unemployment rate catching down to the truth, as the participation rate settles down. 

Trend employment growth still looks okay, but my guess is that this is slowing down.  This is consistent with the soft headline jobs number (+5.6k). 

I’m cautious about interpreting the jobs numbers.  The survey isn’t designed to measure the number of people with jobs.  It is designed to measure the unemployment rate.  While we are talking about data-quality: the variation in the participation rate defies credibility.  Taken together, i think the employment-to-population ratio (above chart) is the best measure — as it doesn’t swing around with the participation estimates. 

On this measure, the labour market is fantastic. We have ~74% of working age people in jobs: a larger share of the working age population than even at the peak of the triple boom (financial, housing and mining) in 2008! 

The problem is that, like everywhere else, the link between the unemployment rate and inflation is broken (or at least, the NAIRU is lower).  This is the main message of RBA Depute Gov Debelle’s speech, The State of the Labour Market. 

Looking forward, my hunch is that it’s all slowing down a bit — as the housing downturn spreads out like molasses across the economy.   And global headwinds are picking up too — the IMF is nudging down global growth downgrades and our key trading partners are having trouble with the US tightening cycle. 

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The problem with Aussie Housing

The RBA just released their semi-annual Financial Stability Review (FSR).  Predictability, the FSR plays down the risks from the maturity of Interest Only (IO) loans — however I think they are over-confident. 

Let me explain. 

In the five years prior to the introduction of policy measures to slow IO lending, IO loans rose to be ~40% of the flow of new loans — and therefore ~40% of the stock.

While the largest part of these loans were made to people who could afford a traditional mortgage — and elected to make IO repayments for other reasons — my hunch is that a meaningful proportion of these loans were made to people who could not afford to repay the principal. You can get a sense for this from the spike in arrears that we see when an IO period expires. 

The thing to note about the above chart is that the observation period used to calculate mortgage performance is Mar’16 to Oct’17 — before the tightening of credit conditions that happened in 2018.  IO borrowers tend to experience stress when their IO period ends — which suggests that some proportion of IO borrowers are unable to afford a P&I repayment schedule.

The two main exits from this situation are refinancing back into a new IO loan, and selling the house.  My guess is that the exit is much tighter now: you have to pass one of the new, tighter, credit checks; or sell your house in a bear market.

Over the five years 2018-2022 ~600bn of these mortgages mature.  Given the timing of the IO mortgage boom, and the fact that most IO periods are 5yrs, I would think that most of these buyers got into expensive Sydney and Melbourne properties in the 2013-2018 boom.

Those who got in early have plenty of equity, so the house may be sold to repay the loan — but given falling house prices the 2016/17 vintages (maturing in 2021/22) won’t have that padding. If the house is sold to repay the loan, there may be a gap. 

The RBA says ‘no problem’, most people can afford higher repayments, and most are ahead.  That’s true, but beside the point.  These events are about the minority of people who can’t afford to repay.  So rather than focus on the right hand side of this chart (the 50% who are ahead), I think we should focus on the left-hand-side.  

Over 30% of households have no mortgage buffer at all, and over 50% have less than six month’s buffer. 

Unfortunately I don’t have the detailed data required to link how far ahead households are to the loan type — but a bit of common sense tell you that new mortgages are much less likely to have a buffer. 

So the main challenge facing the Australian housing market (and economy) is the 600bn of relatively young interest only mortgages that mature over the next few years.  These borrowers are more likely to struggle with the 40% increase repayments, are unlikely to have meaningful buffers, and (given the tightening in credit standards) may find it difficult to refinance into a new loan. 

Their only option will be to sell into an already depressed housing market. 

Let’s say 10% of these loans unfold in this way — that’s equivalent to ~1yr of supply for the housing market (as ~4% of houses turn over each year).  An increase in the supply of housing of that size is likely to weigh on prices in any case — and particularly so given that the new rules reduce average borrowing power. 

Posted in AUD, economics, Housing, RBA, Uncategorized | 4 Comments

Here comes the housing downturn?

It’s been ages since I blogged here — partly because the issues facing the Australian Economy haven’t changed much over the past year or so.   Inflation is stuck at a pace that is too low (at least relative to the RBA’s high-ish 2.5% target), and there isn’t much that the RBA is willing to do about it.  There is something new now — the housing market appears to be in the midst of a slow melt down, and the molasses is slowing the broader economy.

Don’t expect the RBA to do anything about this.  RBA Gov Lowe and Assistant Gov Kent are, after all, a founding members of the financial stability club — they wrote Property-price cycles and Monetary Policy together in 1998!

Those who think that the RBA is going to care much about a housing downturn ought to read this paper very carefully.  The point of the paper is that once you have a bubble a period of slow growth and low inflation is inevitable — and that the monetary authority would do better to bring it on sooner to limit the damage.

“Monetary policy can burst property-price bubbles. Under some circumstances, it may make sense to do so, even if it means that expected inflation is below the central bank’s target” (my emphasis).

So a period of slow growth and low inflation is the expected cost of cleaning up the mess. Put another way, the current period of low inflation is expected — and any future slowdown that’s due to a housing correction is to be ‘toughed out’.

What’s the point of all this suffering? They argue that it’s to avoid an even larger mess later.

“When the bubble bursts, losses are likely in the financial system and economic growth is likely to be below trend. But once a bubble has emerged, avoiding such an outcome will prove even more difficult. By bringing forward the collapse of the bubble, monetary policy can reduce the scale of the inevitable slowdown in economic activity. The main difficulties with such a policy are in identifying that a bubble does indeed exist and generating the necessary public acceptance of a period of tight monetary policy.”

Everyone knows that the Australian housing market has BIG problems.  The RBA knows that it’s (partly) to blame — though the Royal Commission’s interim report blames lax regulators most of all.  Monetary policy was too loose given regulatory settings.  And the RBA just acknowledged, in their October meeting statement, that “credit conditions are tighter than they have been for some time”.

Meriton Harry Triguboff, Australia’s largest builder of apartments, says he has stopped buying land.  With the builders no longer buying land, approvals are crashing — in raw terms, they down ~25% from the peak in Q4’17.  This is due to ‘private other’ (mostly apartment) approvals falling ~45% over that period; private House approvals are down a modest ~4%.  While part of the drama of these numbers is the unusual peak in Q4’17, even smoothed numbers are bad (I use 3mma in the below chart: they are All -13%, Apartments -25% and Houses -2%).

… and we haven’t even got to the reset of the ~600bn of dodgy interest only loans. That’s next year’s problem (with a hangover that will last until 2025).

Posted in AUD, Housing, monetary policy, RBA | 9 Comments

Das Lowe-flation

RBA Gov Lowe gave the ABE Dinner speech this year — a speech entitled ‘Some Evolving Questions’.  The speech looks at the transition away from the mining investment peak , the broken link between jobs, wages and inflation, and the risks arising from the high household debt to income ratio.

The title of the speech is a little dishonest.  There’s really only one question that’s evolving — Lowe has made his mind up about the mining bust (all done now) and seems to have made up his mind about the trade-off with regard to financial stability matters at least 15 years ago.   Debt to income is too high, and he’s not cutting unless it’s falling.

wages nab

So the only real question is why solid growth and a tighter labour markets has not translated into wage and price pressures.  The puzzle is summarised by the above chart — the NAB survey has detected labour shortages, and yet wages are languishing at all time lows of ~2% (and more like 1.5% if you take the Q3’17 number seriously).  Indeed, if you allow for the fact that workers are transitioning from higher paying sectors to lower paying sectors, Average Hourly Earnings are actually growing ~1% (chart below). wages

The discussion of the mining transition in this section is a red herring.  Australia isn’t exactly Robinson Crusoe.  Even in countries that are clearly below historical estimates of full employment, such as the US, Germany and Japan, there is nary a sign of wage pressure.  This isn’t about the mining bust or the transition to services.

So what is going on? Here’s my guess.  Technology has massively increased global labour supply, and Europe is exporting their deflation.

It’s hard to measure, but my sense is that lower shipping costs and better technology has made it easier to distribute and coordinate work across the globe.  This has increased the effective global supply of labour for any job, which is why there’s little wage inflation.  This story, i confess, is not yet fully well worked out (hence my lack of charts).

The retail question is more obvious.  A lack of organic growth opportunities in their home market — otherwise known as the depression in Europe — pushed European discount retailers to expand into new markets.

Attracted by the (previously) high margins in global retail, Aldi went into US retail,  UK retail and Australian retail.  These German retailers are private corporations and can ‘play the long game’ in these markets.  This means multi decade expansions, as they grow their market share to ~25% (depending on the market they are single digits to low teens just now).

This hasn’t even got going yet in Australia.  Aldi is still buying sites, and has barely opened in Perth and Adelaide.  They’ll be able to screw prices down even further once they get a bit more scale.  Their success will pull in other German discounters, and it’ll accelerate.  This story is playing out to some extent in other categories too (H&M, Uni Qlo etc).  This is why we’ve been seeing broad based retail deflation for a while now (below chart).


Amazon isn’t really a part of this story yet.  This is just old fashioned German efficiency … Amazon will make it all hurt a little more.

Lowe acknowledges this in his speech, noting that ‘this still has some way to go’ and that wages and inflation are only expected to pick up slowly.

For me the policy take-away is clear.  The RBA agrees that growth is much better, particularly the traditionally key labour market variables.  However, they have low confidence that more jobs will cause wages to accelerate and drive core inflation back to their 2.5% target over the medium term.  This means that they will be reactive to that pickup of wages and inflation — when they see it.

I find it hard to understand how folks can read this and still believe that Lowe will be raising rates preemptively, based strong growth and a forecast that wages will accelerate.

My guess remains that we’ll see the first hike in H2’19, but if wages remains subdued that’ll keep getting pushed back.

Posted in AUD, RBA, Uncategorized | 8 Comments

Slowest-ever wages

At first glance, the Q3’17 WPI print was a stable at 0.5%q/q (2.0%y/y) — however once you look at the details it is the lowest ever print for WPI.  The  QoQ non-seasonally adjusted print was 0.8%q/q, reflecting the fact that the minimum wage increase typically biases up the Q3 print.  Once you adjust for the bumper minimum wage hike, it looks like the broad wages pulse slowed to an all time low.

I know, this is a familiar story … but it should have been different this around.  The bumper minimum wage hike (3.3% from 1 July 2017; a full 100bps larger increment than 2016) meant we should have seen a larger increase in wages in Q3.  If everything else had just stayed the same, a print in the [0.6, 0.8] range (where 23/24 forecasters in a Bloomberg Poll were located) ought to have occurred.

The logic is simple — if the general level of wage pressure had been unchanged for the rest of the economy, a 100bps speed up of minimum wages ought to have boosted the QoQ pace of economy wide wage inflation by ~20bps, delivering a 0.7%q/q result.  That we ended up with another ~0.5%q/q suggests that the background level of wage pressure has actually eased in Q3, despite the declining unemployment and underemployment rates.  It challenges our most basic ideas about supply and demand!

I’m very sure this would have been a surprise to the RBA.  In their November SOMP they reported that liaison detected an acceleration of wage pressures in Q3, driven by the larger-than-usual minimum wage hike as well as an improvement in broad based private sector conditions.

On this basis, i think we can peg the RBA’s forecast at 0.7%q/q or o.8%q/q … which means that the RBA just missed on wages by 20bps to 30bps.   This means another delay to their forecast return to their inflation target.  The market is pricing the first full hike in Q1’19 at present … this seems at least a few quarters too early to me.

Most people would regard sustained 2.5%y/y cpi inflation with 2% wages growth as very unlikely. I certainly don’t think the RBA would be comfortable with the outlook for inflation so long as wages growth is below 2.5%.  To forecast core CPI of 2.5% with wages growth below that number would mean forecasting a series of negative productivity shocks … something i’ve never seen before!

Given the recent weakness in the housing market, the outlook for wages matter more than usually for inflation.  As you can see from the below chart, the last five years have been characterised by consumption growth that exceeded the pace of income growth.  I think this was encouraged by a housing wealth effect. This drove the savings rate down 500bps to ~5%.  With the housing boom over, consumption growth will slow toward income growth — and it’s hard to see 2.5% inflation if that happens.

Screen Shot 2017-11-19 at 3.40.58 pm

The only way out of this is wage inflation.  With the housing market under control, the RBA can afford to wait to see a few quarters of wage inflation before starting to tighten.

Posted in AUD, monetary policy, RBA | 10 Comments

No means no! (RBA edition)

Say you were the Governor of an inflation targeting central bank and wanted to communicate to the world that you were not about to raise rates — what would you do? How about forecast that inflation remains outside of your control range for your entire forecasting horizon.  That’s what the RBA did today.

tm inflat

As you can see from the above chart, the RBA’s central forecast for Trimmed Mean CPI (their preferred measure) is for it to remain below 2% until 2020.  Recall that their target is 2.5% inflation, with a 2% to 3% control range.  The inflation number tracks up about 25bps per year, so i would assume that the model tells them that inflation hits target sometime in 2022!

These forecasts assume market pricing for the cash rate, which means that the current pricing of a first hike in Q4’18 is assumed in the case case.   The only interpretation of this is that the RBA is telling the market — you’re wrong, we are not going to hike in 2018.  On these numbers it is doubtful that they’ll hike in 2019.

Despite the shibboleth about forecasts being ‘little changed’, the RBA cut their growth numbers today.  This is the tradition.  Like the horizon, 3% growth is always about the same distance away. I think that their growth numbers remain too high.  The Economy has been undershooting their growth numbers for a while now (we were supposed to be at 3% right now 1yr ago).

Recall that these changes are despite a lower AUD and a higher oil price.


Finally, the bank cleaned up their forecast table a little bit — in the process making it a little easier to integrate with their charts.  I think a 2% for core CPI is more transparent (than the 2% to 3% range) and easier to understand.

The message is clear — we’re not raising rates.  How could they, when their job is to make CPI 2.5% (while trying to keep it between 2% and 3%) and they don’t know when they’ll hit their target?

Posted in AUD, RBA, Uncategorized | 7 Comments

RBA is wrong on inflation (again)

Q3 CPI has printed, but it is the same old story — the RBA is wrong on inflation.   They are in good company.  Pretty much every central bank has chronically over-estimated inflation over the past few years.  If it were any other forecaster we’d be accustomed to adjusting down their estimates, but the market hasn’t been doing that to the RBA.  Instead there are hikes priced for 2018 despite the fact that the RBA doesn’t know when inflation will return to their 2.5% target. 

Screen Shot 2017-10-29 at 2.56.02 pm


As you can see from the above chart, the RBA does not currently predict Trimmed Mean CPI, the RBA’s preferred measure of CPI, to converge to their 2.5%y/y target at any time within their forecasting horizon.  Rolling their model forward, my best guess is that Trimmed Mean CPI was expected to hit 2.5% sometime in 2021 or 2022.

I say was because these fan-chart forecasts were made before the disappointing Q3 number. If you squint you’ll see that the RBA expected Trimmed Mean CPI of ~1.95%y/y in Q3. Instead they got 1.83%y/y.   We get new forecasts on 10 November.

This isn’t a massive miss, but it’s meaningful.  More important is the sequential deceleration of inflation: inflation slowed ~15bps from 52bps in Q2’17 to ~37bps in Q3.  The importance of this is that we cannot be sure that the cyclical lows for inflation pressure have been seen.  The annual pace of trimmed mean inflation has steady at ~1.8%y/y for three quarters now — and there are some deflationary headwinds coming in 2018.

The first is the re-weighting of the CPI basket.  The current series is based on spending patterns from 2010.  Over time spending patterns tend to move toward cheaper and more slowly inflating goods, so the current estimates of inflation are almost certainly over-estimates.  We cannot say by how much for sure, as we do not yet know the outcome of the 17th series.  What we do know, from Deputy Gov Debelle’s speech last week, is that the RBA have not adjusted their inflation forecasts to reflect the level shift down of inflation that that will occur when we move to the 17th series. 

The ABS will very shortly update the expenditure weights in the CPI. Because of substitution bias, history suggests that measured CPI inflation has been overstated by an average of ¼ percentage point in the period between expenditure share updates. While we are aware of this bias, we are not able to be precise about its magnitude until the new expenditure shares are published, because past re-weightings are not necessarily a good guide. It is also not straightforward to account for this in forecasts of inflation. (my emphasis)

Finally, Amazon Australia has yet to hit the data — which will set off a chain reaction that i think will subtract about 25bps per year from CPI for three to five years.  Sure, pre-emptive re-pricing might account for some of the food price deflation in Q3’17, but i think that is more about Coles fighting back against the European entrants (Aldi &c).

So the state of play with regard to Australian inflation is as follows:

1/ The RBA overestimated Q3 CPI by ~10bps in their August SOMP, and will downgrade slightly in their new forecasts — which are published 10 November;

2/ The RBA’s current inflation forecasts do not take into account the likely 25bps level decline of the estimated pace of inflation when we move to the 17th series; and

3/ The entry of Amazon into the Australian market (and competition from European entrants) is likely to lead to sustained downward pressure on retail prices over the next few years.  My best guess is that this will shave 25bps to 50bps per year from CPI over the next three to five years.

So these are all reasons why the RBA will have to keep downgrading core CPI over the next year or two.

When will we see 2.5%y/y (core) inflation? My guess is some time in the mid 2020s.

The market continues to flirt with a rate hike in 2018.  I very much doubt it.   I think that’s about a year too early.

Once the unemployment rate dips below 5% and trimmed mean CPI is sustainably above 2% the RBA might start nudging rates up … but we’re a long way away from that just yet!

Posted in Uncategorized | 4 Comments