Lowe locks June … looks awkward

RBA Gov Lowe delivered a speech that was widely interpreted as locking in a 25bps rate cut in June. The market now has a ~90% chance of a 25bps cut priced in for the June meeting — with a follow up 25bps reduction of the cash rate priced at a probability of ~60%.

The awkward thing about this is that there’s almost nothing in the speech that was new. The heart of Lowe’s case for lower rates is that the NAIRU is lower than they’d thought before … but that’s old news. Lowe said in November that the NAIRU was more like 4.5%, and he told Parliament that again in February.

Perhaps it’s even lower now? Possible, but these things move slowly — and in any case Lowe poured scorn on the idea that these things can be precisely estimated when he spoke to Parliament in February.

So the lower NAIRU isn’t new — and it’s unlikely that the RBA’s NAIRU estimate moved by much. Moreover, it’s been clear for some time that multi-decade lows of the unemployment rate weren’t getting the job done (in terms of inflation targets) anywhere else in the world — so the global picture Lowe painted in the first part of the speech isn’t new either.

So what changed?

Looking over the speech, deduction leads me to conclude that the RBA gave up on the idea that the unemployment rate might fall all by itself. Recall that the RBA had the upside risk “Labour market conditions could improve by more than expected” in the Economic Outlook Chapter of the May SOMP.

Lowe trashed this risk in the 3rd last paragraph of the speech:

The labour market has surprised on the upside over recent times, and it could do so again. While we can’t rule out this possibility, the recent flow of data makes it seem less likely.

So the RBA is now reasonably sure that the unemployment rate isn’t going to continue to decline all by itself — and if it’s not going down, the RBA will cut rates to try and push it down. How much? well the May SOMP forecasts assumed 50bps of cuts and they were still pretty rubbish … so the first 50bps is a lock.

In case you’re worried about easing on too many channels, Lowe endorsed a multi-pronged approach, saying that he favored the concurrent use of monetary, fiscal and structural policies to support investment and hiring.

And why not? The RBA has missed their inflation target for years and don’t currently expect to hit their target until some time (way) outside their forecast envelope.

Posted in AUD, economics, Labour Market, monetary policy, RBA | 5 Comments

RBA’s labour market (cut) test is met

The April employment report revealed a slackening of the labour market — and is probably enough to get a 25bps rate cut in June.

The headline unemployment rate rose ~14bps to 5.20%, with March revised up ~2bps to 5.065%. Don’t get distracted by the strong growth of headline employment (+28.4k) — the household survey is designed to measure the rate of unemployment, and that’s what it does best.

It’s tempting to blame sample rotation — as the incoming sample’s unemployment rate was 160bps higher than the sample it replaced — but i don’t think that’s right. The increase in the unemployment rate is actually larger if we exclude that new rotation group: the matched sample unemployment rate rose 18bps to 4.93%, which is a larger move than the 14bps increase in the total unemployment rate.

The underemployment rate data confirms the softening. This measure increased 30bps to 8.5% on the month (prime age was +30bps to 8.7%).

The details are consistent with what you’d expect in a cyclical downturn. Men tend to work in more cyclical industries, so in downturns you tend to see the male underemployment rates rise faster than female underemployment rates. That’s exactly what we are seeing: in April the prime male underemployment rate (15 to 64) rose 50bps to 7% and the female +10bps to 10.5%. The spread between the two has tightened ~100bps in the past six months (from ~450bps to ~350bps).

Combined with the weakness in the employment component of the April NAB business survey and the disappointing sideways profile of WPI, any fair minded person would conclude that the probability of inflation meeting the profile set out in the May SOMP last week has declined somewhat. The leading indicators are softer, and the transmission of labour market pressure to wage growth is less certain — so the downside risks to the inflation forecast are rising.

The inflation forecast was already too weak (and it was made assuming a rate cut in August and another in Feb’20), so I would expect the board to bring forward the rate cut to either June or July. Most likely June.

Posted in AUD, economics, Labour Market, monetary policy, RBA | 5 Comments

Two points on WPI

The Australian Q1’19 Wage Price index again printed at 0.5%q/q (2.3%y/y). This is the 11th print in the ~0.5%q/q ballpark since 2015 — which is to say that it’s been ~0.5%q/q about two thirds of the time over the past five years.

The theory has it that labour supply curve slope upwards at some point — so as the unemployment rate falls, wage inflation accelerates. That may well be true, but it hasn’t worked recently. The experience of other countries suggests that a much lower unemployment rate might be needed.

The chart below shows the relationship between the unemployment rate (qtr average) and WPI inflation (%yoy). The grey points at the bottom are the period 2015+; the red dot is today. As you can see there has been basically no relationship between the unemployment rate and inflation over the past five years.

There used to be a better relationship. It was fairly stable up until 2008, and then actually steepened in the immediate post GFC period.

Or perhaps that was just wages collapsing due to the forces that are still keeping them down? It’s hard to say for sure.

Whatever the truth is, it’s not looking good for the RBA’s WPI forecast. They have 2.4%y/y for Q2’19, and given the low Q1 print they’ll need a ~0.7%q/q in Q2’19 to hit their prior forecast. We haven’t had a 0.7%q/q print since 2014!

I reckon we’ll get another ~0.5%qoq, which will make Q2’19 WPI ~2.2%yoy. So there’s another core CPI downgrade lurking for the RBA’s August SOMP.

Posted in AUD, economics, Labour Market | 4 Comments

There goes the employment bull-case

I must admit to being a bit stunned by the RBA’s May SOMP. There were a number of elements that strained credibility — but in particular i felt that the labour market sections were a stretch. But, as ever, the game is to predict what they will do, so here we are …

Their bull case appeared to fall apart today, with the NAB Employment index falling sharply to a below average level (-1 sigma to -0.5 sigma).

In the SOMP the RBA wrote that “business employment intentions remain above average according to the NAB quarterly survey and the Bank’s liaison program”. That evaporated today. , with the April NAB business surveys falling 7.4pts to -1.2.

This means that there is no longer an interesting divergence between job advertisements and the NAB survey. The RBA leaned on this divergence heavily in the SOMP, when they noted that “there continues to be some divergence in these indicators; the decline in job advertisements points to a much weaker outcome for employment in the near term than the leading indicators from business surveys”.

Presumably this also means that they will also strike out the upside risk that the labour market is stronger than they anticipated.

So regardless of the outcome of the April employment report on Thursday, we just got some important, and certainly challenging, information about the labour market.

Posted in AUD, economics, Labour Market, monetary policy, RBA | 3 Comments

Terry explains RBA’s May statement

RBA Shadow Gov. Terry McCrann has published (what looks to be) a backgrounded story explaining the RBA’s post meeting statement.

Good. Thanks Terry / RBA; we need it.

Terry explains that: “The RBA will cut its official interest rate if the jobless rate does not fall; and it will need to start falling pretty quickly or at least show clear signs that it will fall.“

That’s confusing, as the RBA told us today that the “unemployment rate has been broadly steady at around 5 per cent over this time and is expected to remain around this level over the next year or so, before declining a little to 4¾ per cent in 2021.”

So the RBA has told Terry that if the unemployment rate is stable over the next few months, they’ll cut the cash rate.  I suppose that this is the ordinary meaning of the RBA’s comment that “there was still spare capacity in the economy and that a further improvement in the labour market was likely to be needed for inflation to be consistent with the target”.

However, the RBA’s time line for improvement appears to be short, and their threshold so low it’s meaningless.

Terry writes that the only way we’re going to make it to August with a 1.5% cash rate is if the unemployment rate falls.

If we got to the August meeting and there’d been no rate cut, the inflation numbers and the new forecasts would not trigger one at the August meeting, because the jobless rate must have fallen below 5 per cent. And I do not mean just to 4.9 per cent on dodgy detail.”

And Terry adds that the RBA could cut as soon as June: “If we got a ‘bad’ number — say, the jobless rate kicking up to 5.2 per cent or more or full-time employment falling statistically significantly, we would get a rate cut at the June meeting.”

How you can claim there’s any signal for a 5.2% unemployment rate in June I don’t know.  The unemployment rate was 5.048% in April, the 95% confidence interval on the unemployment rate is ~40bps, and the average move has been ~10bps (up or down) each month for the last two years. So you couldn’t say for sure that the unemployment rate was meaningfully different from 5% just because it printed at 5.2% in April.

Anyhow, a stable unemployment rate, at 5%, is exactly what the RBA forecast. So it follows, from Terry’s claim that the RBA will cut before August if the unemployment rate does not fall, that the RBA expect to cut the cash rate in either June or July.

Thinking about the 7 May meeting, that means the RBA held their policy rate stable, despite producing forecasts that justify a rate cut – and that the RBA intend to deliver a rate cut if those forecasts are met.

Confused? Me too. 

I know what you’re thinking – perhaps politics played a part? In case you’re worried that politics infected the decision, Terry explained:  

“If the RBA — that’s governor, his executive team and his board, which is not just a formalising rubber stamp — had believed an immediate cut, even just 12 days out from the election, was necessary, they would have cut”.

So that’s that then.  The RBA left the cash rate on hold today, despite it not being justified by their forecasts, because they wanted to give the data a sporting chance to beat the economists.

Posted in AUD, RBA | 3 Comments

RBA holds; bring on Lowe-flation

Against my expectations, the RBA left their policy rate at 1.5% today. 

My main lesson from all this is that Gov Lowe doesn’t care much for his 2.5% inflation target. How else can we interpret leaving policy on hold with inflation below target and the unemployment rate going sideways above the NAIRU – at the same time as they acknowledge that a lower unemployment rate is needed to hit their inflation target?

The only other interpretation is that the politics of the situation got to them.

The decision was clearly a surprise to me – but the set of forecasts that accompany the decision are more-so.  They also happen to align with the budget forecasts delivered by the Australian Treasury in early April.  This is probably no coincidence; and is surely a lesson for me.

The prior weakness in housing and consumption has had most forecasters marking down their growth numbers — but I suppose that’s a problem for the RBA’s August meeting.  The RBA trimmed only 25bps from their Dec’19 GDP forecast (to 2.75%) and left their Dec’20 GDP forecast unchanged at 2.75%.  They’ll be lucky if growth is so strong. Today’s 10bps decline of real retail spending for Q1 (the third weak print in a row) suggests that the forces depressing H2’18 have carried over to H1’19.

With growth expected to hold around trend (and leaning heavily on the still-robust ABS Vacancy measure) the RBA expects the unemployment rate to remain ~5%.  It seems like they have pushed the dip below 5% back to 2021 (Q4’20 was 4.75% in the Feb SOMP), but you can’t be 100% sure from the words in the short statement.

They also appear to have downgraded the NAIRU, acknowledging that there remains slack in the economy and that a 5% unemployment rate isn’t going to get inflation back up to their 2.5% target.

With growth at trend and the unemployment rate going sideways above the NAIRU, I don’t see why inflation is forecast to pick up – but they reckon it will. The RBA expect core inflation to be ~1.75% in Q4’19 (down from 2%) and 2% in 2020 (down from 2.25% in the Feb SOMP table … but actually it was more like 2.125% in the fan-chart). We’re trapped in Lowe-flation: CPI is never going back to 2.5%

The final paragraph says that the board will be “paying close attention to developments in the labour market at its upcoming meetings”, which seems designed to make every meeting live. Still, non-SOMP moves are unusual, and the measurement errors on the household labour force survey are HUGE — so if I had these forecasts I’d really want to see the quarter-average unemployment rate trend up to be sure that something’s going on.

The tragedy of this is that if the RBA waits too long to cut the cash rate, the trouble in the housing market will make rate cuts totally ineffective. Missing the chance to cut with a positive message (we cut because we want faster growth, and low inflation means we can have it) increases the risk that the RBA will be (even further) behind the curve when they do get around to easing.

This increases the possibility of an ultra-low cash rate and quantitative easing down the track. In my view, that’s bad risk management.

Posted in AUD, CPI, economics, Labour Market, monetary policy, RBA | 3 Comments

Financial Stability and Mortgage dynamics

My argument for a May rate cut by the RBA basically boils down to the observation that inflation is very low and that there’s no financial stability reason not to cut — plus the judgement that the very low pace of inflation means that the prior test requiring the unemployment rate to rise is no longer needs to be met.

Looking at the ANZ H1’19 results pack suggests that there may even be a financial stability argument for lowering the RBA’s policy rate. The chart below shows the sharp increase in home loan delinquencies across the ANZ loan book over the past few months — and in particular over Q1’19. I think this is strong confirming evidence of a softer household / consumption sector.

Source: ANZ

This is no longer just a WA-story. The chart below shows the breakdown of late loans (90+ days past due) by state. Note the sharp increase in sour loans in NSW & ACT. Something’s going on Mr Jones.

Source: ANZ

Much of the trouble with repayments seems to be with the older loans. The 2yr seasoned 2017 vintage loans, for example, have lower delinquency rates than the 2015 and 2016 vintage did at the same time — though all are souring.

The pressure on loan quality from the expiry of interest only terms is likely to intensify — and this should keep up downward pressure on consumption. The ANZ forecasts about the same level of IO-to-PnI switching (for contract reasons) over the next two years. The issue with this is that about 30% of these households have LVRs greater than 80% — which means they’ll find it very hard to refinance into better / more suitable deals.

Source: ANZ

Given that house prices continue to decline, it follows that the proportion of loans with low equity will continue to increase (few people pay enough per month to keep up with the current pace of declines). At present, the share of the ANZ’s loan book that’s in negative equity has been stable at 5% for some time — but note that the orange bars for less than 80% LVRs are getting smaller, and that the 80%+ bars are getting larger. The mark-to-market from falling house prices is hurting.

Source: ANZ

This is a potential financial stability issue. The RBA can do something to limit these brewing risks. A lower cash rate would reduce monthly repayments and therefore mortgage delinquencies. It would also slow the decline of house prices, which increase the proportion of those trapped in mortgage arrangements they cannot afford to refi away. Selling into a weak market is bad for everyone.

Posted in AUD, Banks, Housing, monetary policy, RBA, Uncategorized | 6 Comments

Inflation and Monetary Policy — redux

My call that the RBA would cut rates in May was originally a little speculative — but following the Q1’19 inflation data, and weak credit data, I now think that it’s very solidly grounded in vanilla macro.

First of all, the very low inflation print cannot be dismissed as a once off. If you take the two-quarter average (as i have done in the above chart), trimmed mean CPI is at an all time low of 0.37%q/q. Given that growth is (at best) around trend, and that the unemployment rate has been stable at ~5% for two quarters, there is no reason to expect inflation to accelerate. Due to measurement issues, inflation is always overstated, so CPI at this level probably means that prices are flat — or perhaps falling a little.

So the question is, assuming current policy settings, can the RBA produce a compelling case that inflation will return to target in a policy relevant time period? I don’t think that they can do so — so the policy rate must fall.

Sure, inflation has been too low for some time, but for most of Gov Lowe’s term, there’s been a trade off between the inflation target and financial stability. This was laid out in Gov Lowe’s landmark speech, Inflation and Monetary Policy, on 18 October 2016. In that speech Gov Lowe emphasised the ‘third pillar’ of the RBA Act, ‘the economic prosperity and welfare of the people of Australia’. The point he made was that rushing the return to 2.5% inflation could have deleterious consequences for the state of household balance sheets.

Over recent times, we have considered the impact of our decisions not only on the future path of inflation, but also on the health of the balance sheets in the economy. Achieving the quickest return of inflation back to 2½ per cent would be unlikely to be in the public interest if it came at the cost of a weakening of balance sheets and an unsustainable build-up of leverage in response to historically low interest rates. 

Gov Lowe, Inflation and Monetary Policy, Oct 2016

Does anyone think that’s still a barrier to rate cuts? The chart below shows the total value of new finance agreements (to households and firms, 3mma). As you can see, this has fallen sharply of late, and is now at the lowest level in 5 years (since 2014). If you adjust for the larger population / size of the economy this looks even weaker.

ABS 5601, table 1

The RBA were already considering lower rates following a string of weak growth data — but were reluctant to cut until the famously noisy GDP data was confirmed by rising unemployment. Some argue that the RBA needs to see rising unemployment to cut — but i don’t think that test is relevant any longer.

The low CPI print totally changed the debate. Inflation is too low and the RBA needs above trend growth and a falling unemployment rate to make a case that inflation will accelerate. They don’t have a plausible story about a return to on-target inflation just now. On current policy settings, and assuming a healthy dose of optimism, I can’t see a plausible above trend GDP forecast until mid 2020 — which means inflation doesn’t get back above 2% until 2021.

When will it get back to 2.5%? Who knows. On current form you’d have to guess it’ll be after Gov Lowe’s term ends. Cutting the cash rate is the only way Lowe can have a chance of hitting his inflation target during his term. With a bit of bad luck he might even average something with a 1-handle.

A final point about politics: I don’t think the RBA will be constrained by the 18 May election. I doubt they will even discuss it. Therefore i find it curious that so many are calling a June or July cut. Such a move would look political itself. It would have to be very carefully managed.

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

Q1’19 CPI makes strong case for 7 May RBA cut

The slow pace of inflation in Q1 makes a very strong case for a 25 bps reduction of the RBA’s policy rate on 7 May, to 1.25%.

The key trimmed mean inflation measure increased 28bps to be 1.6% higher over the year. This is a 24bps deceleration from the Q4’18 print of 1.84% (it has since been revised down to 1.82%).  Nor is the weak inflation pulse some figment of the trim’s construction. The weighted median measure increased by just under 10bps to be 1.24%yoy.

This took the average of the RBA’s two Core measures of inflation up ~19bps on the quarter to by ~1.42%yoy.  This is being held up by the higher prior prints.  The 2qma is a good balance between signal and noise, and on this basis core inflation was ~1.2%yoy.  Both the two-core qoq and the 2qma are below the low inflation prints of early 2016 (of 20bps and 1.26%).  These low prints led RBA Gov Stevens to cut the cash rate, despite a falling unemployment rate.

So coming into the May meeting, the facts are that domestic growth disappointed, inflation disappointed, global growth slowed, and the labour market cooled a little. There is some disagreement between the different data sets, but the story is substantially completed by CPI.

We learn a lot about the balance between supply and demand from the CPI release, and the message from the details of today’s report is that the output gap is widening — in line with the slow GDP data. This makes sense: the origin of the weakness is housing, and falling house prices are slowing consumption — so we should expect CPI to be weak.

That is exactly what we see — sequential slowing of CPI over the prior year.

The fact is that the current data means the RBA cannot present a credible case for a return of inflation to their 2.5% target within Gov Lowe’s term — with current monetary policy settings. So monetary policy must be eased.

The only reason i can think of to leave monetary policy unchanged at 1.5% would be to avoid the federal election–but that is a political act in itself.

The lack of progress toward the inflation target justifies a rate cut, notwithstanding mixed signals on growth. The least political thing the RBA can do is to follow their forecasting/policy process and deliver one.

I think the economic case for a 25bps cut is a slam dunk — because the economy can run hotter, and should be allowed to do so.

Posted in AUD, CPI, economics, monetary policy, RBA, Uncategorized | 6 Comments

Q1’19 CPI, the RBA and May

The case for the RBA to cut their cash rate at their 7 May meeting has been beaten up by the RBA’s own views on the GDP data, but I still think that the data makes a decent case for an easing.

The rosiest possible assessment of the data is that growth has slowed to trend. Indeed, that’s the position i think Deputy Gov Debelle took in his speech, The State of the Economy.

Trend growth isn’t going to get the job done, as you need above trend growth to push down the unemployment rate and drive up wages and inflation over time.

So ultimately, the question is: does RBA Gov Lowe care about hitting his 2.5% inflation target? The chunky GDP downgrade that has to be put into the May SOMP means that the inflation forecast must come down a little over the projections (they linked the slower growth profile with a lower core CPI track in their Feb SOMP, so this part of their inflation model still works).

A weaker starting point would be inconvenient.

The last seven trimmed mean CPI prints have all rounded to 1.8%y/y. I think that’s very unlikely to remain true after today’s CPI print. The 0.6%q/q Q1’18 trimmed mean print will drop out of the base today, and I expect that it’ll be replaced with 0.4%q/q print (0.4%q/q is the average for H2’18). The RBA are expecting a high 0.4x%q/q print (rounding up to 0.5%q/q) which would take deliver ~1.75%

A 0.4%q/q result for trimmed mean CPI will take through-the-year core CPI down ~20bps, to ~1.67%y/y (from 1.84%y/y). That’s uncomfortable, but perhaps they’ll tough it out.

A 0.3%q/q trimmed mean CPI result would be a BIG problem for the RBA — as both inflation and growth will have clearly decelerated over the past year. Based on these starting points, I just don’t see how Gov Lowe could present his board with a credible case that inflation is going back to 2.5% in a relevant period with that starting point.

The RBA’s main job is to make headline inflation average 2.5% over time. The prior two RBA governors have hit their 2.5% target exactly. Given that today is likely to produce a 0 print for headline CPI (headline CPI will slow ~50bps to 1.3%y/y), Gov Lowe seems to have little hope of doing so in his current 7 year term.

Gov Lowe’s contribution to Australian Monetary policy has been the emphasis of financial stability — but with house prices continuing to fall, i don’t see how that’s a barrier to cutting the cash rate.

Posted in AUD, CPI, economics, monetary policy, RBA | Tagged | 4 Comments