IMF downgrades, RBA to follow

The IMF today downgraded global growth 20bps to 3.3%yoy (lowest since GFC), and said that the risks are skewed to the downside.

Among Australia’s key trading partners, Chinese growth was bumped up 10bps to 6.3%yoy; Japanese growth -10bps to 1%yyo; and Indian growth -20bps to 7.3%yoy.

All told, I expect that this global growth downgrade will increase the pressure on the RBA to cut rates — a pressure which I think they’ll respond to at their 7 May meeting. They responded to the IMF’s downgrade in Jan by ditching their tightening bias — so they have form in this area.

We’ll get the next clue about this in the Deputy Gov Debelle speech, The State of the Economy, at the American Chamber of Commerce in Australia (AmCham) with Adelaide Business School event, at 1.40pm on 10 April.

I still think a rate cut at their 7 May meeting is likely.

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

What’s the State of the Economy?

The RBA made a subtle change to their concluding paragraph of their April post-meeting statement last week. Given that they had used the same words for the prior thirteen statements, and that the change occurred alongside downgrades to domestic and global growth, I thought the change material — but reasonable people can disagree, so the RBA needs to do some explaining.

It seems like Deputy Gov Debelle will be doing that explaining in his 10 April Speech, The State of the Economy.

So what is the state of the economy?

Growth is slowing, inflation is stuck ~1.75% (below the 2.5% target and outside their control range), house prices are falling, and the fiscal impulse from the federal budget is a little smaller than most hoped (though we may see more during the campaign). Most forecasters are still downgrading the global growth outlook, and the IMF seems sure to do so again when they publish the updated WEO on 10 April.

According to the AFR, the IMF are also going to downgrade their Australian assessment. The AFR story also notes that the property downturn has been larger and earlier than expected, and that the case for a rate cut is developing. Dr
Thomas Helbling, the IMF’s lead economist for Australia, noted the slowdown would reduce inflation pressures and make the case for a cut.

“maybe the inflation trajectory, the projection, shifts down a bit; labour market conditions are a bit weaker, and then by the very logic of the flexible inflation targeting regime, I would expect they would ease … If there are material changes to inflation trajectory and, or – and typically it will be both, there will be an ‘and’, to the employment picture, I think they will.”

When Deputy Gov Debelle speaks on Wednesday 10 April, I would expect to hear much the same. The local and global economy have both slowed. Inflation pressures have declined a little, and there’s scope to ease without upsetting their financial stability mandate. In any case, the labour market seems far from delivering the 3.5% wage growth that’s consistent with hitting their inflation mandate.

As a side note, last week’s Federal Budget (see the notes to table 1 on page 2-5) assumes spot for AUDUSD (~71c) and uses market pricing for rates — so in a sense, the Australian Government has already assumed (and spent) the rate cuts.

The forecasts for the domestic economy are based on several technical assumptions. The exchange rate is assumed to remain around its recent average level — a trade-weighted index of around 61 and a US$ exchange rate of around 71 US cents. Interest rates are assumed to move broadly in line with market expectations.

The growth (and wages) numbers in the budget look too high to me, so it seems unlikely that recently higher Iron Ore prices will fund further tax cuts.

Posted in AUD, economics, monetary policy, RBA | 1 Comment

RBA sets up for May

The RBA today set up for a rate cut on 7 May.

After thirteen months in a row where they cut and paste the following words:

the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.

they changed to:

the Board judged that it was appropriate to hold the stance of policy unchanged at this meeting. The Board will continue to monitor developments and set monetary policy to support sustainable growth in the economy and achieve the inflation target over time.

See the difference?

For the last thirteen meetings, they have said that policy is sufficient to hit their targets. Now policy will be set to make sure their targets are hit.

That’s a meaningful change. It is relevant that it occurred at the same time as they cut their domestic and global growth forecasts.

It isn’t a lock just now — more weak data is required to complete the case — but the option will certainly be discussed at the May meeting.

Forget the unemployment rate test everyone is talking about — a 0.4% on trimmed mean CPI on 24 April will lock in a 25bps cut on 7 May.

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

The case for an April easing bias

The RBA board will discuss the disappointing Q4’18 GDP data for the first time at their 2 April board meeting. The size of the downgrade is so large, and the domestic and global data for Q1’19 has been so weak, that I think they’ll respond by making a further dovish step — potentially to an explicit easing bias.

The Q4’18 GDP data delivered a ~50bps miss on headline GDP, with particular weakness in dwelling investment, household consumption, and household income. These areas of weakness were partially offset by an unsustainable increase in public demand.

The weak H2’18, and poor start to Q1 (both locally and globally) should see the May SOMP growth forecast fall into the mid 1% region (helped by a negative base effect as the very strong Q1’18 drops out).

With growth so slow, it would be remarkable if the unemployment rate didn’t starting increasing. And a rising unemployment rate means there’s no reason to expect an accelerating rate of inflation.

The global picture has also soured. Since the RBA’s prior board meeting on 5 March, major forecasters have downgraded global growth. The OECD cut 2019 and 2020 on 6 March; and the IMF is widely understood to have already done so once again (they already downgraded in January). The RBA would have a clear idea about the IMF’s April WEO downgrade — though we have to wait until the IMF release when the release the analytical chapters of the WEO on 9 April.

Anyhow, these are just words: the facts call for some empirical judgement about the importance of the recent global growth downgrade. I don’t have time to build an Aussie / Global model, but I did notice a nice chart in the Norges Bank’s March MPR that i have included below. This chart shows the contribution of various factors to changes in the Norges Bank’s policy rate forecast: between the 4th MPR of 2018 (13 Dec) and their 1st of 2019 (21 March).

The global growth downgrade has shaved off ~20bps (10bps in the near term, and 20bps further out). That’s a meaningful step.

It might not seem like much, but it was enough for the RBNZ. Last week Gov Orr said that “the more likely direction of our next OCR move is down”, due to a weaker global growth outlook (partly a weaker Australia) and slower domestic growth in H2’18 (note that Q4 NZ GDP was a decent +0.6%q/q v. Australia’s weak Q4 GDP of +0.2%q/q).

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Underwater mortgages

The fact that Australian house prices are now back to 2016 levels (or below in some areas) means that there is a rising number of property transactions where the purchase price is now above the current valuation (or more importantly, the likely sale price).

This is feeding through into the RBMS sector, with a rising share of the mortgage pools that back recent issues now having very high LVRs.

The chart below is taken from some great work done by Coolabah Capital CIO Chris Joye. He and his team have re-valuated houses in RMBS pools and, after accounting for amortisation, find that the proportion of high LVR (> 90%) mortgages underlying recent RMBS issues has increased by 3x to 4x. Of the twenty RMBS they analyse, twelve of them now have a 90% LVR mortgage share in the teens — up from only one at the time of issue.

Of course, this is only a problem if folks stop repaying. However, that’s very likely for some. Regular (if tragic) life events such as loss of employment, sickness, or death, mean some people will always be unable to repay — and will have to sell to exit.

A high LVR and a soft property market, increases the probability of a loss being made at the point of exit.

So the equity protecting owners of RMBS is shrinking. Also, the softer housing market and economy means that pre-payment rates are slowing. So the RMBS are getting riskier.

If property prices keep falling ~1% per month, the share of mortgages with LVRs greater than 100% will continue rising. Sydney seems to be most at risk just now. The draw-down from the top is ~15% for Houses; Sydney Units are down ~11%, however looming supply (and problems with settlement valuations coming in below contract prices) make another 10% down seem entirely plausible.

Coming back to RBMS, Chris notes that there is already one (recent) issue where over 10% of the mortgages are underwater.

Unless something is done to ease credit conditions, all of these RBMS will have meaningful proportions of the mortgage pool with LVRs that exceed 100%. Given the way that ASIC’s Shipton is talking, I would think that the only easing that’s possible in the near term will have to come from the RBA.

Posted in AUD, economics, Housing | 5 Comments

The right way to think about Job Vacancies

My read of recent RBA communication, particularly RBA Ellis’s speech on the household sector earlier this week, is that the Bank is worried about a consumption slowdown that bleeds into the rest of the economy.

It is therefore through that lens that today’s ABS job vacancies report should be viewed. For while aggregate job vacancy growth has been decent, the split between the consumption sectors (retail, wholesale, accommodation and food services & rental / real estate) and the non-consumption sectors shows the problem.

Job vacancies in the consumption sector are down ~5% yoy, with the down-trend pretty clearly in place. To my eye this matches the housing slowdown pretty well (though the RBA has been resisting that commonsense conclusion).

Job vacancies in the rest of the sectors are growing very strongly (+14%y/y).

The RBA’s worry is that consumption slows and that slower consumption causes the unemployment rate to rise, and further weighs on the inflation outlook. The vacancy data suggests that worry is well founded.

Here’s Ellis from Tuesday’s speech:

“Household consumption spending is a large part of economic activity. A significant retrenchment there would lower growth and feed back into a weaker labour market, as well as into decisions to purchase housing.”

Posted in AUD, economics, RBA | 5 Comments

The RBA’s Consumption trigger

RBA Assistant Gov (Economic) Luci Ellis this morning gave a very careful speech on the household sector. In particular, it goes into some detail about why household income in the national accounts has looked so weak despite a firm labour market — but what’s really notable about the speech is that it seemed to add a consumption trigger for rate cuts.

“Household consumption spending is a large part of economic activity. A significant retrenchment there would lower growth and feed back into a weaker labour market, as well as into decisions to purchase housing.”

This means the RBA could cut rates if they become convinced that there’s a significant retrenchment of consumption underway.

This is highly relevant, as the RBA gets both the Feb and March / Q1 retail trade reports before the May RBA decision. The Feb report is 3 April and the March (+ Q1) report is Tuesday 7 May — a few hours before the RBA’s May announcement.

If we assume that Feb & March nominal retail sales is ~20bps MoM (which is better than the present trend of ~10bps per month), nominal retail sales growth in Q1 will be about +20bps QoQ.

Assuming quarterly retail inflation is flat (the lowest over the prior year is +10bps), this would deliver real retail sales of +20bps qoq. The risks around this number are to the downside. The survey data suggests an ongoing deterioration of of retail conditions. The NAB business survey for Feb shows that conditions in retail sales continued to soften in Feb (chart below; Jan was -11pts; the Q3 average was -5pts).

I would imagine that the RBA is hearing similar things from their business liaison program. Perhaps this is the meaning of RBA Ellis’s comment that they are closely watching consumption. If the hard data follows business sentiment, the RBA would become fairly certain about a rising unemployment rate over time. The RBA could react to their higher unemployment rate forecast and cut rates in response.

Ellis concludes that:

“… demand for housing rests on the household sector’s confidence and capacity to take on the financial commitments involved in the purchase or rental of a home. Without enough income, and so without a strong labour market, that confidence and capacity would be in doubt. This is not the only reason we are watching labour market developments closely. But the nexus between labour markets, households and housing are crucial to our assessment of the broader outlook.”

This is the common-sense point that weakness in the retail sector would make the housing adjustment more difficult.

By the way, this much is true about any source of weakness — the downside risks to the Australian economy from slower global growth are amplified by the currently fragile state of the housing market. A global shock that pushed up the unemployment rate would increase the length and severity of the housing correction — and thereby increase financial stability risks.

Posted in AUD, economics, Labour Market, RBA | 8 Comments

Don’t give up on a May RBA cut

The decline of the unemployment rate to 4.9% in February caused the market to substantially reduce the implied probability of a rate cut in May. This is understandable, but i think it’s wrong.

GDP leads jobs by 2qtrs (or so)

What’s wrong with this is that the unemployment rate is a lagging indicator. Monetary policy works with a lag, so a central bank must be forward looking. Because growth leads employment, being forward looking basically boils down to responding to changes in the growth outlook.

The growth outlook has changed a lot since the February SOMP. Q4’18 GDP printed at ~2.3%, or about 50bps below the RBA’s Feb SOMP forecast. Assuming that Q1’19 is around the same as the average of Q3 and Q4 2018 (the partial data suggests that it’s worse) the pace of growth will slow to ~1.5%yoy in H1’19, or about 100bps below the RBA’s February forecast.

GDP tracking ~100bps below RBA

Given potential growth of ~2.75%y/y, GDP growth of ~1.5%y/y should deliver a ~50bps increase of the unemployment rate by the end of 2019.

With the unemployment rate rising, i don’t see how the staff could forecast an accelerating rate of inflation. Increasing slack is typically associated with a decelerating pace of inflation. At best it’ll be stable at ~1.75%

Given the size of the GDP slowdown (that is pretty much baked in by the base effects) the staff are very likely to forecast rising unemployment and slowing inflation.

The question is if Gov Lowe will be forward looking and will respond to the forecast downgrade — or if he needs to see a higher unemployment rate and a still-slower pace of inflation to act.

When he last spoke to Parliament, Gov Lowe said that he would be concerned about inflation spending too long below 2% as it might depress inflation expectations. In the month since he spoke, that is exactly what has happened.

Inflation expectations have collapsed. The market thinks that the RBA doesn’t care about low inflation — and as a result market based measures of inflation expectations have fallen by ~70bps since mid’18 & ~15bps since mid-Feb (here i’m using the RBA’s 10yr bond and indexed yield from the capital market yields tables).

I think the market’s wrong. I think that Gov Lowe does care about his inflation target and that he will respond to slower growth and plunging inflation expectations by lowering the cash rate.

The obvious time to do it is at their 7 May meeting — in response to a slower growth forecast, a higher unemployment rate forecast, and a lower inflation forecast in the SOMP.

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The RBA just gave notice

The minutes to the RBA’s March board meeting seem designed to put the market on notice for a rate cut — at any time.

The final paragraph repeated that they would “continue to assess the outlook carefully”, but they added a sentence saying that were holding “the cash rate steady while new information became available that could help resolve the current tensions in the domestic economic data.” (my emphasis). This is an incrementally dovish step from the February meeting.

It’s not surprising that they should be more dovish. The minutes downgraded just about everything: global growth, dwelling investment, consumption, the labour market, and it added a few new bits about tighter credit conditions (specifically about tightening to households via the increased HEM, introduction of DTI limits, comprehensive credit reporting, and tightening of underwriting standards for small business loans).

Among all these items, the thing they are giving the most careful attention to is the labour market. This is very important for Gov Lowe, as he needs a strong labour market to keep upward pressure on inflation — which has been below target and outside his control range for pretty much the whole time he’s been Governor.

So what are they watching? The monthly jobs report.

The minutes said that “further reduction in spare capacity underpinned the forecast of a gradual pick-up in wage pressures and inflation. Given this, members agreed that developments in the labour market were particularly important“. The RBA needs a downtrend of the unemployment rate to maintain their forecast of accelerating inflation.

For this reason, the monthly jobs reports seem asymmetric: a weak print gets a cut, but a strong one won’t end the vigil. So long as the growth data remains weak, the RBA will be looking for evidence of weakness in the labour market to confirm the downturn … and that evidence will complete the case for a rate cut.

We get that new information on Thursday 21 March. I still favour the case for a May rate cut — but after the March minutes, the RBA could cut on 2 April in response to a weak jobs report and (justifiably) say that they had given the market notice.

Posted in AUD, economics, RBA | 6 Comments

Another view on the credit crunch

The Sumner stuff on per-capita measures of nominal income growth made me wonder if it made more sense to think about the flow of finance in a per-capita sense. I think it does.

With equivalent economic and credit conditions, you’d expect per capita funds flowing to be about stable (for a given demography … but this changes so slowly it’s not important in the present context).

When you look at the recent decline in the value of new finance commitments in per capita terms (I use the civilian 15+ measure from the labour force report), you can see that this is around equal to the largest ever decline, and that we’re most of the way down to the GFC-low.

The pace of credit creation has declined from a high of around $1200 per person per month in Q1’17 to around $850 per person per month in Jan’19.

The below chart shows the current level as a percentage of the prior peak. So right now the flow of finance is ~73% of the Q1’17 peak (or equivalently is down ~27%).

The last two times the flow was down 30% the RBA cut rates. And both times by substantially more than 50bps.

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