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.

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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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The case for May Rate cut

I think the RBA will — and should — cut their cash rate 25bps to 1.25% at their 7 May meeting. They have a chunky downgrade to put through for growth, inflation isn’t expected to get back to their target ever, and there are no financial stability reasons for maintaining the current cash rate.

The Q4 Growth problem

The charts above and below shows what happened v. the RBA’s forecasts. The basic story is that growth was ~50bps weaker than they expected due to weakness in household consumption and dwelling investment. This was offset by surprising strength of public demand. That’s probably not going to be sustained going forward.

The Q1 slump

It’s early to declare Q1, but i feel okay doing so given base effect and the weak data we’ve seen to Feb’19.

The base effect of the weak end to Q4 is particularly challenging. Consider retail sales, for example. We only know Jan’19 (+0.1%m/m) but we can say with a high degree of certainty that Q1 real retail sales will be soft.

To see why, consider the below chart. Let’s assume that we get slightly above trend outcomes for nominal retail sales growth in Feb and March.

This would yield nominal retail sales growth in Q1’19 of ~20bps.

Assuming that retail inflation is flat (the lowest it’s been year is 10bps), that means the best you could expect for real retail sales is ~20bps.

Personally i think that retail inflation of 10bps is realistic, which gives you the below chart for real retail sales growth.

See the problem? So the growth downgrade should be larger than the ~50bps miss in Q4’18.

The RBA has been worried about a retail slump — and they have got one. Their is no financial stability reason to resist cutting the cash rate, and on current forecasts they never get (core) inflation back to target.

The only argument for not cutting is the Federal election (likely 18 May). The RBA has moved during an election campaign before. The most political thing they could do would be to NOT move despite the downgrade due to politics.

Posted in AUD, economics, RBA | 12 Comments

Another look at Nominal Household Income

I was a little thrilled when I saw a link to my blog from a Scott Sumner post on econlib (thanks Rajat!).

Scott took a look at my NGDP post and said that he prefers total labor compensation — which in the Australian National Accounts is called Household Gross Income (HHGI). The man knows what he is talking about — over the last 30yrs (1990+) the correlation between nominal consumption and HHGI is a bit better than the correlation with Household Gross Disposable Income (HHGDI). I had expected that variation of interest rates and tax rates over time would make HHGDI a better guide to consumption trends … turns out that’s not the case.

If you focus instead on GHHI, nominal growth is ~3.4%y/y, or about 70bps better than the growth rate of GHHDI. The difference between the two is “Total Income Payable”, which is growing at +5.75%y/y. That is an interesting story itself, but beyond the scope of this post.

In Scott’s blog about monetary equilibrium, he argues in favour of targeting a nominal income measure that is also adjusted for population growth. The growth rate of Australia’s civilian (15+) population is ~1.7%y/y, which brings the per-capita growth rate of nominal household income down to ~1.75%y/y (chart below).

From 1980 to 2012, the median growth rate of this measure was ~6%, so I would think that 1.75%y/y is a bit skinny. I’d love to know what Scott (or those of you who think this way) have to say about this development. I would suppose it means that monetary policy is way too tight.

I agree, of course.

Because I’m still stuck to my old ways, I am going to paste the deflated chart below. Annual growth of real per-capita income at ~20bps is around historical lows, and certainly consistent with the periods when the RBA has been cutting rates (the 1980 to 2012 average was ~1.75%). The wonder is that there’s any inflation at all!

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Australia’s NGDP problem

I think that the increased focus on NGDP these days is good. Firms and households live in a nominal world, so it’s important to think about the nominal picture. However, too much of a good thing is also a problem, and a focus on NGDP gives a misleading view of what’s going on in Australia just now.

The chart below shows the annual average pace of NGDP growth (nominal income in the economy) and nominal household gross disposable income over the past 40 years. As you would expect, there’s typically a strong relationship between the two series. When total income in the economy is strong, households tend to do well too.

However, when you look at the tail end, you can see that (like many relationships) the relationship has broken down recently. I’ve shown the current decade below (in %YoY terms) so that you can see the breakdown more clearly.

So while income in the entire economy has accelerated to a solid 5.5% yoy (largely due to the terms of trade), household gross disposable income has slowed to 2%yoy. How can people expect inflation anywhere near the RBA’s 2.5% target, or strong real consumption growth when nominal household income is growing only ~2%yoy?

Fast NGDP growth is one reason people give, but once you know the details … it seems unlikely.

The ratio tells the story … the share of NDGP accounted for by Household Gross Disposable Income has fallen to around record lows. The chart below shows the annual average (64%), but in Q4’18 the ratio fell to 63.5%, which is the lowest since 2007/8.

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The GDP v. Jobs non-puzzle

Today’s speech by RBA Gov Lowe said that they were puzzling about the concurrent GDP slowdown and strength in the labour market. 

Other indicators of the economy, though, paint a softer picture. We will receive another reading on GDP growth later this morning, but growth in the second half of 2018 was clearly less than in the first half. This is similar to the picture internationally. In a number of countries, including our own, there is growing tension between strong labour market data and softer GDP data. We are devoting significant resources to understanding this tension.

As you can see from the charts below, this is something of a non-puzzle.

The first chart (above) simply shows a GDP measure (I used private domestic demand) v. Jobs: as you can see, the orange line (GDP) tends to lead the blue line (jobs) down. This has happened in pretty much all cyclical downturns.

The next chart (below) shows the lead-lag correlations between GDP and Jobs.  The higher the number, the greater the correlation.  As you can see the great mass of correlation is between concurrent (x axis label = 0) and a one year lead (x-axis label = 4). 

I think Lowe’s message was that if slow GDP growth shows up in Jobs he’ll cut. History suggest that’s not too far away.

Posted in AUD, economics, monetary policy, RBA | 7 Comments

Average wages slump in Q4’18

The biggest problem in Aussie macro is weak household cash flow. Today’s Aussie Business Indicators report suggest that things are getting worse — not better.

On the quarter, nominal wages and salaries paid by the private sector grew by a little less than 80bps. This was the slowest pace of growth since March 2017.

Most of this was due to employment growth of a little over 0.6%q/q. If you subtract out employment growth, average wages grew by a paltry 0.1%q/q.

Posted in AUD, economics, Labour Market | 7 Comments

The GDP beauty pagent

Keynes famously compared investing to betting on the outcome of a beauty pageant.  With the RBA providing a little more transparency about their GDP forecasts in an appendix to the SOMP  there is now scope for a similar game — guessing how the RBA’s GDP forecast (for 2.8%y/y or approx. 0.6%q/q) is looking in light of incoming data.

Last week delivered a heavy blow for the RBA’s forecast. The construction work done data pretty much bolts right into the Private Dwelling Investment component of GDP, and it was a big miss. The RBA’s table tells us that they were expecting 5.9%y/y … the CWD release is consistent with growth of ~3%y/y. This line item is about 6% of GDP, so it shaved off ~15bps!

The CWD release also contained bad news about public activity. It fell around 6% (or 750mil), on the quarter. We can’t say for sure what the RBA expected, as their public demand forecast is the sum of public consumption and public capex — but we can put some bounds on things using their forecast of 4.2%y/y growth for public spending (consumption + capex).

Assuming that they went for a high public consumption number (say +1.25%q/q = 4.25%y/y), their forecast for public capex must have been around 3%q/q. Public building is only half of public capex, but it’s going to be very hard to hit +3%q/q for public capex when public building was down 6%q/q. In light of the construction data, I think it’s going to be more like -1%q/q. This line item is about 5% of GDP, so the 400bps miss means that it shaves off ~20bps from GDP.

The Private Capex release was a bit better than the RBA seems to have expected: I have private investment up about 0.5%q/q and 0.8%y/y, which is ~170bps better than the RBA’s -0.9%y/y forecast in the SOMP. That’s a gain of ~170bps in QoQ terms of an item that’s ~12% of GDP, so they picked up ~20bps from the Capex print.

In light of the above, my guess is that the RBA’s tracking estimate of Q4’18 GDP has fallen by around 20bps to 0.4%q/q (or 2.6%y/y). As best as i can tell, they are expecting a contribution of ~20bps from net exports, and roughly 10bps (or so) from inventories.

Assuming that NX and Inventories are ball-park, the focus should really be on the Government Finance Stats (released Tuesday). Given the size of the line item, the RBA’s chunky forecast (4.2%y/y, implies around 1.6%q/q), and the weak start from the CWD release, it’s this item that’s going to make or break the RBA’s Q4’18 GDP foreacst. And that’s important, as the RBA may be one downgrade away from an easing bias.

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The Household Credit crunch

I think the January Credit data just released by the RBA is very interesting. Total credit growth to households is very slow — on the month the 0.17%m/m increase is the second slowest since 1991 and the 0.2%m/m (3mma) increase it’s the slowest ever in trend terms.

The reason is that the housing credit growth component slowed to a fresh cycle low of 0.24%m/m, as owner-occupiers continued to slow down toward the flattish investor housing credit growth numbers (Owner Occupier was +0.33%m/m & Investors +0.05%m/m). Personal credit had the worst month since 2011, shrinking by 0.63%m/m. There are only six months that have been worse for personal credit since 1992, and five of them were in 2008/9.

The combined effect was to slow total credit to households (Housing + Personal) by ~5bps to +0.17%m/m (+0.2%m/m in 3mma terms).

There is only one month in modern history that’s worse for total household credit growth: October 2008 was 1bps slower, at 0.16%m/m. That was only one month. This is the all time low in 3mma terms.

One of the key ways the RBA controls the economy is by shifting the cash rate to ration credit. Right now, it looks like we could do with less rationing.

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Australia’s household cash-hole

When thinking about Australia and the outlook for policy, I find it hard to get past the below chart. It compares the growth rate of household gross domestic income to household consumption expenditure (both nominal YoY). When the black line is above the red line, consumption is growing more quickly than income, so the savings rate is falling.

Right now the household saving ratio is ~2.5%, down from ~8.5% four years ago. So Australian households have been running the savings rate down by ~150bps per year for the past four years. Households have been on a savings diet — and who needed to save cash money anyway? It is hard, and boring, and if you owned a home then capital gains from housing did the hard stuff for you.

With house prices now falling ~1% per month, the capital gains alternative has come to an end. The savings rate can go negative, but it doesn’t go much below zero. So at a maximum there’s another year or two in this — but it is probably over, falling wealth (house prices) ought to make folks a bit more prudent.

There is a clear long run relationship: so you should not expect household consumption to run too far ahead of income growth over any period of time. The chart below shows the long run relationship between the two series (I use an annual average growth rate to smooth the two series, hence the small difference between the first and second charts).

Given the scale of this distressing gap, I think that the household income component of the upcoming GDP report is probably the most important thing to watch.

The RBA’s new table of forecasts tells us that they expect 0.5%y/y for Real Household disposable income (note that the above charts have been nominal). That requires 0.5%q/q. That may sound low, but as the prior three quarters have been basically flat, it’ll be the best quarter since Q4’17.

Posted in AUD, economics, monetary policy, RBA | 7 Comments