Week beginning 12 November 2018

  • AUD/USD to move below 70¢ in 2019 as Fed continues to hike.
  • RBA: Deputy Governor Debelle speaks.
  • Australia: Westpac-MI Consumer Sentiment, wage price index, employment.
  • NZ: retail card spending, house sales and prices.
  • China: retail sales, industrial production, fixed asset investment.
  • Europe: GDP 2nd estimate.
  • US: Fed chair Powell speaks, CPI, retail sales, Veterans Day.
  • Key economic & financial forecasts.

Information contained in this report current as at 9 November 2018.

AUD/USD to Move Below 70¢ in 2019 as Fed Continues to Hike

Over the last month the AUD has lifted from USD 0.705 to around USD 0.73. Markets had abruptly dumped the AUD over the previous two months. Momentum dictated that we should have extrapolated that trend and called AUD into the 60’s last month. Certainly many commentators took that option.

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Westpac resisted that temptation and noted in our October Outlook, “Westpac is retaining its target for AUD to end 2018 around USD 0.72 with further weakness in the AUD through the first three quarters of 2019, bottoming out at USD 0.70 around the middle of 2019.”

However, despite the recent resurgence in AUD we are now revising down our estimate of its low point in this cycle. This is largely because we have reviewed our outlook for the US economy and US Federal Reserve policy.

We have extended our profile for interest rate increases by the Federal Reserve’s FOMC by 25 basis points. We now expect the final hike in this cycle to be September 2019 rather than June. This will see the federal funds rate peak at 3.125%.

This profile is somewhat more hawkish than current market pricing which expects the federal funds rate to peak at around 2.9% by end 2019. While the FOMC’s “dots” envisage a peak of 3.4%, this assumes a continuation of above-trend growth in 2020. We instead expect growth to decelerate to trend in late 2019.

In choosing this somewhat higher “pause point” we have studied “pauses” in the three previous tightening cycles (1995; 2000; 2006). Then the FOMC responded to a slowdown in employment growth and spending, particularly housing and durable consumer goods.

We are expecting a slowdown in employment growth through the second half of 2019 from around 1.6% at March 2019 (six month annualised) to around 1% by year’s end. Furthermore we expect the contributions to growth from housing and durables spending to decline significantly in the second half.

However our estimates indicate that with the unemployment rate settling around 3.5% in the second half of 2019 the FOMC will persevere a little longer with their gradual normalisation through 2019 before the slowdown evidence around employment; housing and durables becomes clear. Figure 1 highlights the importance of jobs growth to the timing of “pauses” while Figure 2 shows our forecasts for jobs growth and the expected timing of the pause in 2019, giving the FOMC ample time to observe the necessary slowdown.

At that key point in December 2019 when we see the FOMC pausing it will feel reasonably comfortable that it has reached a sustainable neutral setting. Inflation will be around the 2% target; growth will have slowed to near “potential” and the unemployment rate, while lower than the previously assessed “full employment” level, will not be driving excessive wage pressures.

In previous tightening cycles (see Figure 1) the labour market subsequently deteriorated sharply whereas in this cycle we anticipate that employment growth can “settle” around 1% – closely aligned with working age population growth. The FOMC will, in those circumstances, be able to hold the federal funds rate around that “neutral” level throughout 2020.

This slight change of profile for the federal funds rate has some implications for our bond and currency forecasts.

Our expected peak in the US 10 year bond rate of 3.5% has been lifted to 3.6% and been extended from June to September. The margin between the US and Australian 10 year bond rate increases from a peak of 60 basis points to 70 basis points through mid 2019.

Given this additional increase in US rates we have also extended and lifted our forecast for the USD with DXY now expected to peak near 100 by September.

For the Australian dollar, we now anticipate a further “leg down” to USD0.68 by September. The USD should then start to lose ground through the December quarter 2019 as markets detect the employment and spending slowdown and anticipate the December pause. In this way AUD would lift through the December quarter to USD0.70, lower than our previous forecast.

The week that was

The US mid-term elections were the focal point for markets this week. However, monetary policy also remained in view, with the RBA, RBNZ and FOMC all meeting.

Who won the US mid-term elections? Seemingly, the answer is everybody. As expected, the Democrats won the house; however, the Republicans increased their majority in the Senate. Equities rallied the day after, while the US dollar and term rates initially edged back before returning to their previous levels.

For the economy, the implications are minimal. In the shortterm, the result clears the way for a planned hike by the FOMC in December. On fiscal policy, infrastructure is set to replace tax and regulatory change as the potential expansionary catalyst. However, if seen at all, progress on this front looks a long way off, with President Trump and the Democrats holding disparate positions on the matter. Also worth noting is that this outcome does not stop President Trump from doubling down on his ‘trade war’ with China. The hope on that front is an upcoming meeting between President Trump and President Xi in late November.

From the FOMC at their November meeting, the message was simple. The US economy is strong and a continued gradual normalisation of the policy stance to neutral justified. While we continue to believe that US growth will slow back to trend in late-2019 as the consumer pulse follows the deceleration already underway for investment, the time taken by the FOMC to reassess their course at prior cycle peaks has led us to add a fourth hike to our federal funds profile. Whereas we previously saw 2.875% at June 2019 as the peak, now we forecast 3.125% at September 2019 to be the point at which the Committee pauses indefinitely. That would leave policy a little above neutral, seeing growth remain at trend and inflation at target, given the strong labour market.

Coming back to Australia, the RBA’s November meeting statement offered no surprise in terms of themes, but did highlight greater optimism over growth, with the GDP forecasts revised up to 3.50% out to June 2019. In the RBA’s view, growth will slow to 3.0% by end 2020, but that is still above trend. The unemployment rate forecast was revised from 5.00% to 4.75% and underlying inflation for 2019 was revised up to 2.25%.

Our own view on unemployment is not dissimilar. However, we are less positive on the pass-through to wages and hence spending. Also front of mind for us is the more firmly entrenched downtrend in house prices, most evident in Sydney and Melbourne. To us, the expected consequence of this trend is declining dwelling investment and a subdued consumer. It is chiefly for these reasons that we see GDP growth slowing to 2.70% in 2019, materially below the RBA’s forecast. If accurate, this is clearly an outturn that would warrant the RBA remaining on hold through 2019 and 2020.

In NZ, the statement from the RBNZ after their November meeting also carried a few hawkish tweaks. Most notably they moved away from a near-term rate cut by removing the previous reference to the next move in the cash rate potentially being “up or down”. Further signalling that the next move in rates will be up, the RBNZ’s medium-term inflation outlook now settles a little above the 2.0%yr target range mid-point as ‘full employment’ is achieved and exceeded. However, even though the RBNZ is projecting an overshoot for these targets in the medium-term, current slow progress for underlying inflation and an absence of untoward wage pressures despite the unemployment rate being historically low warrant stable policy until mid-2020, as risks remain balanced.

Chart of the week: Australia housing finance

Australian housing finance approvals continued to soften in September. The headline number of owner occupier loans declined 1% in line with the consensus forecast. Ex refinancing, the decline was a milder 0.5%mth.

The value of loans was considerably weaker. In particular the value of owner occupier loans dropped 4.2%mth to be down 8% in the space of two months. With the number of approvals showing much milder declines, the implied average loan size has declined notably, by 3.6% since May, or $14.6k. Note that this captures composition shifts such as reduced activity in higher-priced markets such as Sydney and Melbourne, although the detail shows declining average loans sizes across all states suggesting tighter lending conditions reducing borrowing capacity has been the main driver.

New Zealand: week ahead & data wrap

What target?

The past week has been huge for New Zealand economists and financial markets. It started with the September quarter Household Labour Force Survey, which registered a ten-year low in the unemployment rate of 3.9%. That was a lot lower than we were expecting, given that jobseeker benefit numbers are on the rise.

We are wary of the inherent noise in the HLFS survey. On this occasion the drop in unemployment was heavily concentrated among very young people, which may be a sign that sampling error was a factor. One-quarter moves of this size are often followed by at least a partial reversal in the next quarter, and that’s what we expect on this occasion.

That said, a broad sweep of all relevant data does suggest that the labour market is more positive than we gave it credit for. The HLFS probably overstates the case, but the fact remains that unemployment is trending down despite the economic slowdown of 2017 and early-2018. Evidently, low business confidence has not stopped firms from hiring.

Given this evidence of improving employment conditions, the lack of wage growth looks all the more mysterious. The September Labour Cost Index rose by 0.5%, with annual growth slowing a little to 1.9%. The drop in the annual growth rate is not surprising, as the aged care workers’ pay equity settlement had boosted the numbers previously. Private sector wage growth has arguably started to pick up on a quarterly basis, and other measures of wage growth are a little stronger. But it’s been a very incremental lift in wage growth so far.

Our view is that wage growth will gradually strengthen as the labour market continues to tighten. Wage growth is also going to be boosted by the rising minimum wage, pay settlements for nurses and teachers, and moves towards more collective wage bargaining. But this acceleration in wage growth will be too slow to generate much inflation, particularly considering other forces will be acting to keep inflation contained, such as extending free tertiary education beyond one year and competition in the retail sector.

The Reserve Bank’s November Monetary Policy Statement came hot on the heels of the super-strong labour market report, and followed similar massive upside surprises on GDP and inflation. We were expecting a slightly hawkish shift, and that’s exactly what we got. The Reserve Bank removed the phrase that the next move in the OCR could be “up or down”, issued evenly balanced alternative scenarios (rather than skewing them to the downside), and lifted its inflation forecast.

At the same time however, the RBNZ remained adamant that the OCR is not going to rise any time soon. They retained the phrase that the OCR is expected to remain “at this level through 2019 and into 2020”, and the OCR forecast was unchanged from August.

Given the sheer scale of the data surprises over the past three months, this really was a tiny shift in position. This underscores just how much less hawkish the Reserve Bank has become since the change to a dual mandate and a new Governor. We suspect that this week’s events will become a theme. Over the coming year, we expect the economy to strengthen and inflation to rise. Yet we remain very comfortable forecasting no OCR hike until mid-2020.

The most extraordinary aspect of this week’s Monetary Policy Statement related to the Reserve Bank’s medium-term forecasts. The Reserve Bank is actually forecasting that inflation will rise above the 2% mid-point of their inflation target band, on a sustained basis, over the medium term. At the same time, they predict that employment will rise above its maximum sustainable level. In other words, the Reserve Bank is saying that it is going to overshoot its targets. Yet it is not planning to adjust the OCR to avert that miss.

Usually, the Reserve Bank forecasts that it is going to hit its inflation target over a horizon of, say, three years. After all, if inflation was in danger of heading higher three years in the future, the Reserve Bank would still have time to lift the OCR and avert the rise in inflation. On this occasion, rather than forecasting a rise in the OCR it is simply saying that it is not going to hit its inflation target, although admittedly the margin is small.

The situation has become more complex now that the RBNZ must target both employment and inflation. One could imagine the RBNZ forecasting one variable above target and one below, in a sort of balancing act. But that is not the case here – the RBNZ is saying it expects both employment and inflation to be above target.

Perhaps the RBNZ is more wary after many years of below-target inflation, and is prepared to take a small risk on the other side. Or perhaps it is interpreting differently the requirement to keep inflation “near the 2% mid-point” of its target range, and regards 2.2% as close enough. Whatever the explanation, this is a small but significant departure from the approach that the previous Governor would have taken.

Financial markets have taken the recent strong data and slight shift in tone from the RBNZ as licence to mark swap rates and the NZD much higher. That may prove to be a mistake. Our prediction is that the Reserve Bank will remain very dovish even if the data remains strong. If we are right, two-year swap rates above 2.2% are not tenable.

Data Previews

Aus Q3 Wage Price Index – %qtr

  • Nov 14, Last: 0.6%, WBC f/c: 0.6%
  • Mkt f/c: 0.6%, Range: 0.4% to 0.7%

There has been some removal of excess slack in the labour market, as measured by falling unemployment and modest declines in broader measures of labour market utilisation. In the last year there was also the larger than usual boost from the annual lift in the minimum wage. And yet we are still waiting for a meaningful pickup in wage inflation.

Total hourly wages ex bonuses increased 0.6% in Q2, in line with market and Westpac expectations; lifting the annual rate to 2.1%yr from 2.0%yr (was 2.1%yr). Private sector wages grew 0.5% lifting the annual rate slightly to 2.1%yr. Public sector wages grew 0.6% holding the annual rate at 2.4%yr – a pace maintained since 2017 Q1.

This year the lift in the minimum wage was 3.5%yr, a small increase on the 3.3%yr granted in 2017. However, in 2017 the minimum wage increase did not have a meaningful impact on aggregate wages. Will we see a larger impact in 2018?

Aus Nov Westpac-MI Consumer Sentiment

  • Nov 14 Last: 101.5

The Westpac Melbourne Institute Index of Consumer Sentiment rose 1% to 101.5 in October from 100.5 in September. The small gain follows a 5.2% decline over the previous two months as an earlier boost from tax cuts announced in the May budget faded and negatives around the political backdrop; mortgage rate increases; declining house prices and rising petrol prices weighed on confidence. The October gain suggests some of the drag from these negatives has eased while positives around economic growth and the labour market have provided some support.

The November survey is in the field from November 5-10. The backdrop has again been a little more settled although global trade tensions, declining house prices in Sydney and Melbourne and sluggish income growth remain clear headwinds.

Aus Oct Labour Force Survey – Employment ‘000

  • Nov 15, Last: 5.6k, WBC f/c: 20k
  • Mkt f/c: 20k, Range: 10k to 30k

The Sep Labour Force Survey was full of surprises. The first was that employment came in less than expected rising just 5.6k in the month (the bottom of the range of expectations) with a more positive 20.3k gain in full-time employment vs. a –14.7k decline in part-time employment.

At the same time there was a drop in participation to 65.4% from 65.6% (both male and female participation fell) resulting in a –31.6k decline in the labour force. Our holistic view of the survey is that some of the monthly volatility is associated with the rolling of the groups in the survey sample. In original terms, the ABS notes that the incoming rotation group had a lower employment to population ratio (61.9%) than the entire sample (62.1%).

Given this, we are looking for a slightly above trend bounce in employment, up 20k with an associated rise in the labour force.

Aus Oct Labour Force Survey – Unemployment %

  • Nov 15, Last: 5.0%, WBC f/c: 5.1%
  • Mkt f/c: 5.1%, Range: 4.9% to 5.2%

The other big surprise in the Oct Labour Force was the fall in unemployment to 5.0% which has historically been argued to be the level for the natural rate of unemployment.

As the fall was associated with a fall in participation, some may be tempted to argue that were it not for the fall in participation then the unemployment rate would have been higher. We don’t give countenance to such a statement as we believe you should take a holistic view of the labour market and not just look at one factor (say employment) and ignoring others (unemployment, participation, and hours worked).

With our forecast 20k rise in employment and a lift in participation to 65.5% this will see the unemployment rate lift to 5.1%.


NZ Oct house sales and prices

  • Nov 10 (tbc), Sales last: -2.5%, Prices last: +5.4%yr

House price inflation has slowly strengthened in recent months, although there is stark regional variation. Auckland and Canterbury prices are flat to falling, others are rising rapidly.

Going forward the market will be influenced by the recentlyintroduced foreign buyer ban and a recent sharp drop in mortgage rates. We expect the balance to be positive, but less so in Auckland.

We have already seen stronger listings and strong sales from one agency, the October REINZ data may show a modest pickup in sales.

NZ Oct retail card spending

  • Nov 12, Last: +1.1%, WBC f/c: +0.5%

Retail spending levels rose by a solid 1.1% in September, following a similar sized gain in August. Those gains were underpinned by increased spending on consumables (e.g. groceries), as well as firm spending on durables. Spending levels have been boosted by the Government’s Families Package, which has added to the disposable incomes of many households.

We expect more modest spending growth in October and are forecasting a 0.5% gain in the month. While the lift in disposable incomes has added to the level of spending, higher fuel prices are limiting increases in discretionary expenditure in core categories.

US Oct CPI and retail sales

  • Nov 14, CPI, last 0.1%, WBC 0.3%
  • Nov 15, retail sales, last 0.1%, WBC 0.7%

CPI inflation has held above the FOMC’s 2.0%yr target for much of 2018, the headline measure averaging 2.6%yr over the 7 months to Sep. Highlighting the significance of energy to this result, the core measure (excludes food and energy) has averaged 2.2%yr over the same period.

October looks set to continue this trend, respective 0.3% and 0.2% monthly gains to see annual inflation at 2.5%yr for headline and 2.2%yr for core.

On retail sales, monthly volatility has been considerable, both with respect to initial outcomes and revisions. Looking through this however, the trend remains robust. After a weak September, we are due a bounce come October. Furthermore, the risks are skewed upward, given the need to replace auto purchases following Hurricane season.


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