Key insights from the week that was.
This week’s main events are still yet to come, with the Kansas City Federal Reserve’s Jackson Hole Economic Symposium, where FOMC Chair Powell and RBA Governor Lowe will speak, and the Biarritz G7 meeting both on this weekend. In the week so far, markets have focused on RBA and FOMC meeting minutes and political risk.
The most important aspect of the RBA’s August minutes was that the Board showed greater concern over the global economy. Whereas both the decision statement and the Statement of Monetary Policy concentrated attention on the Australian labour market, the minutes highlighted “trade and technology disputes had increased the downside risks to the global outlook”, and that “uncertainty around trade policy had already had a negative effect on investment in many economies”.
Meanwhile, with policy easing to date seen as effective for discretionary incomes and the Australian dollar, and given the turn in house prices, “the risks around the outlook [for consumption] were more balanced than they had been for some time”. That said, downside risks remain, particularly with respect to the labour market. On that topic, it was noted in the minutes that “there appeared to have been more spare capacity in the labour market than previously appreciated”, and there is “a more subdued outlook for wages than three months earlier”. While the RBA is optimistic on the eventual growth outturn, seeing an acceleration from 2.50%yr in 2019 to 2.75%yr, we are more pessimistic over the labour market and so expect growth to remain below trend through both 2019 and 2020 – even with two further cuts to the cash rate, in October and February.
Turning to the US, ahead of the latest escalation of trade tensions by President Trump, the July Minutes make clear that the Committee had varied views on the appropriate stance of policy. While all participants remained constructive on the US’ domestic economy, global uncertainties and the persistent underperformance of inflation in recent years weighed on each member’s assessment to a different degree.
The decision to cut at the July meeting was then justified as a “mid-cycle” adjustment prudent for risk management. While some regional Federal Reserve Presidents such as Esther George have stated that, even after the trade escalation, they are not willing to ease policy without evidence of a deterioration in the economy, it is likely that Chair Powell and the majority of the Committee will remain focused on risk mitigation and the continued promotion of trend growth. Though it is unlikely to be unanimous, a follow-up cut in September is therefore all but guaranteed. And, if employment growth continues to weaken as we expect, then further cuts will ensue. While the US economy can weather a prolonged period of weak business investment, a marked deterioration in consumption will quickly put at-trend GDP growth at risk. A pro-active decision to cut twice more past September however should provide enough stimulus to sustain discretionary incomes and confidence amongst consumers, and hence keep growth at trend.
In Europe, focus centred on political risk this week. Italy’s PM Conte resigned on Tuesday, marking the end of the current League/5-star coalition. However, that does not automatically mean new elections will soon be held, with a new coalition still a possibility. Also, if that fails, President Mattarella may instead install a caretaker government to allow Italy to submit its budget proposal to the EU, due later this year.
Elsewhere, UK Prime Minister Johnson’s letter to European Council President Tusk raised alternatives to the ‘Irish Backstop’ which has so far prevented an exit deal. On the back of that, German Chancellor Merkel and French President Macron met with PM Johnson this week and appeared open to alternatives, so long as they preserve peace on the island of Ireland and the integrity of the European single market. However, whether the alternatives that PM Johnson later referred to are satisfactory to all is still very contentious. Indeed, Irish Minister for European Affairs McEntee pointed to a lack of credibility in many of the suggestions tabled in the Alternative Arrangements Commission report promoted by PM Johnson.