Barclays on the Fed:
Although we had expected a interest rate hike at this meeting, the non-hike was very close call. The language in the statement suggests that the committee was quite undecided in its view. More clearly, with three members dissenting against the decision and three, presumably different, members calling for no further rate hikes this year, the committee is more split than it has been at any time in our memory.
This split in views will make FOMC communication and action increasingly difficult this year. In particular, we believe that this level of dissent will make it difficult for the committee to keep the possibility of December rate hike live in the minds of market participants and, indeed, households and businesses.
Versus BofAML on the Fed:
The FOMC clearly signaled a hike before the end of the year in both the language and the dots
The Fed made two important changes to the statement:
1. the committee noted that near-term risks to the economic outlook “appear roughly balanced”. This is an important step for the Fed to justify hiking rates at an upcoming meeting and is a page out of the playbook from last year.
And, 2. “the Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of further progress toward its objectives.” This is a strong signal that the Fed is planning to hike in an upcoming meeting. It is not explicit calendar guidance, but it is a small step in that direction.
My own view is the Fed’s window is closed as oil falls, Chinese growth eases, Trump wins and Italy is shaken by the rise of MS5.
But that underlines the only point that matters these days. None of these events should be economically significant enough to derail a tightening cycle. What each can do is hammer sentiment and deflate asset markets. That’s why monetary policy observation has become a bit of a joke. You can line up as much data as you like but what the bubble manager feels about risk is now the key determinant in setting the cash rate.
The new reaction function of central banks is not inflation, nor unemployment, nor nominal GDP. It is what s/he had for breakfast, whether s/he got laid last night or whether s/he is dropping prozac.
Another example today is Captain Phil, Australia’s new RBA governor appearing on Capital Hill:
Our economy continues its transition following the boom in commodity prices and mining investment. According to the latest national account, GDP increased by 3.3 per cent over the year to June. This was a better outcome than was widely expected a year ago. It is also a little above most estimates of trend growth in our economy. Partly reflecting this above-trend growth, the unemployment rate has declined by around ½ percentage point over the past year. Again, this is a better outcome than was thought likely a year ago.
As is always the case, these aggregate outcomes mask significant variation across industries and regions. Those parts of the economy that benefited most from the resources boom are now experiencing difficult conditions, while other areas are doing considerably better. In these other areas, business conditions have improved, employment has increased and there are some signs of a modest pick-up in private investment.
Overall, the economy is adjusting reasonably well to the unwinding of the biggest mining investment boom in more than a century. This is a significant achievement. We are managing this adjustment partly because of the flexibility of the exchange rate and the flexibility of wages and through the support provided by monetary policy.
The story on income growth has been less positive, with growth in nominal GDP being disappointing. Over the past five years, nominal GDP has increased at an average rate of around 3 per cent per year. To put this number in context, between 2000 and 2007, nominal GDP grew at an average rate of 7½ per cent per year. This is quite a change. It goes some way to explaining the sense of disappointment in parts of the community about recent economic outcomes.
The main reason for the weak income growth over recent times is the large fall in the prices received for our exports. Since the September quarter 2011, export prices have fallen by around one-third. This fall, though, does need to be kept in perspective. Export prices remain considerably higher than they were in the 1990s and early 2000s, relative to the price of our imports. And of course, some of the fall in prices is because of increased production from Australia. So while we are receiving lower prices for our exports, we are selling more.
The recent news on commodity prices has been a bit more positive than it has been for a while. Over the past couple of months, the prices of some of our key exports have risen, partly in response to production cutbacks by high-cost producers elsewhere in the world. While it is difficult to predict the future, if these increases were to be sustained then we could look forward to the drag on national income from falling commodity prices coming to an end.
A second factor that has weighed on growth in nominal GDP is the slow rate of wage increases. This is a common experience across most industrialised countries at present, even those with strong employment growth. In Australia, the current rate of wage growth is the slowest in around two decades. It is part of the adjustment following the resources boom. Importantly, it means that many more people have jobs than would otherwise have been the case.
The low wage growth and lower commodity prices have meant that CPI inflation has been quite low over recent times. Inflation has also been held down by increased competition in parts of retailing and cost reductions in some supply chains. Slow growth in rents has also played a role.
The low inflation outcomes have provided scope for monetary policy to provide additional support to demand. The Reserve Bank Board decided to reduce the cash rate by 25 basis points in May and again in August this year. Lending rates have come down as a result. Deposit rates have, of course, also come down. The Board is very conscious that this means lower interest income for savers. Overall though, our judgement is that this easing in monetary policy is supporting jobs and economic activity in Australia, and thus improving the prospects for sustainable growth and inflation outcomes consistent with the medium-term target.
Looking forward, we expect the economy to continue to be supported by low interest rates and the depreciation of the exchange rate since early 2013. Importantly, the drag from the fall in mining investment will also come to an end. While mining investment still has some way to fall, our estimate is that around three-quarters of the total decline is now behind us.
Inflation is expected to remain low for some time, but then to gradually pick up as labour market conditions strengthen further.
One issue that has attracted a lot of attention of late is the housing market. The construction cycle has a bit more momentum than we expected earlier. This is adding to the supply of housing in the country, which partly explains the slow growth in rents. The rate at which established housing prices are increasing has also moderated, although there remain some pockets where prices are increasing briskly. Credit growth and turnover in the housing market are also lower than they were a year ago. Under APRA’s guidance, lending standards have also been tightened. Overall, then, the situation is somewhat more comfortable than it was a year ago, although we continue to watch things carefully.
Blather and blah. Captain Phil will cut again the moment he feels that housing is quiet enough that he can drive the currency lower to address weak inflation and income.
Monetary policy has become nothing more than a market soap opera.
