From Tim Toohey at Goldman:
Looking through some negative news flow…
Following on from the material contraction in GDP reported for the September quarter, Monday’s mid-year economic and fiscal outlook incorporated news of a further deterioration in Australia’s public finances. Against this negative backdrop, it is not surprising that surveyed sentiment has been under some pressure recently. However, consistent with increasingly upbeat rhetoric from the RBA, we caution against getting too negative on Australia’s outlook. Looking ahead, alongside a far more supportive global backdrop, Australia is now on course to receive a very significant positive income shock from higher commodity prices, in our view.
…to a very significant positive income shock
Over recent weeks, the Goldman Sachs commodity team has revised higher its 2017 forecasts for iron ore, metallurgical and thermal coal by no less than 77%, 135%, and 32% respectively (Exhibit 1) – including +30-40% upgrades to long-term price assumptions for iron ore and thermal coal. The impact of these changes for the Australian economic outlook are profound. Compared with our prior baseline, the forecast additional upside to metallurgical coal export earnings in 2017 is ~2.0% of nominal GDP, with a further ~1.5% of upside via iron ore (Exhibit 2). In concert with an ~10% downgrade to forecast LNG volumes over the period to 2018 (owing to a slower production ramp-up at the Qld projects, Ichthys and Gorgon; Exhibits 3 &4), one interesting implication is that it is now looks unlikely that LNG export earnings will materially surpass those from iron ore at any point over the next decade (in contrast to our prior expectations (Exhibits 5 & 6)).
More important, however, is that these forecast changes imply that net earnings across Australia’s four major exports could be as much as 3.5% of GDP higher in 2017 than our prior baseline. While we have taken a more conservative approach in our own macro forecasts than is mechanically implied by the commodity team’s changes, there can be no doubt that the surge in commodity prices has transformed Australia’s economic outlook in many respects (for details, see our 2017 Outlook document). For example, we expect Australia will soon record its largest trade surpluses (as a share of GDP) since the early 1970s and that financial markets will shift to factor in a material probability of an RBA rate hike over 2H2017 – both of which should be supportive of the AUD in the nearer term.
Beyond this profound impact on national income, there are also major implications on a number of other levels – including a forecast narrowing in Australia’s current account deficit, important shifts how this deficit will be funded, and related implications for AUD demand, bank funding costs, credit growth and monetary policy.
- Through the prism of investment-savings balances, we expect that a shrinking current account deficit will reflect a combination of public sector deleveraging, further gradual declines in the household savings rate, and an initial period of deleveraging at the corporate level. While from a funding perspective, we expect the recent shift away from foreign portfolio inflows will continue as a multi-year “search for yield” trade unwinds. In concert, with declining foreign direct investment inflows, this is likely to see the CAD increasingly funded by Australian banks in offshore debt markets.
- For the AUD, while an expected sharp improvement in Australia’s international trade balance is likely to support the AUD through 1H2017, the compositional shift in the funding of the CAD is likely AUD negative over the longer run as the broad balance of payments continues to deteriorate and a larger share of Australia’s CAD is intermediated by banks in a way that tends not to generate AUD demand. We forecast the AUD/USD at 0.78, 0.77 and 0.75 on a 3,6 and 12 month view.
- While from a monetary policy perspective, heightened competition for deposits, regulatory constraints and relatively more expensive offshore bank funding risks seeing the recent run of out-of-cycle increases in lending rates extend – weighing on credit growth and contributing to a delay in the commencement of an RBA tightening cycle to 2018 (GS: +25bp in February 2018).
Extraordinary stuff from our Tim though he has pushed back his rate hike called to early 2018. I don’t agree with much of it because:
- the income surge is going to be contained to a narrow band of mining corporate profits and tax receipts because there will be no investment follow through;
- it’s going to unwind faster than GS thinks, not least because of its own wildly bullish USD outlook, and
- the idea of hiking interest rates into the dwelling construction bust later next year is so delicious that it couldn’t possibly come true!