Bill Evans joins the deluge:
Westpac now expects that the Reserve Bank will delay its next cut in the cash rate to April with the final cut to 0.25% occurring in August.
Prior to the release of the surprisingly strong December Employment Report we had expected the cuts to be timed for February and June.
Our analysis of the December Board Minutes highlighted that, with the Board committing to review its assessment of the economy in February, it seemed likely that the Board would have been prepared to cut the cash rate by 0.25% at that meeting.
However we did note that, “The flow of economic data over the next six weeks will be critical to that decision, particularly the labour market; retail sales and confidence”. (Economic Bulletin, December 17).
Although the November retail sales report printed a strong 0.9% we were comfortable to attribute much of that out performance to the “Black Friday” effect expecting a sizeable pull back in retail sales in December, (to be released on 6th of February).
The Westpac-MI Consumer Sentiment Index fell by 1.8% in January to 93.4 – consistent with a down beat consumer.
However, the Employment Report was always going to be the most important data release.
Recall that in the December minutes the Board concluded that, “The Board would continue to monitor developments, including in the labour market, and was prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time”.
The November report showed a tick down in the unemployment rate from 5.3% to 5.2% – Westpac expected that the December Report would see a reversion back to 5.3% but the actual report printed a further fall in the unemployment rate to 5.1%.
This fall in the unemployment rate is not unprecedented. Over the last five years there have been six occasions when the unemployment rate has fallen in back to back months by a total of 0.2% or more.
However, it is sufficiently strong a signal for the Board, which has emphasised the labour market as a key policy driver, to opt for a deferment of the rate cut process pending further information. Westpac still believes that the issues of concern to the Board, “the current rate of wages growth was not consistent with inflation being sustainably within the target range, unless productivity growth was extraordinarily weak, nor was it consistent with consumption growth returning to trend.” (December minutes) will require further monetary easing in this cycle.
We believe that the current positive signals around the labour market will prove to be unsustainable and we continue to expect that the unemployment rate will drift higher through 2020, reaching 5.5% by mid-year.
We also expect that the data associated with the core issues highlighted by the Board – wages growth; inflation; consumer spending – will signal that further monetary stimulus will eventually be required.
It is also important to recall that the Reserve Bank Governor has indicated that the Australian economy should be aiming at an unemployment rate of 4.5% – a level that he expects would assist with the objective of boosting wages growth; income growth; consumer spending and inflation.
We expect that the Inflation Report, on January 29, will print 0.36% for the trimmed mean pushing the annual rate down to 1.5% from 1.6% – well short of the 2–3% target inflation range.
While there is undoubted strong price pressure in the housing market the key variable for the Reserve Bank – housing credit growth (and therefore household debt) remains benign with annual growth having slowed to 3%. In fact the Board has highlighted rising house prices as a positive factor in boosting consumer spending, through a wealth effect and the expected boost to the sale of household goods as turnover lifts in the secondary market.
With this delay in the easing process our forecast for the AUD to fall to USD0.66 by March has been revised with the AUD holding around USD0.68 by March subsequent to falling to USD0.66 in the June quarter in the aftermath of the expected rate cut in April.
The importance of the April date is that the Board will have seen another print of the national accounts for the December quarter which is likely to highlight the soft growth environment while we expect that the surprise improvement in the unemployment rate will be unravelling.
Readers will also be aware that Westpac has been forecasting a decidedly “non-consensus” series of rate cuts from the US Federal Reserve beginning in March.
We recognise that the March date will now be “too early” given the positive sentiment and forecasts emanating from the Fed’s December meeting.
However we still strongly believe in the dynamics of the US economy with the Fed’s core inflation target (a symmetrical 2%) remaining well out of sight (slowing back to around 1.6%) while we expect growth momentum to be slowing.
The key to the US economy has been the resilient consumer but “cracks” are beginning to emerge. Wages growth; employment growth and associated disposable income growth are slowing. There appear to be no encouraging signals that business investment, which has been flat for some time, will compensate for a slowdown in the consumer.
We expect that growth momentum in the US will slow to below trend (1.8%) to 1.5% in the first quarter of 2020 and hold at that below trend level through 2020.
For the Fed, which is expecting above trend growth of 2% and a gradual convergence on the 2% inflation target these developments will be disturbing. While the March meeting now seems “too early” for the FED to respond we think that by June these trends will become apparent – persistent undershooting of the inflation target; growth slowing below trend – and further easing will be required.
Previously we envisaged three cuts beginning in March; we now expect that process to begin in June, with September and December the likely timing.
Those decisions would push the Federal Funds rate back more into line with global interest rates easing unnecessary competitive pressures on the US economy.
With this alignment of Fed rate cuts in the second half of 2020 the expected decision by the RBA to further address its own poor inflation record and underperformance of the Australian economy by easing to the terminal “low” of 0.25% in August seems a reasonable outcome.
As discussed throughout 2019 Westpac does expect that some time after reaching the 0.25% lower bound the RBA will move to a modest form of quantitative easing entailing a $2.5 billion monthly government bond purchase program.
With these central bank developments in the second half of 2020 we expect the AUD to remain in the USD 0.66–0.67 range over the course of the remainder of the year.
A few points:
- Coronavirus is now the wild card. I expect it to worsen swiftly through February, probably not early enough for the Feb RBA meet but definitely by March.
- Why everyone sees the labour market giving off strong signals is beyond me. It’s clearly soft if not terrible.
- Bill is too dovish on the Fed. The US housing market is leading a recovery there and the Presidential election is delivering tax goodies.
- That suggests that when the RBA cuts the Fed won’t and we’ll see new lows in negative yield spreads with the Australian dollar pushed lower to 65 cents (and lower if the virus turns bad).