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FOMC and President Trump Exacerbate Volatility

The past week has again seen policy makers return to centre stage as 2018’s schedule of central bank meetings concluded, and the Australian government released its mid-year update.

Beginning with the domestic scene, the mid-year Federal budget update highlighted the benefit that the Government’s bottom line has received from a stronger-than-expected labour market and elevated commodity prices. Overall, a $31bn improvement in the budget position was announced for the four year forecast period from 2018/19. The much-improved starting position has set the scene for additional pre-election tax cuts/ spending of around $9bn – the detail of which will be forthcoming.

It could be argued that this support is timely as, despite continued strength in employment growth (2.3% over the year to November, and 2.9% on a six-month annualized basis), the consumer remains a significant source of uncertainty for the outlook. This was again highlighted in the December RBA meeting minutes, with slow income growth, high debt levels and falling house prices cited as a combination that poses downside risks for activity.

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Note that this description preceded the weak Q3 GDP report. On the back of that update, we expect that, come February, the RBA will revise down its growth forecast for 2018 and 2019. As highlighted by Chief Economist Bill Evans, “at this stage, the Bank cannot be described as having moved to a ‘neutral’ bias. However, taking into account the attention given to the credit; housing; consumer; and external risks, these minutes should be interpreted more ‘dovishly’ than we have seen over the course of 2018”. For a full picture of economic conditions across Australia, see our just-released December Coast-to-Coast report.

Moving offshore, this week New Zealand GDP also disappointed in Q3, rising just 0.3% after Q2’s outsized 1.0% gain. Q3 was the smallest quarterly gain in five years, but this looks to, at least in part, be the result of transitory factors. Given upward revisions to 2017 and the detail of the Q3 accounts, our NZ team does not see cause to change their forecasts. Into 2019, growth is expected to pick up on the back of government spending and greater momentum in housing. Further out however, slower population growth and a peak for construction loom as headwinds.

Then to the US. Heading into the December FOMC decision, the focus of the market was on the tone of the decision statement and accompanying Committee forecasts rather than the rate hike to be delivered. The Committee effectively provided two views in their communications: the decision statement focused on the strength of economic growth and the labour market; while the forecasts and press conference emphasised the risks. On the latter, recent financial volatility; tightening financial conditions and softer global growth have clearly increased in prominence in the minds of Committee members now that the bottom of their forecasted neutral range has been reached (2.50%). Whereas the real economy data continues to justify two-to-three more hikes, these other “cross-currents” could see the FOMC’s gradual normalisation concluded early. The market is clearly nervy, pricing in less than one hike for 2019.

As we go to press, political brinkmanship in Washington is further heightening market uncertainty. President Trump is refusing to sign the short-term spending bill necessary to avoid a government shutdown from this Saturday because Congress has not included funding for his border wall. The Democrats have no interest in providing said funding, and the Republicans don’t have the numbers by themselves. Friday will be a tense day in Washington, and for financial markets, as a last-minute compromise is sought.

Finally, in their December post-meeting statement, the Bank of England highlighted the deterioration in conditions that the UK is facing in the absence of an agreement over Brexit. In particular, the Committee noted “Brexit uncertainties have intensified considerably since the Committee’s last meeting”. Further, “UK bank funding costs and non-financial high-yield corporate bond spreads have risen sharply and by more than in other advanced economies”. In addition to these specific UK concerns, in line with other central banks, the Bank of England also believe that “the near-term outlook for global growth has softened and downside risks to growth have increased”. It is difficult to see conditions being supportive of further rate hikes by the Bank of England. In our view, the risks for the UK are instead heavily skewed to the downside.