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Australia & New Zealand Weekly: Some Risks Next Week, and Observations on the US

Week beginning 4 March 2019

  • Some risks next week, and observations on the US.
  • RBA: policy decision, Governor Lowe speaks.
  • Australia: GDP partials, GDP, dwelling approvals, retail sales, trade balance.
  • NZ: building work put in place.
  • China: National People’s Congress, trade balance.
  • Europe: ECB policy decision, GDP 3rd estimate.
  • US: non-farm payrolls, Fed Chair Powell speaks.
  • Key economic & financial forecasts.

Information contained in this report current as at 1 March 2019.

Some Risks Next Week, and Observations on the US

The Reserve Bank Board meets next week on March 5.

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On February 21 Westpac announced a change in view for the outlook for the cash rate.

After correctly forecasting unchanged policy since August 2016 (despite the RBA; the market and most economists predicting rate hikes) we finally changed our call to a 25 basis point cut in August and another 25 basis point cut in November.

We would be very surprised if the Board decided to move next week but, given our change of view, must accept that as we move closer to our August target, meetings will become increasingly “more live”.

The reasons behind our change in view have been extensively explained in the note on February 21.

The GDP report for the December quarter 2018 which prints on March 6 will be important for the rate outlook. Following the 3.1% reported fall in construction (around 14% of GDP) we have further revised down our forecast for Q4 GDP growth to 0.2%. That would follow a currently reported 0.3% for Q3, implying that the economy lost considerable momentum through the second half of 2018. This forecast is based on consumer spending growth of the reported 0.3% in Q3 and our estimated 0.5% in Q4. Risks to our consumption view are substantial statistical revisions to Q3 and a stronger than expected lift in Q4, despite weak retail sales and falling vehicle sales.

Insights on the US and FOMC policy

On February 18, I returned from a two week marketing trip in the US where I met with a number of FOMC members; real money managers; hedge funds; and corporates.

One consequence of this visit has been the decision to revise our forecast for the federal funds rate in 2019 from hikes in June and September to one hike which will be delayed until December.

We had been aware that on November 28 (Economic Club of New York) Chairman Powell noted: “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy — that is, neither speeding up nor slowing down growth”.

Subsequently on December 15, he further increased the federal funds rate by 25 basis points.

With that move and the expectation that the economy was likely to slow from a 3% growth pace in 2018 to a 2–2.5% pace in 2019, the appetite for rate increases from the Federal Reserve has dissipated in the markets.

While it is accepted that the consumer will continue to support growth, other, more cyclical parts of the economy, are seen to be slowing. These include business investment; housing and exports.

Even the economists who confidently expected multiple rate hikes from the Federal Reserve as recently as early December have now retreated to expecting “maybe” one more hike near the end of the year.

It is accepted that it will take considerable time for the FOMC to make a case for higher rates. The earliest likely opportunity would be around the Jackson Hole Conference in August. The Chairman is also likely to need to link any further hikes to a clear rhetoric around the economy (i.e. the FOMC did not raise rates, it was the US economy).

Proponents of the “neutral” setting approach accept that the measure of neutral is too imprecise to be able to assess that rates are at or above neutral.

It was much easier in 2018 – rates were clearly below neutral; and the economy had tailwinds – fiscal policy; global growth and easy financial conditions.

In 2019, rates are 100 basis points higher; the stimulatory effect of fiscal policy is dissipating and should a range of spending programs expire by 2019 H2 (as currently legislated), fiscal policy will become a headwind. In addition, global growth is slowing and financial conditions are tightening.

While equities usually have a relatively low weight in Finan