Cliff Notes: Concerns Over Growth Near and Far

Fundamental analysis of Forex market

Key insights from the week that was.

The past week has been another focused on monetary policy and political matters, both in Australia and offshore. Markets have remained volatile as a result, foreseeing a need for ultra-lose monetary policy to limit the risk of another marked deterioration in conditions.

Beginning with the RBA’s August meeting, on the whole the statement was as expected, with the cash rate left unchanged and guidance in the final paragraph again pointing to a multi-month pause between cuts as conditions are assessed.

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The revised forecasts in Friday’s Statement on Monetary Policy also subsequently met expectations by remaining constructive on the outlook. While the growth and inflation forecasts were lowered for 2019, in 2020 GDP growth is still seen at trend and, come 2021, inflation is forecast to be back at the low end of the RBA’s 2-3% target range. These forecasts are predicated on the two further cuts the market has priced in over the coming year as well as the 2019 tax cuts.

To our mind, this stimulus notwithstanding, the RBA’s forecasts are still too optimistic. Whereas the RBA believe that the unemployment rate will hold at 5.2% in 2020 (previously 4.9%), we instead believe it will rise to 5.6%. In accordance, we foresee growth below trend in 2019 and 2020, and enduring disappointment for inflation.

While the rate cuts delivered to date and those we expect in October and February are justified by domestic weakness alone, it is worth highlighting that the RBA have also recognised “increased uncertainty” offshore related to “trade and technology disputes” and that “the risks to the global economy remain tilted to the downside”.

Across the Tasman, offshore developments were also clearly on the mind of the RBNZ as they cut their cash rate by 50bps, an unprecedented move in a non-emergency setting. Though domestic considerations were also front of mind, namely disappointing GDP growth and low business sentiment as well as housing market weakness, arguably recent global developments is what led them to decide that ‘getting ahead of the curve’ was appropriate. With these forces to remain active in coming months, our New Zealand team now expects another cut in November. Thereafter however, a much more constructive domestic economic outlook in 2020 is anticipated to preclude further action.

That being said, it is clear that RBNZ as well as the RBA are increasingly mindful of the skew of risks and their open-ended nature. As such, both banks have noted that an assessment of possible unconventional policy measures is prudent. Highlighting the views of the RBA, in response to questions during his testimony to Parliament today, Governor Lowe noted that any use of such measures would depend on the circumstances of the situation, but would likely be focused on reducing the risk-free rate further out the term spectrum (i.e. government bond yields) and, based on offshore experience, was most likely to be effective if delivered as a package of measures.

A full analysis of the Governor’s testimony and how it relates to our view is provided by Chief Economist Bill Evans.

Before moving further afield, Antipodean data out this week pointed to another positive foundation for consumption and housing in New Zealand, their unemployment rate falling to a 11-year low and wages growth picking up, as well as an outsized contribution to Australian GDP growth from net exports in the June quarter, with the trade balance hitting a new high of $8bn in June. Note on the latter that, even with a 0.4ppt contribution from net exports, we still only see GDP growth of 0.5% in the June quarter as domestic demand remains weak.

Tensions between the US and China continued to flare this week as China responded to President Trump’s new tariffs by allowing USD/CNY to lift through CNY7.00 and remain above that level through the week. Targeting a key ‘good-will’ gesture from previous negotiations, Chinese authorities also reportedly told State Owned Entities to halt purchases of US agricultural goods. It is still early days in assessing the implications of these developments, but at a minimum it highlights that current uncertainty is set to persist for an extended period. As we highlighted late last week, this is cause for the US FOMC to be pre-emptive with policy so as to avert an undue slowing in investment and consumption growth. Highlighting the risks that the US economy is facing, following persistent weakness in business investment, the July employment report suggested corporates are now ratcheting back their demand for labour, the 6-month average nonfarm payrolls gain coming in at its weakest level since 2013.

For all the implications of recent developments for the US, China, the global economy and financial markets, see our August Market Outlook.

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