Key insights from the week that was.
This week highlighted Australia’s continued outperformance coming out of the COVID-19 recession. In the US meanwhile, there was clear evidence of the FOMC’s willingness to provide extraordinary support for years, if necessary.
Beginning in Australia, the Federal Government’s mid-year fiscal update revised down the projected Federal Budget deficit for 2020/21 from $213.7bn to $197.7bn, 9.9% of GDP, and the cumulative deficit over the next four years by $24bn to $456.6bn. The economy has rebounded more quickly and the outlook is promising; the iron ore price has also, at least up until now, provided an additional dividend to nominal income and hence the budget position. While the Government’s outlook for the real economy is broadly in line with our own, we believe both the outlook for nominal income (thanks to the iron ore price) and the labour market can beat the Government’s current expectations, further improving the Budget’s bottom line.
Speaking of the labour market, in November another 90k jobs were created as Victoria rebounded from its second lockdown. This follows a 180k gain in October and leaves the level of employment just 1.1% lower than March 2020, pre-pandemic. Despite a 0.3ppt increase in the participation rate, November’s employment gain drove the unemployment rate down 0.2ppts to 6.8%. Highlighting Australia’s recovery from COVID-19 more clearly, our estimate of effective unemployment (which takes into consideration those working zero hours for economic reasons) has more than halved from its April peak of 15.3% to 7.5% currently.
Of course these benchmarks still point to a substantial degree of slack in the economy which is restricting both wage and consumer price inflation. The consequence is that, despite anticipating a robust recovery in activity through 2021 and 2022, we believe the RBA will need to continue with quantitative easing over the period, extending the program by another $100bn from May 2021 to October 2021, then in two further $50bn six-month increments over the following year.
Another reason this policy will be required is that all the major central banks of the developed world are facing the same issues as Australia and are responding in kind.
Following the Bank of England in November and the European Central Bank last week, at their December meeting the US FOMC made clear their willingness to extend more support. Instead of increasing the monthly purchase pace, the FOMC decided to increase the time they are willing to continue purchases. Previously the commitment was only for “coming months”. Now it is “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals”.
On the FOMC’s forecasts, most notably an unemployment rate still above pre-pandemic levels at the end of 2023 and inflation only just getting to target at that time, this new policy guidance could be used to justify years of quantitative easing. Moreover, the FOMC regard uncertainty to be historically elevated and risks skewed to the downside. On this point, note that November retail sales materially disappointed expectations this week and, affected by growing restrictions on domestic trade, initial jobless claims rose for the fourth week in five.
For the US economy, these considerations point to financial conditions remaining highly accommodative, bolstering prospects for residential investment and durables consumption. Low rates and robust prospects for growth will also provide considerable support for financial markets, not only in the US but across the world.
2021 and 2022 are therefore expected to provide a positive environment for risk assets such as equities and the Australian dollar, which we see rising from its current level of USD0.76 to USD0.80 end-2021, then to USD0.82 in early-2022. The outlook for Asian growth and commodity prices also supports this view.
Cliff Notes will return in January 2021. We’d like to wish our readers a Merry Christmas and happy new year.