Stephen Miller
In some sense the September quarter national accounts don’t reveal much that wasn’t already known.
Private demand is weak, but apparent supply constraints (exemplified by ongoing languishing productivity) are a brake on how weakness in demand manifests itself in lower inflation.
That all said, there are some (very) tentative signs that private demand may be bottoming out. Household disposable income was assisted by the income tax cuts, albeit that much of that increase in disposable income found its way into household saving in the quarter. Nevertheless, household balance sheets are in better shape.
On productivity, some of the weakness can be attributed to employment growth being concentrated in the non-market sector together with declining mining output.
However, governments (federal and state) have not had their eye on the productivity ball for some time. A plethora of unnecessary regulation relating to “reporting and compliance”, obligations together with the adverse impact of a number of industrial relations measures make it difficult to confidently forecast a meaningful rebound in productivity and supply.
All of this would have been known (more or less) to the Reserve Bank of Australia (RBA) even prior to the release of the September accounts.
Inflation appears to be declining more or less in line with the RBA projections. The November projection revealed a very marginal acceleration in the expected rate of disinflation compared with the August projection.
Importantly, given the Board’s dual mandate, the labour market has showed resilience, and that resilience is forecast to continue, albeit with some slight rise in the unemployment rate.
That said, and as the RBA Board has acknowledged, there is a risk that the “pickup [in household spending] is slower than expected, resulting in continued subdued output growth and a sharper deterioration in the labour market.”
There is, as yet, no evidence of that “sharper deterioration in the labour market” but nor is there evidence of any pick-up in household spending.
The accounts reveal decelerating wage growth which likely reflects weaker employment conditions in the private sector. Languishing productivity growth means, however, that unit labour costs (the most relevant labour cost guide to inflation) are a little “sticky”, even if some of that productivity weakness is attributable to aforementioned compositional factors.
In any case, a deterioration in the labour market remains a non-trivial risk and one to which the RBA would certainly need to respond.
If, as I suspect, labour market outcomes and inflation outcomes are broadly in line with RBA forecasts (or inflation a little better and the labour market a little more fragile), then the RBA could conceivably cut rates in February.
That would certainly be the case if (trimmed-mean) consumer price inflation is below the RBA’s 3.4 per cent projection for the December quarter.
Markets have recently started to push out the likelihood of the first cut in the policy rate to as late as May.
Fair enough maybe, but I wouldn’t rule out February…yet!
Trump 2.0 and the RBA – be careful what you wish for?
I struggle with the notion that Trump’s tariffs will have any meaningful upward effect on Australian inflation and by extension contribute to a higher for longer RBA policy rate.
Of course, that is different from saying that any decline in the RBA policy rate may be later than markets had previously contemplated (even if I harbour doubts that will be the case). If it is the later, it will be for reasons unconnected with Trump tariffs.
If that is the case, Australian bonds may do better than US bonds and provide superior diversifying qualities to US bonds.
Trumps policies are inflationary for the US. But they will have a barely perceptible impact on inflation in Australia. That is the case even if China and others retaliate.
The more important impact is on Australian economic activity which would unambiguously suffer and that would be disinflationary.
US tariffs on imports from China, Mexico or the EU will not change the price of goods we import from those nations and nor will they alter in any significant way the price of goods the US exports to Australia (Australian import prices) except in those (I’m thinking limited) instances where tariffs attach to goods that are inputs into the production of US exports to Australia.
Tariffs will of course have an impact on US inflation.
Similarly, were China and others to retaliate it would not change the price of goods we import from the US or the price of exports from those countries to Australia (Australian import prices), again with a caveat attaching to tariffs applied to goods that are inputs into the production of exports bound for Australia.
The only way in which there is a significant price impact in Australia will be if we “shoot ourselves in the foot” by engaging in retaliatory tariffs.
There may be some effect via the exchange rate (i.e. lower AUD leading to modestly higher import prices) but more importantly, rather than inflation being the more significant effect locally (and globally as well), of greater significance will the consequences for activity growth and employment and these effects will be disinflationary.
If in fact the bigger impact is disinflationary, then “other things equal” that argues for lower policy rates sooner in Australia.
Global trade wars are an internecine by nature. Global growth will suffer in a global trade war and given our leverage to the freer international trade, the Australian economy will suffer a hit to growth (bigger than most) and an attendant disinflationary impetus.
It could be a case of “be careful what you wish for”!
The RBA may lower the policy rate but only because the economy is in worse shape than it otherwise would be as a consequence of a global trade war.
Coming up: US November non-farm payrolls; Next week’s CPI release may be critical for the Fed
When the Federal Reserve (Fed) first enacted its “jumbo” rate cut back in September it cast that decision as reflecting the notion that inflation risks have diminished while labour market conditions are at some risk of deterioration.
Of course, it subsequently followed up that decision with a further cut by 25 basis points (bps) at the November meeting.
Arguably, the news flow since September has assuaged concerns that the labour market is cooling too rapidly but at the same time reignited concerns over “sticky” inflation.
Among the distractions afforded by the policy consequences of a new Administration, the November US monthly non-farm payrolls report to be released on Friday represent something of a return to normality for markets.
These figures are released after comments overnight from Fed Chair Powell that the Fed can “afford to be a little more cautious as we try to find neutral”. The Chair also noted the economy is in remarkably good shape.
Against that background the payrolls report will of course be keenly watched.
On balance markets see a further 25 basis point (bp) rate cut when the Fed’s FOMC next meets on 17-18 December rating the probability of such a move at around 70-75 per cent. Such a move would also be consistent with the Fed’s “dot plot” issued back in September.
Friday’s report might be critical to assessments of the applicability of the Fed’s “dot plot” attaching to 2025 which currently has a further 100 bps of easing projected in 2025 taking the policy rate to 3.4 per cent.
After initially thinking that such a number was on the conservative side, markets have priced in something closer to 75 bps of easing in 2025.
The more elongated and shallower rate cutting path reflects stronger activity and employment and projected “stickier” inflation.
The consensus estimate for November non-farm payrolls is for an increase in employment of around 200k and an unchanged unemployment rate at 4.1 per cent (with some small upside risk). Wages growth, as measured by average hourly earnings, are expected to grow by 3.9 per cent, slightly down from the 4 per cent in October.
The October Job Openings and Labour Turnover Survey (JOLTS) report released on Tuesday were stronger than anticipated and while maybe not inconsistent with some ongoing cooling in the US labour market they remain some way from signalling any worrying dislocation.
The ADP June payrolls report released overnight showed employment growing by a respectable enough 146k (even if that is somewhat short of the expected 166k). That too is a far from worrisome picture of the labour market. While a reasonable enough indicator in and of itself, its record in foreshadowing month-to-month movements in the Bureau of Labor Statistics payrolls measure is at best mixed.
The employment component of the Institute for Supply Management (ISM) manufacturing Purchasing Managers Index (PMI), increased from October, albeit that it remained in contracting territory. More important was the employment component of ISM non-manufacturing PMI, released overnight. That component fell from October but remains in expansionary territory.
An outcome close to expectations for the aforementioned components of the non-farm payrolls report won’t move the dial for the Fed.
Whether that dial moves to a “no rate cut in December position” is somewhat dependent on next week’s consumer price index (CPI). The 3-month annualised rate of increase in the core CPI troughed in July at 1.6 per cent. In October it was 3.5 per cent. An outcome for November close to that 3.5 per cent makes it more likely that the Fed eschews a policy rate cut in December.
It also sets up an interesting 2025 given new occupants of the White House from January 2025.
By Stephen Miller, investment strategist
