Economic Update – April 2015

The main focus for the month in markets was the speech by Dr Janet Yellen, the United States (U.S.) Federal Reserve Chair. As with our own Reserve Bank (RBA), analysts go through every word looking for the slightest change in policy stance. This month, analysts expected the word ‘patient’ to be removed from Yellen’s words in reference to the timing of the first rate hike.

Expectations had fluctuated between June and September as the start point for hikes. Yellen deftly did indeed remove the word ‘patient’ but emphasised that it did not mean they were now ‘impatient’. Markets loved that and surged on the news.

Moreover, the Fed forecast for the Fed rate was halved with 2015 now expected to end at 0.625%. The previous (December 2014) forecast for 2015 was 1.125% and before that it was 1.35%.

Clearly, the view now is that the first rate hike will be very small and that may, indeed, be the last increase for some time.

The US nonfarm payrolls (jobs) data again came in very strongly with more than one million jobs having been created in the last three months. Unemployment fell from 5.7% to 5.5% but the hourly average wage rate fell back to +0.1% from +0.5% in the prior month. It is this statistic above all that will show any real signs of life in the economy or not – at least in terms as to whether the US economy can sustain a rate hike.

At home, the RBA left our rate unchanged but the market has priced in a cut for April or May. Our jobs data were better than many expected after the previous month’s slippage.

We created +15,600 new jobs which were more than those lost in the previous month. Moreover, the December jobs data were about three times bigger than the one just released! Unemployment fell from 6.4% to 6.3%.

Our economic growth was not great at +0.5% for the quarter and +2.5% for the year but such figures are not weak – they are just a bit below trend.

The Intergenerational Report was released by Joe Hockey in March and it showed that, under a no-change in economic policy scenario, our National Debt to GDP ratio would rise to 122% in 40 years – from 12% today – and put us in the same debt category as those countries in Europe and elsewhere that we now think are struggling.

As we said in our budget paper report last May, the government was on the right track but it failed to sell its story. It just released a ‘White Paper’ on tax reform to open up that discussion. Carrying on doing what we are doing is simply not an option and it never was in recent years.

With only 2% of taxpayers contributing 26% of the total personal tax collected by the country, raising the top rate is not the answer either. Importantly, the government is declining to cherry pick one tax or benefit at a time but to stand back and take the country into a full and proper realisation of the extent of our problems and its solutions.

Not only the discussion but also the reduction in the speed of budgetary change will stimulate the economy more than we all previously thought. Things are starting to look pretty good.

We have estimated the fair price of the market to be 5,750 meaning that we are ahead in making our forecasts made last June and which we refreshed on January 1st. The end-of month March close on the broader index was 5,892 so we are about +2.2% overpriced.

The market is so close to 6,000, the first crossing since early 2008 is most likely to happen soon but it did get to 5,996 on March 3rd 2015 before a very sharp retreat! Markets often get the jitters around ‘big numbers’ like 6,000. We are confident that closes above 6,000 (and retreats) will be common in the coming quarter and may even ‘stick’ at some point near mid-2015. Our 2015 forecast is for a close at 6,150 and a temporary ‘high’ before that of 6,500. In other words, the November 2007 high might seem tantalisingly close within the next 12 months.

As we stressed last month, with more rate cuts on the horizon by the RBA, cash is certainly not king. When rates start to rise, they might rise quickly! High yield stocks could then take a small beating with capital losses wiping out their recent yields.

Yellen helped us all with her well-chosen words but one day those words must include ‘rate increase’. Then, there will almost certainly be some market volatility to follow – even though we all know it will happen and the real impact of a tiny rate rise will be small. It’s a bit like being told at a New Year’s Eve party that ‘the party’s over’ – even though it is 3am.

Around the world many government bond yields are close to zero or even negative. Our ten year yield stands at about 2.3%.

What is interesting is that only 7 of 27 economists surveyed by Bloomberg expect a cut on Tuesday 7th April but the market – those people who take actual financial positions – are pricing in a 70% chance of a cut. It seems easier to position for a cut on Tuesday than simply be forced to wait a month for some action, if necessary. Missing the cut means the chance has gone!

The US Fed is in no rush to raise rates but there are consequences on its growth when it eventually does. Quite frankly, the current Fed rate range of 0% to 0.25% is not very different from 0.25% – 0.50% after one little hike, but markets would react negatively in the short run. We still think a hike before September is unlikely.

The US jobs data due out on Good Friday (they don’t have a holiday like us!) will give us a big clue – if we focus on how much workers are earning (via the hourly average wage rate) rather than the actual number of people working. If wage rates are not rising, there is no real pressure in the economy that needs subduing and rates will likely be on hold in the US.

What was fascinating in a Boston Federal Reserve research paper at the end of March (they usually fall far short of exciting) is a survey that is showing a big shift to so-called ‘informal’ employment – such as baby-sitting and dog-walking – which is not necessarily reported to the relevant agencies – including the IRS! People in the US have been supplementing full and part-time work at quite an unprecedented rate.

At least 24 countries have cut rates so far this year. It will be a brave Central Banker that bucks the trend. New Zealand tried it and regretted it!

Oil prices are still low but off the recent lows. The Saudi Arabian incursion into Yemen is increasing oil-price volatility even further.

Gold got back above $1,200 / troy ounce but it has returned to bubbling along just below that level. Our dollar has been fluctuating in the high seventies but it did fall ???2.0% over March.

Queensland and NSW had state elections that came in with starkly opposing outcomes. The political party popularity polls have started to move, but more importantly, the government has massively changed its short-term policy stance. It seems to have the same long-term plan for Australia’s future but it now realises (at last) that it must take the electorate with it.

We find it exciting and refreshing that positivity has replaced negativity – at least on the business TV channels.

There are so many confidence polls these days it is difficult to make sense out of the very small changes that we have been seeing in each poll. We can summarise that the results are not yet strong – neither are they seemingly deteriorating. If we are correct in our assessment of the impact of the more recent changes in the government’s approach, both business and consumer confidence levels might be seen to start rising sharply from the end of April.

The new China growth plan is targeting economic growth of 7% going forward, from 7.5% last year. China’s inflation (CPI) came in at +1.4% against an expectation of +0.9%. The limited stimulus is helping get the rate of inflation back into the target band.

US growth came in at +2.2% in its third and final revision for Q4, 2014. However, most commentators are attributing the particularly cold weather for bringing growth down to that modest rate. On the other hand, the consumer spending part of that GDP read was very strong at over +4%.

The US is starting to struggle with its stronger dollar. After several years of having a weaker dollar because of its stimulus programmes, it is now on the other end of the stick. Japan and Europe have big stimulus packages on the go while the US ended its last October.

Had the new Greece party done a better job, there could have been some very negative ramifications for the whole European economic situation.

The ECB has lifted its 2015 growth target to +1.5% but lowered its inflation forecast to 0.0%. Slowly but surely, the recession fears are receding.

Russia is reportedly talking to Argentina over the rightful ownership of the Falkland Islands that caused a war between Britain and Argentina in the early eighties. Russia is also looking for other allies around the globe. The dominance of the US and Europe is slipping. China and Russia are playing bigger roles.

And now Saudi Arabia has mounted air strikes on Yemen. One media outlet questioned whether this could amount to a ‘Vietnam-like conflict’ that the US, Australia and others were involved in over 50 years ago. One can only pray that the parallel is far from reasonable.