Licensee Economic Update – October 2013
Global financial markets started September worried about the situation in Syria and amid expectations that the US Federal Reserve [Fed] would start the Taper imminently. By the end of the month, these issues had been well and truly eclipsed by the political stalemate in Washington over the US fiscal position.
Markets have reacted nervously but as with all political posturing, they always revert to the long term outlook and this has been witnessed with several days of high fluctuations.
Somewhat disappointingly, in the short term post-election, the Australian economy continues to run below-trend, although sentiment indices showed some improvement for both households and businesses. The Reserve Bank left the cash rate unchanged at 2.5% at its October Board Meeting. With continued strengthening of the housing market particularly on the Eastern seaboard it is unlikely this will change on the immediate future. The strength of the housing market is stimulating growth and revenue on the one hand but is putting pressure on downward rates on the other.
Despite the concerns and difficulties confronting markets in September, equities still rallied with emerging markets outperforming as the Taper was delayed further. This surprised some economists who favoured mature economies and is a timely reminder again that diversification yields steady returns often contrary to professional forecasting. Bonds had a better month, but commodities weakened. The $A rose as the US$ slipped in response to developments in the US.
Figure 1: $A picked up in September while commodities fell
Although the RBA noted that the Australian economy is still operating below trend, commentators cited recent improvements in consumer and business sentiment as well as increases in house prices, notably in Sydney, as reasons for the RBA to wait and see how the economy will react to the interest rate cuts already working through the economy.
At this stage it is hard to know if the improvement in the sentiment indices reflects a temporary response to the change of Federal Government – or at least relief that the election is finally over – or the start of a more sustained improvement. There is some evidence that the stronger equity market is having a positive wealth effect on household confidence and it is reasonable to expect that the depreciation of the $A so far will have helped business confidence.
Figure 2: A wealthier household is a happier household!
The unemployment rate rose to 5.8% in August from 5.7% in July and the Westpac-Melbourne Institute consumer sentiment index rose 4.7% in September and 12.7% over a year earlier. In other news, the World Economic Forum released its latest Global Competitiveness Report, which ranks 148 countries on various measures of competitiveness. Australia’s ranking fell to 21st in the world, down from 20th the previous year. Labour market rigidities and excessive government regulation were cited as factors hurting Australia’s overall competitiveness.
September saw the fifth anniversary of the collapse of Lehman Brothers, following what may have been one of the worst policy decisions in modern times. By letting Lehman collapse it now appears the US Treasury and Federal Reserve turned a worse-than-average cyclical downturn into a full-blown global crisis. Sending a message about moral hazard was one of the reasons behind their decision. Fast forward to today and many question whether Ben Bernanke – then head of the Fed, would think it was worth it and would do it again?
The messages coming out of Washington continue to cause uncertainty and volatility in global markets. Pretty much everyone had expected the Federal Reserve to start easing back on the easing program in September – the start of the so-called Taper. And yet when the moment came, the Reserve baulked at the hurdle, citing uncertainty about the strength of the economy. The latest figures from the United States suggest the broad pattern of moderate recovery we have seen for most of 2013 is continuing.
- 169,000 new jobs were created in August with the unemployment rate falling from 7.4% to 7.3%, although a lower participation rate contributed to this;
- Consumer sentiment fell in September;
- Retail sales rose 0.2% in August, a bit less than had been expected;
- The CPI rose 0.1% in August and 1.5% over a year earlier;
- New home sales rose 7.9% in August after a big drop in July;
- The ISM manufacturing PMI increased one point over the month
It seems likely that The Federal reserve was also influenced by the fiscal fight between the Democrats and Republicans which has led to the first government shutdown in seventeen years and heightened tensions ahead of the mid-October deadline for lifting the Federal debt ceiling. Financial markets have generally expected these issues to be resolved without significant disruption to the US economy. In particular, failing to lift the debt ceiling could have very severe consequences which would unravel much of the hard-won gains of economic recovery since the GFC. It does not seem rational for US politicians, no matter how dogmatic, to let this happen.
All going well, financial markets continue to expect the Taper to commence in coming weeks. If the shutdown is not protracted it will have a transitory effect with slower spending now being offset by some pickup when workers receive back pay.
Finally from the US, the race for the Chairmanship of the Federal Reserve was simplified with Larry Summers dropping out to save the President from an embarrassing rejection of his nominee in the confirmation hearings. Insider Janet Yellen will be nominated to succeed Ben Bernanke. Yellen has been a strong advocate of the easing program.
A consequence of the delayed start to the Taper has been that the US dollar has softened again and as a result the $A has consolidated its position above $US0.90. The Reserve Bank has made it clear it would like to see $A fall further to help the domestic economy, but the Board of the Bank refrained from facilitating this and left the cash rate unchanged at 2.5% after its Meeting on 1 October.
Politics were a headline issue in Europe again with elections in Germany and Silvio Berlusconi Trying to bring down the Italian government to somehow protect himself from the consequences of his court convictions and pending incarceration. Fortunately this did not come to pass with Berlusconi being forced to back down after the Government comfortably won a confidence motion in Parliament. Angela Merkel won a strong personal victory in the German elections but still needs a coalition partner to form government.
In other news, Slovenia emerged as “the next Cyprus” requiring financial support from the rest of the Eurozone. The ECB again stated that it will keep monetary policy accommodative for as long as necessary and said that the improvement in financial markets over the past year are working their way through the economy. The ECB also specifically said it stands ready to help banks if they need liquidity.
China ….& elsewhere
The latest figures from China showed retail sales rose 1.2% in July and 13.4% from a year earlier and that house prices rose further in most major cities. However, manufacturing data continues to paint a mixed picture with official figures showing an improvement in manufacturing while the HSBC flash figures told the opposite story. This may be an ongoing challenge for Chinas business community and Government credibility with figures.
In India, the newly-appointed Governor of the Reserve Bank of India increased the repo rate by 0.25%, to the surprise of the markets. India faces a mix of economic problems including too much inflation and too high a current account deficit. In its latest report the Asian Development Bank cited slower growth in both India and China as key factors for downgrading the regional growth outlook.
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