Fed forecasts still well above the private sector

Its curious in hindsight that the market was surprised that the Fed failed to reduced bond purchases back at the last meeting, when the private sector has been much more bearish on growth.  Even following the recent downgrade to FOMC member expectations, growth at 2% for 2013 remains well above the 1.6% consensus number, with the FOMC also above in 2014.

If the private sector doesn't expect the Fed to hit their numbers anytime soon, then markets should be skeptical about the prospect of tapering in the near future.

It seems unlikely that growth will surprise to the upside given the federal government shutdown, although momentum is potentially better than expected before the political deadlock began.  The latest ISM data were healthy at both the headline level and in the details.

It would have probably taken more than a good ISM reading to convince the Fed that the tapering delay was only going to last one meeting.  And with other uncertainties emerging, it seems likely that they will sit on their hands for a bit to gauge the fallout from the current issues in Washington.

Aus GDP: muddle-through Q2

Aus GDP growth was a little bit better than expected at 0.6%QoQ and 2.6%YoY in Q2, with quarterly growth a little better than the last 9 months or so.  Details of the data, however, don't paint a picture of improving conditions, with growth likely to resuming slowing in 2H13.

The details of the expenditure measures of GDP were once again confused by a transfer from the public sector to the mining sector in NSW, with the following charts adjusting for these large flows that confuse real contribution to activity.

All areas of investment were a small drag on economy in the quarter, although it was nothing particularly dramatic from any one area.  Household consumption was a little better than expected, while inventories also made a large contribution as heavy destocking in the wholesale sector in Q1 ended.

Getting caught up in the the QoQ movement can miss the bigger picture, which continues to be one of weakness in investment weighing on the overall economy.

Looking at YoY contributions to growth, private sector investment is now a drag on GDP, although stronger net exports is helping to offset this.

When adding in the household sector, its not apparent that lower interest rates are supporting the switch in drivers of growth just yet.  The contribution from consumption has edged lower, but its dwelling investment that has yet to make a meaningful impact on growth.  This should come in the coming quarters, although won't be massive.

Government investment is also turning into a small drag on the economy. Fiscal consolidation has become a more pressing issue, although the next likely Coalition government will have to be careful that they don't contribute to a potential recession rather than help offset it.

Adding in the movements from inventories gives an overall slower picture, albeit not disastrous at this stage.

Policy makers still have time to boost other sectors as investment continues to roll over.  This decline will intensify from a YoY standpoint, with private sector investment already 5% off its peak levels of December 2012.

I think this will take growth below 2%YoY, even with the improvement in other sectors in train.  While this is not a total disaster, its still below the expectations of the Treasury and the RBA and implies more rate cuts and AUD weakness.

US GDP & the FOMC

There were some notable changes to the FOMC statement following the most recent meeting. The FOMC was more downbeat about economic activity, which is now "modest" rather than "moderate". This gels with the GDP data released this morning, which while better than expected was still a rather slow 1.7% ann.

The FOMC also made a stronger statement about the downside risks from low inflation. It also seems they no longer believe it is "transitory" but nevertheless should return to target over the medium term.  This seems to have appeased FOMC member James Bullard, who dissented in June.

The Fed are likely conscious of saying too much with regards to the path for policy given the violent reaction in bond markets over the last couple of months.  The Fed acknowledged that the sharp rise in mortgage rates could have a detrimental impact on the housing market and will want to avoid shifting mortgage rates higher again.

It is too early to say what impact the 100bps jump in mortgage rates has had on the housing market. In the very near term it will likely actually boost sales as those who are close to buying homes will be rushing in to secure loans before rates rise further.

Subsequently sales data could provide a bit of a head fake in terms of the resilience of the housing market, with a potential fade out in 3 months time giving a better guide to how resilient current housing demand is.

GDP growth for Q2 ended up being a bit better than forecasts based on the partial information to date, thanks to stronger inventories.  But at 1.7%QSAAR, its hardly strong.  To be sure, over the last 9 months has been a shade under 1% annualised.

Some of this weakness is expected to fade given now is the point of maximum pain from fiscal consolidation.  Less of a drag from government cuts and tax hikes on consumers is expected to lift current growth rates closer to 3%, although it will be a struggle to get to Fed estimates of 2.3-2.6% for 2013 as a whole.

These GDP data also included some large revisions to historical data following a reevaluation of the GDP methodology by statisticians at the BEA.  The level of GDP at the end of 1Q13 is now 3% higher than it was previously estimated to be, with growth in recent years revised higher.

This perhaps gels better with the labour force data which previous showed a break in relationships between employment and GDP growth.

But this really a distraction to the road ahead.  The bottom line is growth is currently weak and it should not be taken for granted that things will get better once we pass the point of maximum pain from fiscal contraction.  While the downside risks to growth may have diminished since last year, the Fed doesn't want to get in the way of things by unnecessarily tightening financial conditions.

Piecing together a soggy Australian GDP picture

The latest GDP data were a little below expectations at 0.6%QoQ and 2.5%YoY.  Most importantly, this is below where the RBA is looking for growth, with the risks over the next 12 months to the downside.  This means more easing, lower bond yields and a weaker Aussie dollar.

While growth of 2.5%YoY is by no means disastrous, the challenge is to stop it slipping further. This remains all the more difficult given the RBA has already lowered interest rates quite alot, while fiscal policy remains focussed on reducing deficits.

It is also increasingly difficult as it is  becoming clearer that the investment cycle will soon be much larger drag on growth, with it unlikely that the other components of growth will fully offset this decline.

The chart on the left shows my expectations for growth 12 months ahead.  The big challenge is that the light blue business investment component, which is already fading as a growth driver, will likely fall significantly. Net exports should continue to contribute strongly, although not any more so than present.  Housing investment is also projected to add 0.7ppt, but this isn't enough to stop growth from falling from the current rate of 2.5% to ~1.8%.  This is below the RBA's expectation of 2-2.5% for next year.

Looking at the 1Q13 data shows that the challenge of managing weaker business investment has already begun.  Private business investment was a 1ppt drag on quarterly growth when adjusting for a large private to public transfer last quarter.  The negative momentum in the capex data suggests this will only get worse.

Net exports helped fill this gap, although a big driver of this was via weaker imports, which points to poor domestic demand.

Consumption activity has been rock steady despite an uptick in unemployment, but dwelling investment has so far disappointed.  This should rise in the next 6-12 months given the recent jump in housing finance and building approvals.

Government investment was actually a little stronger in the quarter, but is a drag on yearly growth.  This will only get larger given the push for fiscal consolidation from both political parties with an election looming.

So far the picture isn't too bad, but 1Q also saw significant destocking, which was a surprisingly large drag on activity.  In particular, inventories at a wholesale level were drawn very sharply, while mining also destocked to support exports.

Aus GDP ends 2012 OK, big challenge for 2013 remains

GDP growth came in line with expectations at 0.6%YoY and 3.1%YoY.  As expected, the backbone of this was strong export growth, although some of this was driven by destocking from mines and ports.  Domestic demand was slow, with not much happening in consumption or investment.

Looking at quarterly contributions to growth is a bit misleading on the investment side, as the a change in ownership of the Victorian desalination plant makes the swings in public and private investment look huge, when in reality its a wash.

The contribution from domestic final demand of 0.3ppt follows a zero in the September quarter, with the last 3 months about as weak as it gets for domestic final demand outside a recession.

Luckily the dividends of investment are coming through with exports lifting.  Because some of this was driven by destocking, its hard to know what net exports will look like in Q1 next year when taking into account inventory movements.  On the domestic consumption side, housing and consumption might be a touch better, although not radically so.

Looking at the bigger picture 3.1%YoY growth is pretty good, with 2.5% annualised over the last 6 months not disastrous. So the Australian economy has managed a transition in the drivers of growth to date without suffering terribly.

Consumption has been contributing less to activity than prior to the financial crisis as households consolidate balance sheets.  But the big drag from net exports has been reversed.

Government investment has also pulled back after the big surge during the crisis, with the gains in the current quarter more about accounting than growth.

Private sector investment has been providing a strong contribution to growth through mining investment, although is starting to provide less to growth. Again, the data in the last quarter are impacted by an ownership change of assets.

The challenge now is that the light blue part of the chart is going to shrink further and more rapidly and its not clear how much of an offset the economy will get from elsewhere.

While interest rates have been cut quite a bit, the impulse on activity has not been very big.  And I think the reduction in capex plans is much more concerning than most analysts have interpreted from the latest capex survey (see this post).  Subsequently it seems likely to me that growth will be quite a bit lower than current rates over the next 12 months.

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RBA changes very little

Along with leaving interest rates on hold, the RBA didn't change the accompanying statement very much from the February announcement. The assessment of the global economy was practically identical,  as was the outlook for inflation.

There was only scant change to the assessment of domestic conditions as well.  On investment outside of the resources sector, the RBA added "recent data suggest some prospect of a modest increase during next financial year", although now judges dwelling investment to be "slowly improving". On resources investment, there was no change to the statement, suggesting the most recent capex data had not done enough to change their current view on when it will peak.

The fact that GDP is likely to come in under the Bank's forecast of 0.7%QoQ also doesn't seem to be much of an issue.  For my money, it looks like it will be ~0.3-0.4%QoQ.

With the final statement also unchanged, it would appear that the RBA retains an easing bias. I think there is enough in the data to suggest they probably will need to cut again probably earlier than the market is anticipating.

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Aus Q4 GDP looking wobbly

Today's release of construction work done was bad news for Q4 GDP.  Private sector construction slipped 0.5%QoQ, which after astronomical growth in the last few years is not hugely surprising or concerning in itself.  The problem is that there is not much happening elsewhere.

Retail sales barely grew in Q4, although household consumption will get a bit of a lift from stronger car sales.  Data on equipment investment are released tomorrow, although its hard to believe they will be strong given how poor business sentiment was. 

Net exports will probably be decent, although this is partly down to a surge in December of iron ore and coal which at least in part was thanks to destocking (see this post).  Inventories appear likely to be a drag given they rose quite a bit in Q3, so even a slower increase would be a substantial negative.

Tomorrow's data on capex expectations will probably be much more important than this for policymakers and punters alike.  But don't forget to check what has happened in the recent past, for which I'd take the under on forecasts for Q4 GDP.

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visualising US GDP

The advanced US GDP data for 4Q12 were disappointing with the US economy recording the smallest of declines.  Much of this was attributed to lumpy factors, like a big fall in in defense spending and a slower rate of accumulation of inventories.

The weakness in the quarter doesn't seem to have much to do with weather effects, with consumption and business investment still ok while housing construction made a meaningful addition to growth in the quarter as well.

Nor does it have much to do with the "fiscal cliff" debate. Perhaps the slower build up of inventories could be attributed uncertainty over the "fiscal cliff", but  the reality seems to be that the impact on growth seems to have been over exaggerated.

The chart below looks at the contributions to growth over a longer time period on a YoY basis to put more recent growth into perspective.  Growth has been sub-trend for years now, which is a very poor outcome in the context of the decline in 2008/09.

The darker blue consumption component has been consistently adding less to growth than prior to the crisis and this probably wont change anytime soon.  Business investment has been ok, although government spending has been a major offsetting factor.  So far it has been mostly at a state and local level, but this will now transfer to the Federal level. Net exports have been pretty much neutral to activity.

The hope is that the light orange component of housing will start to make a more meaningful contribution, which should have positive spillovers into employment and consumption.  But the upside here is not particularly high, perhaps we can get a bit closer to trend growth, but it will probably prove elusive.

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China data deluge: GDP, steel and power

There was a huge amount of data released on China's economic performance today for 2012.  GDP is the headline grabber and was a little higher than expectations in Q4.  The YoY measure rising 7.9% and quarterly growth at 2%.

There was some revision to seasonal factors on the quarterly data buried in the release, although this doesn't appear to have affected the headline measures too much. This was actually a little weaker in Q4 vs. Q3, suggesting in aggregate growth was actually weaker, contrary to all reports, expectations and even interpretation of the end of 2012 in China.

 I've always found series like fixed asset investment hard to use as growth rates don't seem to deviate much from very high levels, which seems totally at odds with the volatility of markets.  Besides, for things like commodity consumption, we can always look at steel production or power generation to give us a better sense of the industrial economy.

Power production data seemed to have been revised upwards for the whole year in terms of levels, although the growth rates haven't signalled too much of a change.  Total generation was up 7.6%YoY in December, with full year growth at a slow 4.7%.

So the improvement seen through Q4 continued in December, although the pace of improvement wasn't spectacular, especially given the weak comps of 4Q11.  The industrial production mirrored this change.

Crude steel production was reportedly weaker in December at 678mt ann.  That said, as reported in this post, this probably contains under reporting from small mills, which annually disappear off the radar around the end of the year.

There does appear to be some revision to historical in these data too, with full year crude steel production reported at 716.6mt, with the reality probably a little higher than this.

These data confirm industrial activity finished the year with better momentum, although there is an issue with weak comps.  Perhaps the the QoQ GDP data i most accurate, which suggests things were around on par with Q3.

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