Strong labour market + global finance turmoil = conflicted RBA?

Last week, RBA Governor Philip Lowe explained that the choice between another 25bp hike rate or a pause in the tightening cycle at the upcoming 4 April 2023 monetary policy meeting would be guided by ‘four really important pieces of data’ - the latest monthly readings on the labour force, business conditions, inflation, and retail sales.

We received the first two of those data points this week (February’s retail trade data will be published by the ABS on 28 March and February’s monthly CPI indicator will be released the following day) and if the ABS labour force and NAB Business Survey were all that had happened over the past week, it would be pretty challenging to make the case for an imminent RBA pause. That’s mostly because of the labour market result, which showed falls in the unemployment, underemployment and underutilisation rates on a seasonally adjusted basis, rises in the participation rate and the employment to population ratio, an increase in hours worked, and a 64,600 jump in employment. No signs of weakness there. The NAB survey results were more mixed. On the one hand, forward-looking business confidence fell back into negative territory in February as the relevant index tumbled by 10 points; on the other, current business conditions remained healthy, even as the survey also continued to signal strong cost pressures.

Overall, then, this week’s numbers do not make a compelling case for a pause.

Of course, those two data drops were not the only things to happen over the past week. Rather more dramatically, the global financial system was shaken by the failure of three US banks. In particular, Silicon Valley Bank (SVB) went under in what was the biggest banking collapse since the global financial crisis and the second-biggest in US history after the 2008 closure of Washington Mutual. Fears of financial panic and bank runs spreading to other parts of the US financial system prompted rapid action from both the US Federal Deposit Insurance Corporation (FDIC), which announced it would extend deposit insurance cover to all deposits including those above the standard US$250,000 cap, and from the US Federal Reserve, which promised a new lending facility to provide additional funding to financial institutions on a favourable basis. At the time of writing, those moves had not been sufficient to calm market sentiment, however, with investors further discombobulated by developments around Credit Suisse Bank, which had been forced to tap liquidity support from the Swiss Central Bank.

You can listen to our (very) initial take on developments at SVB in a special episode of the Dismal Science podcast from earlier this week.

The past week’s sharp and abrupt rise in financial stress puts central banks in an awkward position. Continue tightening monetary policy to control inflation but thereby risk, intensifying the current market turbulence and undermining financial stability, or back down in the face of market pressure and hence confirm earlier fears that central bankers would ultimately blink when faced with costs involved in taming inflation. In the United States, the immediate market reaction was to assume not only that the Fed was now unlikely to tighten rates at its meeting next week, but to start pricing in rate cuts before year-end. Here in Australia, futures prices as of market close on 16 March were likewise predicting not just that the RBA’s tightening cycle was now done, but that rates were likely to fall over coming months.

With financial markets still unsettled by the past week’s developments, it’s too soon to judge what the RBA will actually choose to do, come 4 April. As we’ve  been reminded, a week can be a long time in the current economic environment, let alone two weeks and a bit. Granted, the RBA is in a somewhat better position than the US Fed. Unlike the former, it had already flagged the possibility of a pause in the tightening cycle, so any policy adjustment will look a bit less like a knee-jerk reaction to financial market pressure and more part of a considered policy process; the Australian banking system isn’t displaying the same pathologies applying to segments of the US system, which means the financial stability risk profile looks different; and the Australian policy meeting is further into the future, giving Martin Place more breathing room before it has to make its own call on interest rates. All of which should help. But as well as the domestic data flow, RBA actions will now also be dependent on developments in global financial stability.

To control inflation, central banks have been tightening monetary and financial conditions at an extremely rapid rate and in an extraordinarily synchronised fashion. As a result, ‘things’ – starting with crypto assets last year and now dramatically extended to include several banks – have started to break. How much more breakage is in store, and how large a bill the monetary authorities are prepared to pay as a result, in order to return inflation to target, has suddenly become a pressing question.

Australia’s unemployment rate is back down at 3.5 per cent

According to the February 2023 ABS Labour force release, after showing some signs of weakness in December and especially January, Australia’s labour market again looked in rude health last month (all figures seasonally adjusted):

• Relative to January, employment increased by 64,600 persons (0.5 per cent) over the month, while hours worked rose by five million (0.2 per cent). The number of unemployed people fell by 17,000.
• The unemployment rate fell from 3.7 per cent in January to 3.5 per cent in February and the underemployment rate fell from 6.2 per cent to 5.8 per cent. The underutilisation rate (the sum of the two) fell 0.5 percentage points to 9.4 per cent. With the exception of November 2022, when it stood at 9.3 per cent, this was the lowest underutilisation rate reported since April 1982.
• The participation rate edged up from 66.5 per cent to 66.6 per cent, while the employment to population ratio climbed from 64.1 per cent to 64.3 per cent.

We noted after last month’s reported fall in employment and rise in unemployment, that the ABS had cautioned that in January there had been a larger than usual number of people waiting to start a job, and that this might have skewed the results. That does indeed seem to have been the case, as in February, most of those people look to have either returned to or started employment, with the Bureau noting ‘larger than seasonal numbers of people entering into employment across New South Wales, Victoria and the ACT.’ The ABS also added that the number of people waiting to start a new job has now returned to normal levels.

As noted above, taken on its own, this labour market result would argue against the RBA choosing to leave rates unchanged next month, indicating as it does a labour market that is still very tight. But, also as noted above, that’s now only one piece of the puzzle that Martin Place is having to grapple with.

Meanwhile, we still have two more of those ‘four really important’ data points to come before April’s meeting.

What else happened on the Australian data front this week?

The NAB Monthly Business Survey for February 2023 reported that business confidence fell back into negative territory last month, with the index dropping 10 points to minus four index points. In terms of other forward-looking indicators, forward orders fell three points to +3 index points, while capacity utilisation eased to a still strong 85.2 per cent. In contrast, although the index for business conditions edged lower by one point, that still left it at a strong +17 index points, with all three sub-indices also deep in positive territory: trading conditions (+27), employment (+12) and profitability (+14). NAB also reported that inflationary pressures were still strong in February, with labour cost growth picking up to 2.8 per cent in quarterly terms and purchase cost growth unchanged at 3.1 per cent, while output price growth was also unchanged at 1.6 per cent.

The Business Survey was another of the  ‘four really important pieces of data’ that the RBA Board is to consider in deciding whether to pause in its tightening cycle at the monetary policy meeting next month. On balance, this release looks unlikely to swing the decision either way, with the softening in business confidence balanced by evidence of ongoing price pressures and strong current conditions.

The Westpac-Melbourne Institute Consumer Sentiment Index was unchanged at a reading of 78.5 for March 2023, keeping the index near historical lows for a second consecutive month. According to Westpac, back-to-back sub-80 index readings are rare – both the COVID shock and the Global Financial Crisis each only saw one month of sentiment readings at these levels, for example, and runs of sub-80 readings were last seen during the late 1980s/early 1990s recession and in the ‘banana republic’ period of 1986 after the Federal Government lost its triple-A rating.  Interestingly, this month’s results showed little difference in sentiment between respondents surveyed before the RBA March rate hike and those surveyed after, suggesting the increase was widely anticipated (but note the weekly confidence survey results noted below).  At the same time, the Westpac-Melbourne Institute Unemployment Expectations Index rose 2.9 per cent in March, after having already jumped by 10.6 per cent in February, indicating that more consumers now expect rising unemployment over the year ahead. Note, however, that in level terms this index is still below its long run average (122.9 vs 129, respectively).

The weekly ANZ-Roy Morgan Consumer Confidence Index dropped 2.9 points last week to an index reading of 77, its weakest result since early April 2020. The confidence index fell below 80 in all five mainland States, with the slump following (and likely in response to) the RBA’s latest 25bp increase in the cash rate. At the same time, weekly inflation expectations rose to 5.7 per cent.

The ABS monthly business turnover indicator for January 2023 reported month-on-month falls (seasonally adjusted) for seven of the 13 industries covered, with the largest decline for electricity, gas, water and waste services (down 10.1 per cent due to a combination of unusually cool weather and falling wholesale energy prices) and the largest rise for other services (up 4.5 per cent). All 13 industries saw turnover up over the year.

The ABS monthly household spending indicator rose 17.8 per cent over the year in January 2023 (calendar adjusted basis), with spending for services up 28.2 per cent and spending on goods up 8.6 per cent. Overall, eight of the nine household spending categories were higher in January 2023 than in Omicron-hit January 2022, with transport (up 41.5 per cent) and hotels, cafes and restaurants (up 38.5 per cent) leading the way.

The ABS said the total value of residential dwellings in Australia fell by $271.5 billion to $9,615 billion in the December quarter 2022, while the number of dwellings rose by 45,500. As a result, the mean price fell $28,700 to $881,200.

The ABS said the number of weekly payroll jobs rose one per cent between the weeks ending 28 January 2023 and 11 February 2023, while total wages paid were up 2.2 per cent. Over the month to 11 February, payroll jobs were up 2.6 per cent and were 3.1 per cent higher than the same period in the previous year.  The Bureau also noted that the growth in payroll jobs in 2023 to date has been broadly consistent with the same period in 2020, before the start of the pandemic.

The Tourism Satellite Accounts quarterly tourism labour statistics show that there were 676,400 tourism jobs in the December quarter 2022, a rise of 12.1 per cent (73,100 jobs) over the September quarter 2022 and an increase of 42.1 per cent over the same quarter in 2021. The ABS said the total number of tourism jobs is now back to almost pre-pandemic levels, with nine out of 10 tourism jobs that existed in December 2019 now filled.

According to the ABS, international arrivals rose to 1.6 million in January 2023, a monthly increase of more than 347,000 trips. Monthly departures fell by more than 138,000 to closer to 1.4 million.

Other things to note . . .

• The March 2023 RBA Bulletin is available, including pieces on the rental market, the influence of fixed rate housing loans on monetary policy transmission and financial stability risk, wage setting mechanisms and labour market productivity, and developments in banks’ funding costs and lending rates.
• The second Treasury Quarterly Report on foreign investment in Australia.
• The changing nature of patents in Australia.
• John Blaxland on the AUKUS submarine plan – the biggest defence scheme in Australian history (already estimated as costing between $268 billion to $368 billion over the next 30 years – presumably before the inevitable cost overshoots…).
• How restrictive is Australia’s trade in services?
• WSJ big read on the failure of Silicon Valley Bank (SVB). Related, Barry Ritholtz lists all the things we do not know about SVB.
• The FT’s Martin Wolf says banks are designed to fail. AFR version.
• The WSJ’s Greg Ip on why the US economy seems weird. NB. Pre-dates the SVB closure.
• How tight is US monetary policy right now?
• Simeon Djankov on economic backwardness in Russia.
• The Peterson Institute says Europe’s switch to fossil fuels in response to the Ukraine war was only temporary.
• An Economist magazine briefing on the US, China and Taiwan.
• The macro effects of global supply chain disruptions during the pandemic: lower output, higher prices and increased stock outs.
• Noah Smith interviews Kevin Kelly.
• Barry Eichengreen asks will geopolitics or technology do more to reshape the global monetary order?
• Eurasia Group’s Atlas of Impunity ranks 163 countries across five dimensions: unaccountable governance, abuse of human rights, economic exploitation, conflict and violence, and environmental degradation. Rankings range from the lowest (Afghanistan at #1) to highest (Finland at #163). Australia comes in at #145.
• Ditchley Conference Report: Macroeconomics in a time of pandemic and war.