Australia’s unemployment rate edged up to 5.3 per cent in August, prompting markets to revise their views on the likelihood of an RBA rate cut at the upcoming 1 October meeting.

    The general government budget effectively returned to balance in 2018-19. Minutes from the RBA’s September meeting showed a central bank somewhat more concerned about global weakness and still committed to – at minimum – an ‘extended period of low interest rates’. As widely expected, the US Fed cut rates by 25 bp this week, but like the ECB’s moves to further loosen monetary policy last week, the decision was contentious. And the weekend’s attack on Saudi oil production reminded the world economy about the potential dangers associated with oil price shocks. This week’s readings cover innovation and the boardroom, managed trade, volatility in US money markets, the President and the Fed, and the relationship between ‘rentier capitalism’ and liberal democracy.

    What I’ve been following in Australia . . .

    What happened:

    According to the ABS, Australia’s unemployment rate edged up to 5.3 per cent in August (seasonally adjusted), its highest level since August 2018.

    unemployment graph

    The underemployment rate also increased, rising from 8.4 per cent in July to 8.6 per cent in August, taking the underutilisation rate up from 13.7 per cent to 13.8 per cent.

    unemployment and underemployment

    Employment increased by 34,700 to 12.9 million persons, with full-time employment down by 15,500 to 8.8 million persons and part-time employment up by 50,200 to 4.1 million persons.

    change in employment

    Since August 2018, full-time employment has increased by 186,700 persons and part-time employment has increased by 124,000 persons. The average monthly rate of employment growth over that period has been running at a little shy of 26,000 jobs a month, with full-time employment growth averaging almost 15,600 and part-time around 10,300.

    participants rate employment

    The participation rate increased by 0.1 percentage points to a new high of 66.2 per cent while the employment to population ratio increased by 0.1 percentage points to 62.7 per cent.

    payments receipts and underlying cash balance

    Why it matters:

    Consensus estimates had put the unemployment rate unchanged at 5.2 per cent in August, but the increase came even though actual employment growth comfortably beat expectations of a 15,000 gain. The offsetting factor at work was another rise in the participation rate, as more Australians have joined the workforce. Increased female participation rates have been a big part of the story, rising from 60.4 per cent in August 2018 to 61.2 per cent in August 2019 on a seasonally adjusted basis. Gains in male participation rates have been more modest (up from 71 per cent to 71.3 per cent over the same period).

    Despite the effectiveness with which the labour market is generating work for more Australians, however, the big takeaway from the August readings is the increase in the degree of labour market slack. The headline rise in the unemployment rate took it further away from the RBA’s estimate of a 4.5 per cent non-accelerating inflation rate of unemployment (NAIRU), or more loosely the rate of unemployment consistent with ‘full employment.’ Moreover, the increase in the underemployment rate suggested an additional element of spare capacity in the labour market.

    The RBA has been clear that it wants to see a tighter labour market in order to generate the rates of wage growth needed to get inflation back on target. With the data moving in the wrong direction, the financial market response to this latest read on the Australian labour market has been to revise their expectations about the timing of the next RBA rate cut, with an increase in the implied probability of a rate cut at the next RBA Board meeting on 1 October. At the time of writing, the probability of a cut next month had increased to 79 per cent, with that probability rising to 88 per cent for the 5 November meeting and 90 per cent for the 3 December one.

    What happened:

    Treasurer Josh Frydenberg announced that the federal budget had returned to balance for the first time since 2007-08. Technically, the 2018-19 underlying cash balance was just in deficit, but only to the tune of $690 million, which as a share of GDP is equivalent to zero per cent. That outcome represented a $13.8 billion improvement relative to the underlying cash deficit estimated at the time of the 2018-19 budget.

    budget forecasts vs outcomes for tax receipt growth

    As a share of GDP, total receipts rose to 24.9 per cent, their highest level since 2007-08, while total payments were held at 24.6 per cent of GDP, their third lowest level since the same year.

    Total receipts were $11.5 billion higher than expected while total payments were $6.6 billion lower. Tax receipts were $8.1 billion higher than the 2018-19 budget had anticipated, boosted by higher income tax receipts ($5.7 billion above expectations) and higher company tax receipts ($4.6 billion above the budget estimate), which more than offset lower than expected GST receipts (down $2.3 billion on budget projections due to weaker than expected household consumption and dwelling investment). The underspend on payments relative to budget reflected lower than anticipated expenditure on the NDIS ($4.6 billion below budget projections), GST-related payments to the states, payments under the Disability Care Australia Fund, and Family Tax Benefit payments.

    net government debt and interest payments

    Despite the fall in borrowing needs relative to budget, general government net debt was $373.6 billion or 19.2 per cent of GDP at the end of 2018-19, which was about $23.7 billion higher than Budget 2018-19 had predicted. That increase was mainly the result of an increase in the market value of Australian Government Securities due to lower than expected government bond yields.

    residential house price index

    Why it matters:

    Although real GDP growth in 2018-19, at 1.9 per cent, was significantly softer than the three per cent growth rate forecast back at the time of the 2018-19 budget, nominal GDP growth turned out to be a fair bit stronger than predicted, at 5.3 per cent vs a projected 3.75 per cent rise, mainly due to higher than expected commodity prices. That windfall helped deliver a much stronger budget bottom line through stronger mining sector profits and hence higher company tax receipts.

    There was also a helping hand from better than expected employment growth, which ran at 2.6 per cent over the year compared to budget forecasts of 1.5 per cent, translating into more than 100,000 jobs than had been anticipated. That helped boost the income tax take even though actual wage growth of 2.3 per cent was weaker than the budget projection for a 2.75 per cent result.

    The strong fiscal outcome leaves the public finances in good shape and that means that there is ample fiscal space should the government decide – in line with repeated RBA recommendations – that fiscal stimulus is warranted.

    What happened:

    The RBA published the minutes from its 3 September Board meeting, at which it had decided to leave the cash rate unchanged at 0.5 per cent.

    Members noted that the news over the previous month (the escalation of US-China economic tensions, weaker global trade, investment and industrial production, slower growth in East Asia in general and in China in particular, and softer commodity prices) ‘had confirmed that the risks to the global growth outlook were to the downside.’ In terms of the domestic economy, despite strong employment growth and a participation rate at a record high, the unemployment rate had remained steady and wage growth remained subdued, suggesting ‘that spare capacity remained in the labour market and that the Australian economy could sustain lower rates of unemployment and underemployment.’ The discussion recognised ‘further signs of a turnaround in established housing markets, especially in Sydney and Melbourne, although housing turnover had remained low’ and while the meeting took place before the release of Q2 GDP, RBA Board members had been expecting a relatively soft result with growth driven by exports and public demand, which was pretty much in line with the actual outcome.

    Given that context, members ‘judged that it was reasonable to expect that an extended period of low interest rates would be required in Australia to make sustained progress towards full employment and achieve more assured progress towards the inflation target. Members would assess developments in both the international and domestic economies, including labour market conditions, and would ease monetary policy further if needed to support sustainable growth in the economy and the achievement of the inflation target over time.’

    Why it matters:

    September’s minutes contained no real surprises, with the RBA picking up on the fact that August had been a relatively tough month for the global economy and hence sounding somewhat less optimistic than it has in the past about global growth prospects, as some of the downside risks it has been highlighting manifested last month. Continued weakness in private sector demand here at home and the persistence of spare capacity in the labour market were also referenced.

    The familiar refrain that ‘an extended period of low interest rates would be required’ got another outing, while the central bank also signalled that it stands ready to ease policy again ‘if needed’. Remember, markets expect another rate cut before the end of the calendar year, and a second in the first half of next year, an expectation that was reinforced this week by August’s small rise in the unemployment rate.

    What happened:

    The ABS released data on second quarter residential property prices. The figures show prices for the ABS’s weighted average of eight capital cities down by 0.7 per cent over the June quarter, with sizeable drops in Darwin (-1.8 per cent), Perth (-1.4 per cent), Melbourne (-0.8 per cent), Brisbane (-0.7 per cent), Adelaide (-0.6 per cent) and Sydney (-0.5 per cent).

    residential house price index

    Relative to June 2018, capital cities prices were down 7.4 per cent, with the largest annual drops in Sydney (-9.6 per cent) and Melbourne (-9.3 per cent).

    fed funds target rate

    The total value of Australia’s 10.3 million residential dwellings fell for a fifth consecutive quarter, dropping by $17.6 billion to $6,610.6 billion in the June quarter, while the mean price of residential dwellings fell by $4,400 to $638,900.

    Why it matters:

    The ABS numbers give a sense of the scale of wealth destruction wrought by falling house prices, which in turn has likely been a significant contributory factor to the weak consumption growth the economy has experienced in recent quarters. Note, however, that the ABS data lag the monthly CoreLogic statistics, which in July and August have indicated a turnaround in the housing market. In the commentary accompanying the release, the ABS Chief Economist noted that ‘a number of housing market indicators, such as auction volumes and clearance rates, have begun to show signs of improvement, though they remain below the levels seen one year earlier.’

    . . . and what I’ve been following in the global economy

    What happened:

    Following its meeting on 18 September, US Federal Reserve Open Market Committee (FOMC) announced that it would lower the target range for the fed funds rate by 25bp, to 1.75 per cent to 2 per cent. The accompanying FOMC statement cited ‘the implications of global developments for the economic outlook as well as muted inflation pressures’ and noted that although the labour market remained ‘strong’ and that household spending had ‘been rising at a strong pace’, elsewhere ‘business fixed investment and exports have weakened.’ The FOMC also emphasised that the Fed would ‘continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.’

    central bank policy rates in selected markets

    The details of the FOMC vote, however, show that the committee remained split over the direction of monetary policy. Of the ten voting members, only seven voted in favour of this week’s decision with three against1. The latter group was also split, with two members voting to leave the target range unchanged and one voting for a larger 50bp cut.

    Diverging views were also apparent in the economic projections released after the meeting. These showed that the median expectation of the total 17-member FOMC was for no further easing this year or next, but that behind that median were seven FOMC members seeing another 25 bp cut before year end, taking the fed funds rate down to 1.625 per cent (that is, a 1.5 per cent to 1.75 per cent range), five officials expecting the rate to be unchanged from its current level, and the remaining five saying that the funds rate should finish the year back up at 2.125 per cent (a 2 per cent to 2.25 per cent range), implying a rate hike.

    For his part, President Trump remained resolutely unimpressed with the Fed’s actions, tweeting ‘Jay Powell and the Federal Reserve Fail Again. No “guts,” no sense, no vision! A terrible communicator!’ The fraught relationship between the President and the Fed is covered in this week’s readings.

    The Fed also said that it would lower the interest rate it pays on required and excess reserve balances to 1.8 per cent, which is 20bp below the top of the (new) target range for the fed funds rate. This was a response to disturbances in US money markets this week, which had seen a spike in the repo rate to a record high and the fed funds rate jump briefly above the (old) target ceiling of 2.25 per cent. For more detail on this, there are a couple of ‘explainers’ in this week’s readings, below.

    Why it matters:

    The clear consensus had been for the Fed to cut rates by 25bp this week, and the Fed duly delivered. But the message coming from both the dissent to the actual decision, and from the forecasts delivered by the Fed’s so-called dot points, is that the FOMC overall is less convinced than financial markets had been pre-meeting of the need for additional monetary policy easing. It seems that the committee is placing relatively more weight on still-resilient US domestic conditions, and less on any adverse spillover effects from the turbulent global economy, than are many market commentators.

    The disagreement over the Fed’s latest rate cut also echoes some of the response to the ECB’s decision to ease monetary policy last week. Outgoing President Mario Draghi – who is due to finish his eight-year term in October and then hand over to Christine Lagarde – had promised decisive action to support growth in the euro zone, including by locking in an extremely accommodative monetary policy for several years in advance. Draghi’s approach had received some pushback from sceptics in advance of the meeting, but in the end he was able to deliver, with the ECB cutting the interest rate on its deposit facility by 10bp to -0.5 per cent and restarting its program of net asset purchases under its Asset Purchase Program (APP) at a monthly pace of 20 billion euros from the start of November. The ECB’s governing council also promised that the restarted AAP will ‘run for as long as necessary to reinforce the accommodative impact of its policy rates’ and will only end ‘shortly before it starts raising the key ECB interest rates.’

    gross peak supply loss in oil production

    According to press reports, up to nine members of the ECB’s governing council spoke against the package beforehand, however, while on the day following the announcement, the head of the Dutch Central Bank described the ECB’s response as ‘disproportionate to the present economic conditions’ while the Bundesbank president was quoted as saying that Draghi had ‘overstepped the mark’.

    The increasingly contentious debate over monetary policy in both the euro zone and the United States illustrate the mounting pressure on central banks in the current era. And although its far too soon to be penning an obituary just yet, it’s now looking at least possible that central bank independence – which along with inflation targeting has been one of the cornerstones of the modern monetary policy regime – risks turning out to be another victim of our current economic circumstances.

    What happened:

    Last weekend saw attacks on Saudi Arabia’s oil industry, targeting the Khurais oil field and the Abqaiq processing facility, which is responsible for processing up to 70 per cent of the Kingdom’s oil production. The initial impact was to cut 5.7 million barrels per day (bpd) of Saudi crude, equivalent to more than five per cent of the world’s oil supply. But the attack is also thought to have constrained the country’s ability to use the more than 2 million bpd of spare production capacity it carries. At this scale, the disruption to supply was the largest on record:

    brent futures prices

    The immediate impact of the news was to trigger a sharp increase in oil prices: the benchmark Brent crude futures price soared by 15 per cent on Monday before retreating later in the week on reports from Saudi that oil production was in the process of being restored much more quickly than had initially been feared.

    Why it matters:

    Timing is everything. Just after having noted last week that the exit of John Bolton from the White House had triggered an immediate fall in oil prices on the assumption of a lowered risk of conflict, the following weekend sees an attack on Saudi oil production and a spike in prices! Market observers are now talking about a new risk premium embedded in the oil price and the danger of further turmoil in the Middle East.

    Historically, of course, the oil price has been a key determinant of global economic activity. The experience of the oil shocks of the 1970s suggested a naïve model whereby high oil prices were a key trigger for a global recession, or at least a global downturn. In a worst-case scenario they could even trigger stagflation – a really nasty combination of high inflation and slow growth. But subsequent experience has shown that the global economy is able to cope with periods of relatively high prices and still deliver decent growth outcomes. That prompted a slightly more nuanced view, which argued that the source of the oil price shock was important: while a disruption to supply was indeed likely to be bad news for global growth, the argument ran, a shock arising from the demand side – due to more rapid growth in oil consuming countries - was thought to be less damaging and could be associated with healthy global economic activity.

    The current disruption is clearly a negative supply shock, however. Typically, supply shocks are thought to operate through two main channels: (1) higher prices work to redistribute global income away from oil importing economies to oil exporting ones, and to the extent that the latter have a lower propensity to spend than the former, this leads to slower global growth; and (2) higher oil prices increase production costs and put upward pressure on prices, which in turn could lead to central banks tightening monetary policy. Those higher input costs and higher interest rates then both act as a drag on economic activity. It follows that if the current disruption were to lead to a sustained increase in prices, then we would expect that to translate into another headwind for global growth at a time when the global economy is already struggling.

    For now, at least, the actual increase in prices, although initially quite sharp, has still left oil prices well below the levels they were at a year ago. Indeed, until recently the challenge facing the oil market was more one of a negative demand shock given slow global growth and the International Energy Agency (IEA) has said that global markets ‘remain well supplied with ample stocks available.’ Moreover, any pressure on central bankers to increase interest rates in the current environment – as noted, one of the key transmission channels for a supply shock – appears to be very limited. But the situation in the Gulf remains another key source of uncertainty compounding the ‘uncertainty epidemic’ overhanging the world economy.

    What I’ve been reading: articles and essays

    My colleagues here at AICD have released a new report on innovation and the boardroom. Their study argues that while Australian directors clearly recognise the importance of innovation, more needs to be done to prioritise its delivery. Their research finds that Australian boardrooms in general have relatively low innovation and digital literacy levels, with only three per cent of respondents to the survey work that informs their report saying they brought science and technology expertise to their boards and just ten per cent saying they provided innovation, product development and R&D expertise.

    The AFR reported that Australian aluminium producers had been warned to limit their exports to the United States in order to avoid new trade restrictions. Is this an example of an (informal) Voluntary Export Restraint (VER)? VERs made their debut during the protectionism-rife years of the 1930s and were then ‘rediscovered’ in the 1980s when Washington was pressuring Japan over the bilateral trade imbalance. VERs are a form of managed trade, which in the past has also included Voluntary Import Expansions (VIEs) – which are arguably one of the things that Washington is seeking from Beijing during the current trade negotiations. It really does seem to be a case of ‘back to the future’ for global trade, alas.

    ABARES has released the September 2019 edition of Agricultural Commodities. In 2019-20, the volume of farm production and agricultural exports are both expected to fall below long-term averages, mainly due to the ongoing drought in large areas of Australia (although this is partially offset by above average crop production in Victoria). At the same time, the disruption of global markets by the US-China trade conflict has had mixed implications for Australian producers: on the one hand, Chinese import demand for some Australian products has been boosted as China looks for non-US suppliers; but ABARES reckons any short-term gains will be outweighed by long-term implications, including lower growth in East Asia which could see regional demand shift from higher-value Australian produce to cheaper alternatives, and disruptions to supply chains in related markets such as clothing, which could impact Australian fibre exports.

    The RBA has published the latest edition of its Bulletin. Topics covered include a history of counterfeiting, the changing global market for Australian coal and the liberalisation of Chinese portfolio investment flows.

    This week saw the New York Fed intervene in money markets for the first time since 2008 after the cost of borrowing cash overnight via repurchase agreements saw the repo rate jump to a high of ten per cent (normally it would be expected to trade in line with the Fed’s target band, which was 2 – 2.25 per cent before the mid-week meeting). Back in 2008, the Fed was responding to credit-market dislocations and financial distress, with a run on the repo market playing a key role in the demise of Lehman Brothers and Bear Stearns. This week, the drivers seem to have been less alarming: a mix of timing (quarterly tax payments taking cash out of the market at the same time as new Treasury Department auctions pushed treasuries into the market), along with new regulatory measures and a reduction in banks’ excess reserves as the Fed has shrunk its balance sheet. The FT has an explainer here and the WSJ has a guide to the US repo market here. See also this earlier Bloomberg piece on the repo market and how it has changed since the crisis.

    Sticking with the Fed, readers might remember that late last month, former NY Fed President Bill Dudley caused something of a stir when he argued that the Fed ‘should refuse to play along’ with Trump’s trade wars by mitigating the damage via offsetting monetary stimulus, and that Fed officials ‘could even state explicitly that the central bank won’t bail out an administration that keeps making bad choices on trade policy, making it abundantly clear that Trump will own the consequences of his actions.’ The heat of the subsequent reaction prompted an explanatory Q&A from the author, including a disclaimer noting that he was not part of any ‘deep state’ conspiracy taking in the Fed and retreating from the apparent implications of his earlier comment suggesting that there was ‘even an argument’ that the US presidential election could fall within the Fed’s purview. Eminent economic historian Barry Eichengreen gives his take here, and also draws an analogy with the Bank of England and its approach to speaking on Brexit-related matters.

    Martin Wolf reckons that rentier capitalism is damaging liberal democracy. Starting from the US Business Roundtable’s rethink on corporate purpose (flagged here a few weeks ago) Wolf’s proposition is that ‘something has gone very wrong’, especially in the United States, with an ‘unholy trinity of slowing productivity growth, soaring inequality and huge financial shocks.’ Too much finance and too much rent-seeking, along with too little productivity growth and insufficient competition, are a big part of his diagnosis.

    A new IMF working paper attempts to estimate the flexibility of global value chains (GVCs) by looking at the differing sensitivity of relative prices to final demand for value added. Their test suggests that GVCs are ‘largely inflexible in the short-term and relatively inflexible in the long run’. That means that temporary disruptions to supply chains – whether through natural disasters or trade policies – will be harder to manage. How does this stack up with evidence of the impact of the current trade war on supply chains? One view has emphasised that regional markets such as Vietnam have benefited from production relocating from China – so much so that the country has itself risked becoming the target of US tariffs. But other commentary has stressed that even supposed winners like Vietnam struggle to offer a full replacement for China, without the latter’s scale, developed production networks, infrastructure connectivity and skilled workforce.

    Also from the IMF, a new measure of trade uncertainty.

    Timothy Taylor wonders whether the US economy might be experiencing an Engels’ Pause (referring to a period of up to several decades where a high level of technological progress coincides with stagnant wage levels, soaring profits and rising inequality, as experienced by the UK during the first wave of the Industrial Revolution).

    piece from the New Yorker on the perils of statistics in the era of big data. The piece is reviewing this book and you can watch the book’s author, Professor David Speigelhalter, here, talk about the art of statistics. (There’s also an audio only version available, but then you miss out on the slides.)

    The Economist has a briefing on Europe’s Single Market project. The thesis here is that not only does the project remain incomplete, but that in some places its going backwards. Part of the challenge is that the Single Market was proposed at a time when the focus was on goods, and existing frameworks are less well equipped to deal with the rising relative economic importance of services and the digital economy. The looming departure of the UK, which has been one of the countries most keen to drive services liberalisation, seems unlikely to help matters.

    1 The FOMC consists of 12 voting members: the seven members of the Board of Governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York, and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis. Note, however, that two positions on the Board of Governors are currently vacant, lowering the number of voting members to ten. All 12 of the Reserve Bank presidents attend FOMC meetings and participate in discussions, but only five of them get to vote.

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