“Patient” was the key word for March. Once upon a time central banks never told markets what they were thinking about, but nowadays they go to great lengths to ensure markets are ‘informed’, in the hope it reduces market shocks – doesn’t eliminate them altogether, just reduces them. So in previous Fed commentaries Governor Yellen effectively said once they drop the word ‘patient’ from their outlook statement it means they’re one step closer to raising rates. And that’s exactly what happened in March and U.S. markets in particular were a little bit shocked. The question now is when will U.S. rates ‘lift off’ (as the market calls it); will it be June or September, or as late as December? And how much does it matter?
It matters a lot, but it’s mattering less. U.S. cash rates are 0.25%, which is way too low for an economy with unemployment at the target rate of 5.5% with an average of 280,000 new jobs being added every month. However, as we wrote recently, it’s likely long term rates are going to stay low for a long time yet. The Fed desperately wants to get off what is in effect an emergency cash rate, if only to give itself some monetary policy wriggle room, but its quandary is the U.S.$ has risen sharply to a 12 year high (see the chart below) in anticipation of the well-telegraphed interest rate rises and it’s starting to hurt the U.S. economy as well as adding to the dreaded deflationary pressures.
US dollar index
Source: Bloomberg, Deutsche
With 46% of the S&P500’s earnings coming from offshore it’s not surprising that companies are starting to squeal. In a recent survey of 1,000 CFO’s, two out of three big U.S. exporters said the appreciation of the dollar has had a negative impact on their businesses. And nearly one-fourth of big exporters said they have reduced their capital spending plans as a result, reflected in the core capital goods data falling now for six consecutive months. The QE-weakened dollar had done wonders for U.S. exports and now it’s going the other way, with anecdotes of U.S. firms having to lower prices by as much as 15% in the past year just to retain customers in the face of European import competition.
Consequently, the Fed has lowered its 2015-16 GDP growth forecast yet again, to 2.7% from 3%. Governor Yellen has explicitly identified the problems of a strong dollar and is talking about a ‘flexible’ approach to interest rates, saying “the actual path of policy will evolve as economic conditions evolve, and policy tightening could speed up, slow down, pause, or even reverse course depending on actual and expected developments in real activity and inflation.” In other words, be ready for anything! If the U.S.$ does start to weaken off it will come as an unpleasant shock to the rest of the world, which is still seeing competitive devaluations with more than 20 countries cutting rates just this year, including India, Thailand, Sweden, China, Korea, Portugal and, of course, Australia.
At long last Europe looks like it’s through the worst. In 2011 the world held its breath, as one by one commentators declared the Eurozone must surely fall apart. Since then it has grown from 17 members to 19 – countries want to get in not out! The charts are showing early signs of a turn around, or at least things being less awful, and that’s what markets get excited about: if you wait until things look great, you’ll have waited too long.
Unemployment across the Eurozone has fallen to 11.2%, (see the chart below) well off its peak of 12% (when you look closely Germany’s at 4.7%, a 30 year low, while Greece is at 25.8%).
Euro area unemployment
Source: Trading Economics, Eurostat
GDP growth has also picked up off its lows (see the chart below) and the ECB increased its forecast growth for 2015 from 1% to 1.5%, though they have all the credibility of a Melbourne real estate agent.
Euro area GDP annual growth rate
Source: Trading Economics, Eurostat
Finally, the current account is surging thanks to a weak Euro (see chart below). All in all, Europe could well be past the worst, though one can never rule out the possibility of them finding new ways to throw spanners into the works.
Euro area current account to GDP
Source: Trading Economics, Eurostat
Here in Australia GDP grew at 0.5% in the December quarter of 2014, for an annualised rate of 2.5%. That’s a fair way below the trend rate of growth of 3.25%, but there are very few countries growing anywhere near their long-term trend rate. Unemployment came in steady at 6.3% and job ads rose for the ninth month in a row. More significantly both consumer and business confidence levels didn’t respond to the Reserve Bank’s February rate cut, possibly because of the dysfunctional federal politics. The RBA is hoping the non-mining industries will step up and do the heavy lifting on economic growth now the commodity cycle is in reverse, but that’s less likely to happen if confidence is low. The RBA must be getting very frustrated with the government by now.
After taking almost everyone by surprise and lowering rates in February, the RBA didn’t back it up in March, which appeared largely to reflect concern about the residential housing market. Both domestic and international reports show Australia’s house prices to be amongst the most expensive in the world on almost any metric you want to throw at it. The media breathlessly reports about how young people are being priced out of the market and, perhaps not unexpectedly in a frothy market, rumours abound and fingers point to foreign buyers (see the chart below).
Australian housing prices*
* Excludes apartments
Source: CoreLogic RP Data, RBA
What’s most unsettling is that Australia’s household debt levels are very high by international standards and continues to rise. And the quality of the lending is no cause for comfort: an all time high in loan approvals to investors, an all time low for first home buyers and owner-occupiers are flat (see the chart below).
Australian housing loan approvals
Source: RBA, ABS
Perhaps more disconcertingly, the number of interest only loans – the ultimate expression of buying an investment purely for capital gain rather than any yield – has risen to record levels as well. Markets-wise, with the bond market pricing in a 75% likelihood of the RBA cutting rates again this month, the added liquidity is helping share prices.
Finally, China announced it has lowered its 2015 growth target rate to a measly “approximately 7%”, which would be the lowest in 15 years. The Prime Minister attributed the reduced target in part to lower global growth. The market has been fretting about a hard landing in China for years, and to date it’s never happened. Whilst the statistics are not the most reliable, certainly the government’s determination to keep the population content through consistently full employment and rising living standards is.
The good stuff
Researchers at the Lawrence Livermore National Laboratory in the U.S. have developed caviar-sized polymer bubbles that can absorb carbon dioxide. Filled with plain old baking soda, the idea is they could line chimney stacks and catch the CO2 before it hits the atmosphere. The bubbles can then be retrieved to capture the CO2 in a controlled way, and then re-used. Whilst it doesn’t stop the CO2 production, it’s shaping up to be a cheap way to capture and store it.