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Cliff Notes: an abrupt turn in expectations
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Cliff Notes: an abrupt turn in expectations


CLIFF NOTES: AN ABRUPT TURN IN EXPECTATIONS

Elliot Clarke

June 18, 2021

Key insights from the week that was.

This week, two key events have materially altered our view on the medium-term
outlook for Australia and the US. The first was the outcome of the June FOMC
meeting; the second, Australia’s May labour force survey.

While the market has focused on the 50bp increase in FOMC participant’s median
forecast for the federal funds rate at end-2023, to us the most significant
change in the Committee’s June post-meeting communications was the shift in
Chair Powell’s attitude towards the economy and policy.

Despite two disappointing reads for employment growth in April and May, in the
post-meeting press conference Chair Powell was very constructive on the
near-term outlook for the US labour market, stating the US would have “a very
strong labor market pretty quickly here”. The 2.2%yr forecast for inflation at
end-2023 also speaks to a belief that, while the current episode of high
inflation will prove transitory, in time a strong labour market will create
robust wage gains and allow the FOMC to sustainably achieve its inflation aims.

Until now, the FOMC’s caution over the recovery and their desire to make up for
prior disappointing inflation outcomes has led us to expect a delayed taper in
the second half of 2022 and no rate hikes before 2024. The confidence now shown
in the US economy and a seemingly pragmatic attitude to policy has led us to
shift this expectation to a taper from December 2021 (to be announced in
September, conditional on the data) followed by a sequence of three quarterly
rate hikes from December 2022 to June 2023.

Coming back to Australia and our labour market, June saw a startling jobs gain
of 115k leaving the level of employment 1% above that seen prior to the
pandemic. As a result of this strength in job creation and despite a further
increase in participation, the unemployment rate fell sharply to 5.1% -- a level
last seen in February 2020.

We take the May outcome as an accurate depiction of our economy and remain
positive on employment growth in coming years. As such, we now expect the
unemployment rate to fall to 4.0% in June 2022 and 3.8% by December 2022. An
unemployment rate in this range should be expected to yield persistent wage
gains “materially higher” than those seen recently and a sustainable lift in
inflation into the RBA’s target range. As such, having completed their taper in
2022, we now expect the RBA to lift the cash rate from 0.10% to 0.75% over the
course of 2023. Chief Economist Bill Evans has today provided a detailed view on
this forecast change and the implications for the economy.

Other data released this week was mixed. In New Zealand, GDP for the March
quarter surprised materially to the upside. As detailed by our New Zealand
Economics team, the surprise was in the magnitude of growth, not its source.
While it is expected that some of the March quarter upside surprise will reverse
in the June quarter, with the team’s forecast for Q2 reduced from 1.2% to 0.6%,
the gap to potential is still closing faster than initially expected.

In contrast, China’s monthly fixed asset investment, retail sales and industrial
production outcomes for May all disappointed in year-to-date terms. For each
variable however, the surprise was marginal and has not given us cause to revise
our positive outlook. As we detailed in a video update this week, China’s belt
and road and dual circulation strategies promise a robust uptrend for Chinese
exports; a growing income stream from offshore investments; and a reduced drag
on GDP growth from imports. Note that these are enduring structural themes for
China’s economy which should result in GDP growth being sustained at or above
5.5% into the medium term.      

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