Jobs hold key for RBA

November’s labour force survey delivered an unexpected drop in the unemployment rate from 5.3% in October to 5.2% in November. And in December, the labour market surprised to the upside again, the second straight month, as employment rose by more than expected taking the unemployment rate down to 5.1% in December. This period of relative strength in the labour market outcomes along with the RBA’s concerns surrounding financial stability and the propensity for low rates to fuel asset prices (over any meaningful economic recovery/vibrancy) led to the board keeping the cash rate on hold at a record low of 0.75% in February.

So in comes January’s labour force survey. Economists’ forecasts were for a pickup in unemployment to 5.2% from 5.1% with employment rising by 10,000 according to Bloomberg’s survey. The unemployment rate came in at 5.3%, above expectations, this as the participation rate increased by 0.1ppt to 66.1%. Characteristic of a dilemma that the RBA and government have faced for some time, whereby jobs growth, but also a rising participation rate has seen unemployment remaining too high.

If participation trends lower throughout 2020 this could help the RBA in moving toward a lower unemployment rate if the pace of hiring continues. The problem is that jobs growth is poised to slow in 2020 which will prevent the unemployment rate from moving lower and the labour market tightening. This is of particular concern in the wake of the devastating bushfires and uncertainties surrounding the economic impact on Australia of the coronavirus outbreak. The share of exports to China, both goods and services, relative to GDP renders the Australian economy one of the most China dependant economies globally. More than 30% of total exports go to China. It will be some time before we can gauge the full effects of that hit to the economy. But regardless, several quarters of below trend economic growth, along with weak consumer spending along with those heightened uncertainties presents a deteriorating outlook for the labour market and employment growth. Other forward looking indicators of labour market health like ANZ job ads, capacity utilisation and vacancies also point to weakness in the labour market ahead and reduced demand for labour, pre virus outbreak. If jobs growth does slow as we expect, unless participation drops off at a much faster rate, which is unlikely with Australia’s strong population growth, unemployment will continue to drift higher.

Whilst participation increased in January, spare capacity also rose, further cementing the realities of anaemic wage growth. Substantial spare capacity in the labour market remains an ongoing issue for the RBA, with high levels of labour market slack preventing material upward pressure on wages. The monthly seasonally adjusted underemployment rate increased by 0.3ppt to 8.6%. Underutilisation is a broader measure of spare capacity than the unemployment rate, including those unemployed and underemployed, and this rose to 13.9%. The highest level since April 2018. Underutilisation will need to fall considerably before seeing a material uptick in wages, that can in turn boost household incomes and spur inflationary pressures. Without income growth household consumption will remain pressured for a protracted period even as house prices recover, hence pointing to a weak outlook for private consumption and continued policy easing.

The labour market needs to be a lot tighter, with underutilization likely falling back towards 12/12.5% before any semblance of wage growth above 3% can be reached. Under current policy settings, both monetary and fiscal, that is a long way off. Although we expect further easing from the RBA, the heavy lifting cannot be left to monetary policy alone putting the focus on fiscal policy and necessary structural reforms from the government. A coordinated policy response is necessary, without a collective effort from policy makers to restore business conditions and revive economic activity, slower lower growth is set to endure. Up next should be a real focus on productivity reforms, infrastructure spending and other fiscal measures to reignite business and consumer confidence and promote dynamic and thriving economic outcomes.

The January labour force survey is supportive of the case for continued policy easing from the RBA, particularly given the impact of coronavirus is yet to be felt. However, the RBA remain optimistic on the trajectory for the economy and have already outlined they are reluctant to take the cash rate lower, citing that the benefits must outweigh the costs of lower rates (asset price inflation, hit to savers and financial stability). This means the RBA’s hurdle to cut is now higher than throughout 2019. This means 2 or 3 months of labour market data will be needed to confirm the trend that labour market realities are moving in the opposite direction to the bank’s targets. On that basis cuts are unlikely to be imminent, given that labour market data is notoriously volatile.

Although not imminent, it is likely an inevitability that the RBA will need to move to cut rates again this year. The RBA remain too optimistic about the domestic outlook, several leading indicators are pointing to a slowdown in hiring ahead and unemployment still remains well above the RBA’s estimate of full employment of 4.5%. Households remain cautious and spending is anaemic, despite interest rates being cut to a record low and tax cuts, consumers are choosing to save more and reduce discretionary spending. Without income growth this dynamic is likely to persist. This is even before accounting for the impact of the virus outbreak which is only going to present additional downside risks and further inhibit the RBA’s progress toward towards full employment and the inflation target. If the scenario we have laid above comes to fruition and we do see a sustained higher unemployment rate over the coming months, the RBA will likely have to capitulate and cut the cash rate to a new record low by April.

Clearly with undisputed consensus expectations that the first quarter of 2020 will be subject to a material drag as the impact of the coronavirus and the bushfires weighs. The RBA may be tempted to look through the weaker data as a temporary diversion not derailment from their expected outcomes. That means the risk to our forecast is skewed toward a later move.

AUD

This will see both the AUD and Aussie bond yields shackled by the domestic outlook. If the reflation trade regains momentum in the coming months once the threat of the coronavirus outbreak has dissipated, the AUD could be momentarily swept up in that tide. But those reflationary bounces will likely be short lived and strength sold into as the domestic policy outlook weighs. As market pricing for continued easing ramps up the AUD will remain under pressure, despite a lot of bad news already reflected in the currency already, market positioning dictates it can fall further.