Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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The fiscal cannon has been fired, is monetary policy next?
Summary: The Australian Federal budget handed down yesterday is more of a political document than a real forecast of coming policy moves, but the fact remains that Canberra and the RBA are moving towards stimulus measures as data confirming a coming slowdown continue to roll in.
Last night when Australia’s Federal budget was handed down, Treasurer Josh Frydenberg announced a tax cut package worth AUD 158 billion over one decade for low- and middle-income earners, an AUD 100bn infrastructure package and some benefits for small- to medium-sized enterprises.
The budget has a heavy emphasis on tax cuts and handouts, but most of the tax cuts don’t kick in until 2022-23 so bracket creep is still important coupled with expenditure reductions. On the plus side, the budget is projected to reach surplus in FY'20, so Australia is “back in black”. This slogan is being heralded by the coalition government, who may well be counting their chickens before they hatch if the global slowdown, slumping local property market and trade wars have anything to do about it.
The budget has a heavy emphasis on tax cuts and handouts, but most of the tax cuts don’t kick in until 2022-23 so bracket creep is still important coupled with expenditure reductions. On the plus side, the budget is projected to reach surplus in FY'20, so Australia is “back in black”. This slogan is being heralded by the coalition government, who may well be counting their chickens before they hatch if the global slowdown, slumping local property market and trade wars have anything to do about it.
This year's budget is more like a campaign manifesto, and should be viewed as such. If the betting markets are anything to go by, the chances of the coalition government actually implementing any of these proposals are slim.
This is why the budget has a heavy emphasis on tax cuts and handouts aimed at boosting consumption, taking pressure off one of the weakest sectors in the economy. Households are feeling the pinch under the pressure of a slumping property market and the outlook for household consumption is a big driver of economic growth.
People earning between $925 and $1730 a week will get a tax cut equivalent to approximately $20 a week, backdated to July 2018. This will come in the form of a refund cheque upon submitting their annual tax return in a few months' time. Those earning less than $925 a week, or greater than $1730 a week, will get much less. But again, the important question for the economy is how quickly these measures can be delivered, and if at all. This makes the opposition address on Thursday equally as important in determining what stimulus will actually flow through to the economy, given that Labor are tipped to win the federal election.
This is why the budget has a heavy emphasis on tax cuts and handouts aimed at boosting consumption, taking pressure off one of the weakest sectors in the economy. Households are feeling the pinch under the pressure of a slumping property market and the outlook for household consumption is a big driver of economic growth.
People earning between $925 and $1730 a week will get a tax cut equivalent to approximately $20 a week, backdated to July 2018. This will come in the form of a refund cheque upon submitting their annual tax return in a few months' time. Those earning less than $925 a week, or greater than $1730 a week, will get much less. But again, the important question for the economy is how quickly these measures can be delivered, and if at all. This makes the opposition address on Thursday equally as important in determining what stimulus will actually flow through to the economy, given that Labor are tipped to win the federal election.
The handouts will be welcomed by consumers as it is extra money that goes straight to the back pocket. This is supportive of sectors like retail that may benefit from increased spending. Cash payments will be a welcome boost to confidence and spending at a time when there are concerns about economic growth given that we have seen a sharp deterioration in the economic outlook since the second half of last year.
While it’s great to get excited about the promise of fiscal stimulus, and stimulus measures will support the consumer at the margin, the trajectory for the economy at the moment is down and growing below trend, so this boost really just keeps the wheels turning. As house prices continue to fall and the private sector also continues to lose momentum, the promised fiscal boost likely isn’t enough to materially offset the continued drag on activity. A material boost to productivity and wage growth would be far more effective in maintaining economic growth and stimulating potential output
There is also the question of whether or not consumers will actually spend the extra cash, and where in the economy they spend it. Following Kevin Rudd’s $900 cheques in the mail in 2009, there was a 16% uptick in gambling and gaming on electronic poker machines; lottery sales also picked up. These are not the most effective sectors for a cash hit to be spent as the number of jobs tied to these industries is less than in others.
Fiscal stimulus was not the sole driver arresting the decline in the Australian economy following the financial crisis; rather, it was a combination of easier monetary policy, a major exchange rate depreciation and a big pick-up in commodity demand from China. On that basis it is difficult to know what would have happened to household consumption in the absence of the policy change.
Does the budget change the Reserve Bank of Australia's outlook? Well, it hasn't changed the economic outlook significantly, and on that basis we still expect the RBA to downgrade its growth forecasts in its May Statement on Monetary Policy. We believe it is likely it will adopt an easing bias at that point as well. In fact, yesterday saw the RBA take a small but significant step towards adopting a formal easing bias by changing the last line in the statement accompanying its rate decision.
While it’s great to get excited about the promise of fiscal stimulus, and stimulus measures will support the consumer at the margin, the trajectory for the economy at the moment is down and growing below trend, so this boost really just keeps the wheels turning. As house prices continue to fall and the private sector also continues to lose momentum, the promised fiscal boost likely isn’t enough to materially offset the continued drag on activity. A material boost to productivity and wage growth would be far more effective in maintaining economic growth and stimulating potential output
There is also the question of whether or not consumers will actually spend the extra cash, and where in the economy they spend it. Following Kevin Rudd’s $900 cheques in the mail in 2009, there was a 16% uptick in gambling and gaming on electronic poker machines; lottery sales also picked up. These are not the most effective sectors for a cash hit to be spent as the number of jobs tied to these industries is less than in others.
Fiscal stimulus was not the sole driver arresting the decline in the Australian economy following the financial crisis; rather, it was a combination of easier monetary policy, a major exchange rate depreciation and a big pick-up in commodity demand from China. On that basis it is difficult to know what would have happened to household consumption in the absence of the policy change.
Does the budget change the Reserve Bank of Australia's outlook? Well, it hasn't changed the economic outlook significantly, and on that basis we still expect the RBA to downgrade its growth forecasts in its May Statement on Monetary Policy. We believe it is likely it will adopt an easing bias at that point as well. In fact, yesterday saw the RBA take a small but significant step towards adopting a formal easing bias by changing the last line in the statement accompanying its rate decision.
The RBA has maintained the last sentence, "taking account of the available information", since March 2017 – almost the entirety of Governor Lowe’s tenure. Yesterday’s change in the last sentence now implies that the RBA will shift course on monetary policy should growth continue to deteriorate and inflation continue to remain persistently below target.
Yesterday's change in the policy statement, coming in the wake of the February speech wherein Lowe recognised the mounting downside risks, is evidence of the RBA moving towards a more balanced outlook. "Looking forward, there are scenarios where the next move in the cash rate is up and other scenarios where it is down," Lowe said. It is clear that the RBA’s bias is slowly shifting away from the stubborn optimism that has prevailed for so long.
These subtle hints of moving towards cutting rates if growth deteriorates imply that if the unemployment rate starts to pick up, the RBA will move fairly quickly. We don’t necessarily need to see unemployment move up in a big way, given that it has remained the RBA’s pillar of strength in the domestic economy. If this were to crumble, there is probably a relatively low threshold for moving to a cut.
The economy and the labour market will not continue to show divergent paths. While the labour market has been the one bright spot of the domestic economy, with unemployment now sitting at an eight-year low of 4.9%, stagnant wage growth means most people don’t feel the benefit. Construction is one of the largest employment sectors, making up nearly one in 10 jobs in Victoria and NSW. As residential construction activity deteriorates over the coming months, this will hit employment.
The multiplier effects of house price declines on the economy are yet to be felt and as declines continue, they will intensify. The housing slowdown will feed back to the real economy through the negative wealth effect, which will continue to weigh on over-leveraged households’ consumption, resulting in weaker GDP growth. With the current savings ratio near decade lows, consumers will no longer be able to hold up spending habits as asset prices continue to fall. House prices have continued to fall throughout the first quarter of 2019, and on that basis it doesn’t look like a reprieve is on the horizon. Employment will not continue to hold up as confidence is eroded and growth continues to lose momentum. The labour market remains resilient, but unemployment is a lagging indicator so the data only give us a rear-mirror view.
We don’t necessarily need to see unemployment move up in a big way; there is a low threshold for moving to a cut given that the option has been opened for a potential downwards move in the cash rate. In our view, this is inevitable. The RBA will move to cut the cash rate in the second half of this year, but so long as employment remains at a cycle low, the RBA will not fully capitulate on policy guidance.
Yesterday's change in the policy statement, coming in the wake of the February speech wherein Lowe recognised the mounting downside risks, is evidence of the RBA moving towards a more balanced outlook. "Looking forward, there are scenarios where the next move in the cash rate is up and other scenarios where it is down," Lowe said. It is clear that the RBA’s bias is slowly shifting away from the stubborn optimism that has prevailed for so long.
These subtle hints of moving towards cutting rates if growth deteriorates imply that if the unemployment rate starts to pick up, the RBA will move fairly quickly. We don’t necessarily need to see unemployment move up in a big way, given that it has remained the RBA’s pillar of strength in the domestic economy. If this were to crumble, there is probably a relatively low threshold for moving to a cut.
The economy and the labour market will not continue to show divergent paths. While the labour market has been the one bright spot of the domestic economy, with unemployment now sitting at an eight-year low of 4.9%, stagnant wage growth means most people don’t feel the benefit. Construction is one of the largest employment sectors, making up nearly one in 10 jobs in Victoria and NSW. As residential construction activity deteriorates over the coming months, this will hit employment.
The multiplier effects of house price declines on the economy are yet to be felt and as declines continue, they will intensify. The housing slowdown will feed back to the real economy through the negative wealth effect, which will continue to weigh on over-leveraged households’ consumption, resulting in weaker GDP growth. With the current savings ratio near decade lows, consumers will no longer be able to hold up spending habits as asset prices continue to fall. House prices have continued to fall throughout the first quarter of 2019, and on that basis it doesn’t look like a reprieve is on the horizon. Employment will not continue to hold up as confidence is eroded and growth continues to lose momentum. The labour market remains resilient, but unemployment is a lagging indicator so the data only give us a rear-mirror view.
We don’t necessarily need to see unemployment move up in a big way; there is a low threshold for moving to a cut given that the option has been opened for a potential downwards move in the cash rate. In our view, this is inevitable. The RBA will move to cut the cash rate in the second half of this year, but so long as employment remains at a cycle low, the RBA will not fully capitulate on policy guidance.
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