In Australia this week, eyes will be on Tuesday’s Federal Budget, which may well live up to the “dull” label slapped on it by the Prime Minister, says Instreet Managing Director, George Lucas.
“Failure of the budget to provide any extra support to the economy will be disappointing and it could place an even greater burden on the Reserve Bank of Australia (RBA) to cut interest rates further,” he said.
“We expect the budget will be light on measures with a few small spending policies funded by a few small revenue-raising policies. What it will be big on is politically palatable buzz words like “integrity”.”
“We’re anticipating the cash deficit to narrow from around $35 billion in the current 2014/15 financial year to around $14 billion in 2017/18, somewhat higher than the $11 billion published in the Mid-Year Fiscal and Economic Outlook.”
The budget may also show that by 2017/18 the ratio of net debt to GDP will have risen to 18.5 per cent. This would be higher than the previous estimate of 17.0 per cent and well below most OECD economies, which have debt to GDP ratios nearer 100 per cent.
Beyond the budget, the strong run in Australia’s labour market came to an end last week when the release of April’s employment data revealed a drop of 2,900. Helping drive the unemployment rate from 6.1 per cent to 6.2 per cent was an increase in population.
“That said, we are wary of reading too much into monthly changes in such a volatile data series and prefer to look at the three month average which continues at around 28,000 jobs a month. This compares favourably to the past five years, where an average of 13,000 jobs were created each month.”
Last week was all about long bond yields
And it’s not surprising given German Bunds have gone from 7bps to 70bps+ in just a few short weeks. In fact yields all around the globe have increased quite significantly since mid-January.
What’s driving them? It’s mainly down to the recovery in the price of oil, which in turn has reduced fears of deflation. At the same time, expectations of a rise in inflation have increased as investors have begun to consider how rapidly the US federal funds rate is likely to be raised in the coming years.
There have also been some suggestions that the rising oil price will enable the European Central Bank (ECB) to conclude its bond buying earlier than planned, however we think this is unlikely. Whilst momentum in growth continues, deflation remains a threat in the highly-indebted countries of the Euro-zone:
– The size of planned purchases is not large by the standards of other major central banks
– Inflation expectations remain well below the ECB’s inflation target
– Stopping the policy prematurely could backfire by eroding confidence in the ECB’s willingness to tackle deflation.
There seems little hope that Monday’s Eurogroup meeting will result in a deal between Greece and its creditors that will allow the disbursement of financial aid, creating uncertainty over Athens’ sizeable IMF repayment due on Tuesday.
Meanwhile, we think Euro-zone GDP for quarter one will have expanded by 0.4% quarter on quarter (annualised rate of 1.6%), which is higher than expectations from six months ago.
Oil price recovery
Speaking of the recovery in the price in oil – a barrel of Brent crude has reach nearly $70 (a 50 per cent gain from its January low of $46). Prices have been boosted by a few main factors including:
– Evidence that previous sharp falls undermined US production
– Reversal of some of the Dollar’s earlier strength
– A surge in speculative buying
– Hopes for a pick-up in demand, particularly from Europe.
We believe oil prices will average around $65 this year given OPEC supply is ample (even before any boost from the easing of sanctions on Iran) and US output could quickly rebound. Indeed, the active rig count in the US may start to rise again soon. We also expect the dollar to resume its climb as the Federal Reserve moves closer to increasing its rates.
We don’t think a rebound to $60-$70 per barrel presents a major threat to the global recovery. Even at these levels, prices would be well below the average of $110 (for Brent) that prevailed from 2011 to mid-2014.
The only real risk to economic growth is the response of bond markets to the rebounding oil prices. Whilst the oil price has eased the immediate threat of a damaging period of deflation in some economies, the risk remains that it could reduce the pressure to keep monetary policy loose for longer.
For example, if Brent were to recover to around $80, average energy price inflation in the CPIs of OECD countries could jump significantly. This is a risk associated with many current central bank policies of loosening to weaken currencies including our own RBAs.
Central banks would of course look through the swings in headline inflation, but we are less confident that jittery consumer and investors will do the same.
