For a more comprehensive round up of the week, listen to Stephen’s full report here
Two developments last week reinforce our view that global growth will improve in 2014 and that the long rally in risk assets will extend well in to 2014. One development was the confirmation hearing of Fed Governor elect, Janet Yellen, where she made it plain that the US economy is unlikely to grow at an acceptably strong pace for a long time to come, that the Fed should not consider withdrawing unconventional monetary stimulus until growth is acceptably strong and that improvement in asset prices, including house prices, were assisting recovery and in her view there are no signs of bubble behavior among investors. Janet Yellen takes up the position of Fed Governor in January and is already showing clear signs of extending the Fed’s $US85 billion a month (QE) for longer than market is currently allowing (varying expectations that QE tapering will start between the next meeting on 17-18th December to the second meeting in 2014 on 18-19th March).
Given Janet Yellen’s strong credentials as one of the world’s leading labour market economists, still high US unemployment and her priority to see the US operating closer to full employment (an unemployment rate sub 5% on recent Fed research) the start of tapering QE may not occur before the second half of 2014. Very accommodating US monetary conditions are likely to be maintained for at least another 7-8 months and that timespan could be longer if the US economy does not strengthen considerably by mid-2014.
The other big development last week occurred on the other side of the globe in the world’s second biggest economy China and promises to sustain very strong growth (7% or better) through the remainder of this decade and the next one too. The 18th 3rd Central Committee Meeting of China’s policymaking elite established a list of economic reforms that will increase the pace of urbanization, reduce the influence of state-owned enterprises, establish the market as decisive in resource allocation, grant stronger property rights to farmers and free up the financial system. One headline grabbing change is the end of China’s one-child policy which alone will change the ageing population dynamic that would start crimping China’s growth potential later this decade and through the 2020s.
Many of the reforms proposed run counter to the Communist Party’s desire to control all facets of business and social activity, but that is the mark of the boldness of the current leadership’s desire to transform China in to a truly advanced economy with the capacity to generate high income per head.
The two big developments over the past week have a variety of implications for Australia. Over the next few months the rally in risk assets is likely to extend on the basis that global growth prospects look brighter and particularly for our biggest trading partner China. A second implication, mostly stemming from the longer period of very easy monetary conditions in the United States is that the US dollar could remain comparatively soft and the Australian dollar may stay comparatively firm, probably well above the level of $US0.85, or lower, that the RBA has nominated as being consistent with Australia’s terms of trade (export prices relative to import prices).
This failure of the floating Australian dollar to sink in line with the declining terms of trade on mostly softening export commodity prices is a direct result of the unusually easy monetary policy positions of the US, Japan and Europe and throws up a policy dilemma for the Reserve Bank of Australia (RBA). The RBA could try and match the exceptionally easy monetary conditions overseas taking the cash rate down to near-zero, but the consequence would be an excessive price boom in Australian assets such as housing. So far the RBA’s response has been to lower the cash rate to the limit of what is prudent for Australian economic circumstance. Even if Australian economic circumstances start to improve, as seems to be occurring in some sectors, the RBA is likely to be limited in how it responds. In the past, the RBA has been pre-emptive when the economy has strengthened, working to nip in the bud any possibility of inflation lifting too high. This time, because of the risk that the Australian dollar might appreciate, the RBA may wait until it is clear that inflation is accelerating before it tightens. The bottom line is that current 2.50% cash rate may prevail for much longer than usually occurs at the bottom of the interest rate cycle.