Past performance is no guarantee of future performance is an adage that every investor should have etched in to their psyche before considering any investment. Equally it should be etched in to the psyche of policymakers when considering past economic performance and how their policies should adjust for expected economic performance. The past performances of both the US and Australian economies increasingly look as if they may be poor guides as to where they travel next. The central banks in both the US and Australia are talking as if the future is a continuation of the recent past – reasonable economic growth in the US continuing to build momentum and slow but stable growth in Australia generating just enough jobs to keep the unemployment rate steady.
The economic views of the two central banks are leading the US Federal Reserve to provide guidance that it will soon start lifting its funds rate and the RBA to hint at a steady cash rate at 2.00% for the next few months. The problem is that international economic factors appear to be shifting quickly. China seems to be lingering for longer in a weak growth patch that despite the considerable efforts of policymakers in China is taking time to stabilize. Softer Chinese growth for longer is adding to downward pressure on growth in many emerging economies. Capital outflows from emerging economies are threatening to turn softening growth in to a vicious cycle of even softer growth. The threat of higher US interest rates and the strengthening US dollar are a compounding factor in the capital outflow story for emerging economies.
If the US Fed starts to acknowledge that future US economic growth prospects are at risk from changing global growth prospects and surprises in mid-September by providing changed guidance on interest rates effectively along the lines of lower rates persisting for longer, there is likely to be a much better chance in our view that the China/emerging economies’ growth set-back will be a comparatively short-lived affair. If the US Fed does the opposite, however, and ignores the warning signs from emerging economies and clings to the policy plan it has been building on past US economic performance and starts to lift the funds rate at its mid-September, the risk rises of a more serious and prolonged downturn in global economic growth quickly damaging US economic growth prospects too.
The US Fed is not the only central bank facing the risk of making a policy mistake over the next month or two. The RBA’s views expressed earlier this month in its quarterly Monetary Policy Statement of stabilizing growth in China and global growth continuing close to trend already look in need of significant downward revision. At the very least Australia’s mining investment downturn looks set to run deeper than previously estimated reinforcing recessionary conditions in many areas of Queensland, Northern Territory and Western Australia. More generally, business and consumer confidence look set to lurch lower.
The RBA can choose whether to ease monetary conditions further in the face of the approaching deterioration in economic conditions, or wait. If it waits, it risks adding to the extent of the downturn in our view.
One tricky part in this entire assessment is that China has been easing policies aggressively and at some point those easier policies should lead to stabilizing economic growth in China. Also China has the capacity to ease policies further. At some point economic conditions in China are likely to improve with flow-on benefits to other emerging economies too. The problem is that it could be several months before the stabilization in China is evident and that timespan could be influenced too by policy settings in China’s key trading partners including the United States.
The next few weeks are shaping up as a very challenging period for investors and economic forecasters. The policy positions of key central banks, including the US Fed and the RBA are likely to play a part in determining whether the current weakness in China and emerging economies passes relatively quickly or lingers threatening to push global growth to the brink of recession. Their policy positions are likely to determine whether progress is comparatively hard or easy.
The hard path would include in our view the Fed starting to raise rates soon and the RBA sitting on the cash rate at 2.00%. An easier path towards seeing global and local growth prospects brightening sooner would include the Fed keeping and saying it will keep rates lower for longer and the RBA cutting the cash rate again soon.