Key insights from the week that was.
A quiet week for data kept the focus on central banks and the heightened uncertainty surrounding Ukraine.
The first key event for the week was the release of the RBA February meeting minutes. Following a speech and parliamentary testimony by the Governor as well as the February Statement on Monetary policy, this set of minutes provided little additional insight with respect to the policy outlook. As discussed by our Chief Economist Bill Evans, taken together, recent guidance from the Governor and RBA Board continue to point to a “patient” approach to policy, with two more CPI prints likely to be assessed before an interest rate decision is made. Regarding wages, comfort looks to be growing amongst the Board that momentum is building, with the minutes noting that “the outlook for broader measures of employee earnings growth had been upgraded more substantially than base wages.” This supports our view that we do not need to see the Wage Price Index print above 3.0%yr before the first rate hike. Westpac continues to believe this step will be taken in August after the June CPI report is received in July. We also continue to forecast that the cash rate will reach a peak of 1.75% in early-2024. This tightening cycle is expected to have a material impact on the housing market, with a 14% price decline forecast between late-2022 and end-2024.
The January labour force survey was the sole primary data release for Australia this week. As in prior months, it pointed to robust strength in employment growth and a tight labour market overall, with 13k jobs created in the month and the unemployment rate unchanged at 4.2% despite a 0.1ppt increase in participation. The 8.8% decline in hours worked in the month highlights the impact of omicron; however, the weakness coming in hours rather than headcount signals it is only a transitory shock.
Moving offshore, the key release was the minutes of the FOMC’s January meeting, the tone of which was supportive of our expectation of a measured FOMC rate hiking cycle. The Committee are clearly confident in the economy’s prospects, with ‘maximum’ employment likely achieved and the risk discussion focused on inflation versus activity. Still, there was no evidence of alarm over inflation, with the risks on this front still seen as primarily coming from supply disruptions, global re-opening and US fiscal policy’s temporary support of demand, not the underlying strength of activity. On the latter, the Committee twice referenced “real wage growth in excess of productivity growth” as necessary to stimulate additional sustained inflation pressures.
This is certainly not in view for the US. Deflating annual growth in the Employment Cost Index wage measure at December by headline PCE inflation shows real wages down 0.6%yr in 2021; deflating instead by the CPI at January points to a real wage loss of closer to 2% over the past year. To make up this loss, US nominal wage rates need to grow 5.0%+ in 2022, assuming our CPI forecast of 3.3%yr is correct, and materially more if real wages are to grow “in excess” of productivity.
Two other discussions from the minutes are worth highlighting. With respect to the pace of tightening ahead, the Committee made a specific comparison to the last tightening cycle which began in 2015. The FOMC sees current conditions as warranting “a faster pace” of tightening in 2022; but this still points to only a modest action, with both 2015 and 2016 having seen just one rate hike after which 2017 and 2018 respectively saw three and four hikes (and 2019 rate cuts). Clearly, if the FOMC were considering a 50bp hike at the March meeting and/or the six hikes that the market has priced for 2022, a very different conversation would have been had at the January meeting.
On the balance sheet, it is notable that the Committee again considered ending asset purchases early, but instead chose to let them continue until March (again signalling comfort with the inflation outlook). Subsequently, they outlined that “a faster pace” of run off was likely appropriate ahead than in 2017-19. This speaks to our belief that the Committee will look to run two forms of tightening at the same time in 2022, with a willingness to be more aggressive with the balance sheet given the financial stability concerns associated with this form of easing.
The take home from these discussions is that a measured, conditional fed fund rate hiking cycle is most likely through 2022 and 2023, while remaining aware of the evolution of inflation risks. Our baseline forecast remains one hike per quarter beginning in March, with the fed funds rate peaking at 1.875% in Q3 2023. This should be a stance tight enough to mitigate inflation risks into the medium-term, but which still allows growth to remain at or near trend.
