Key insights from the week that was.
This week had a near sole focus on economic policy, here and abroad.
For the RBA, the minutes of their September meeting highlighted the reasoning behind their decision to take the first step in tapering asset purchases this month, but to then delay the next until 2022. Keeping asset purchases at $5bn per week until “at least November 2021” was also considered, but the decision to taper this month was eventually made given the economy is seen returning “to its pre-Delta path by mid-2022” and as “a number of other central banks are tapering”.
The decision to reduce asset purchases based on expectations of our economy over the year ahead and policy abroad contrasts with the RBA’s clear intention with regards to subsequent rate hikes to make each decision on actual data instead of forecasts, and to not let the timing of other central banks impact. Arguably, this is because QE is seen as an extraordinary measure for times of heightened risk and uncertainty, and as reducing the pace of asset purchases is not regarded as policy tightening, but rather easing at a lesser rate.
We take from the September minutes and other recent RBA communications that the RBA believe the outlook is likely to be strong enough to see a further reduction in asset purchases from February, and an end to the program in May/August. Thereafter, the decision to increase interest rates will be made on progress in the economy, particularly the pursuit of full employment and robust wage gains which are seen as necessary to hold inflation in the RBA’s 2-3%yr target range.
The first steps towards policy normalisation were also front of mind in the US this week as the FOMC held their September meeting. As we anticipated, there was no formal taper announcement. But Chair Powell and the Committee guided that the conditions for this decision were “all but met”. Depending on the strength of the September and October employment reports, their decision to taper could come at either the November or December meeting. At present, risks related to the US’ delta wave of COVID-19 and developments in China seem to be having little bearing on US monetary policy (more on China below).
Highlighting the belief that Chair Powell and the Committee have in the US economy, not only do they expect to taper asset purchases fully by mid-2022, but a first rate hike by end-2022 is now seen as an even bet, with a moderate rate hike cycle to follow, taking the fed funds rate to 1.8% by end-2024.
Over this period, full employment and growth above trend are expected to be sustained. This highlights that at no time over the forecast period is policy expected to be restrictive. Indeed, if the 1.8% for the fed funds rate at end-2024 is achieved, the real fed funds rate would still be negative. These revised FOMC forecasts are broadly in line with Westpac’s existing views, both with respect to the timing and scale of policy changes. Our terminal fed funds rate is a little lower though at 1.625%.
While the US dollar gained on the September FOMC meeting communications, it more than reversed the move in 24 hours. Principally this looks to have come about because of the Bank of England’s September meeting which saw a greater focus on supply constraints, wage pressures and hence the persistence of inflation in 2022. Inbuilt in our currency forecasts is a view that the FOMC will be slower to act on tapering (the BoE/ECB respectively stopping/materially reducing purchases at December 2021/ March 2022) and potentially could raise rates after some other major central banks, most notably the Bank of England and Canada.
To March 2022, we therefore continue to expect the US dollar to weaken at the margin before recovering back to near current levels by end-2023. While the US may take time in beginning both stages of normalisation, they are likely to increase interest rates further to end-2024. Note the ECB is unlikely to increase rates over this entire period, leaving the Euro most susceptible to weaker outcomes in late-2022 and 2023.
China has also remained in the headlines this week, not because of monetary policy, but instead because of the plight of Evergrande and the impact of broader reforms to the residential construction sector which, together, have materially reduced momentum.
The Evergrande situation is immensely complex and so will take time to work through. But there is a way forward, at least for the construction projects being undertaken by the firm. These projects are diversified by region and, even with the Evergrande holding company in a precarious financial position, still in demand.
To protect both the purchasers of these apartments and the workers, they could be sold or handed over to other developers for completion. Notably, Evergrande’s spread across tier 2 and 3 locations is important to authorities as it fits with their intention to make wealth and quality of life more equitable across the population. This means the projects should also be valuable to other developers.
While such a course would allow existing projects to be completed and prices to stabilise, thereby resetting the sector for another period of growth, it would do little to alleviate the parent company’s financial issues, at least in the near term. We expect these would be worked through slowly to not hit confidence or take unnecessary risks, at least for domestic investors. These parties will receive the proceeds that flow from the construction subsidiaries and the other assets of Evergrande, likely in order of sophistication – least to most. Preferencing retail investors and domestic bond holders over the local banks also makes sense given the banks can be helped by liquidity provision as necessary.
Our take home for China’s outlook from the current circumstances is that, while risks will remain near term, like most regulatory change China undertakes, authorities actions here will make the economy and financial sector stronger for the long-term.
