Trump's tariffs likely to lead to further interest rate caution: Westpac's Elliot Clarke

GUEST OBSERVATION 

The past week has been light on data, but full of angst. At the centre was President Trump again raising questions over the appropriateness of the Federal Open Market Committee's (FOMC) ongoing gradual normalisation.

The market subsequently found cause to be more cautious on growth, the S&P500 jolting 3% lower on Wednesday before recovering almost 2% on Thursday. Markets across the world, by and large, followed suit.

During an interview with the Wall Street Journal, President Trump made clear his displeasure with the FOMC over their gradual normalisation.

President Trump’s focus was arguably more on his economic legacy than the appropriateness of the FOMC’s actions, made clear by comments referencing President Obama’s “zero [interest] rates”.

But President Trump did clearly say that he sees the FOMC as the biggest risk to the US “because I think interest rates are being raised too quickly”.

Many across the globe would instead argue that it is his administration’s trade policies that are the greater cause for concern, particularly with respect to business investment.

While the US Markit PMI’s held up in October, according to the flash release, core durable goods shipments and orders both showed weakness in September.

For core shipments, September was the second consecutive flat outcome. Core orders furthermore signalled that growth is to remain absent, falling for a second consecutive month in September.

This soft trend fits with the deterioration seen of late in the regional business surveys’ investment intention series, but is a stark contrast to the optimism around fiscal expansion and domestic demand.

Taken together, these observations highlight the uncertainty that the tariffs have created.

Combined with the end of extraordinary fiscal policy in late-2019, the negative shock to business investment from the US’ own tariffs is crucial to our view that growth will decelerate through mid-2019 and see the FOMC go on hold – indefinitely.

US housing data released this week gave the FOMC an additional reason to be cautious but not alarmed.

New home sales fell over 5% in September; moreover, this was the fifth decline in six months.

If we take a step back and consider data for the past two years however, the trend looks more flat than downward.

Given home builder confidence and Case-Shiller house price growth remain strong, and the 30-year mortgage rate accommodative, the current level of sales should persist and inventories remain manageable.

Turning to Europe, the ECB met for their October meeting this week. By and large, their views were unchanged.

The Council continues to have considerable confidence in the domestic economy, particularly the strength of employment.

The latter is expected to flow through to wages and underlying inflation in time, bringing inflation to the ECB’s ‘near 2% year target’. Although risks are still considered “broadly balanced”, evident in the Q&A however was that external risks to this view have built.

This highlights a need to pay close attention to the ECB’s forecasts as they are updated at the December meeting and the end of each quarter thereafter.

We remain of the view that only the deposit rate will be increased from late-2019, with the refinance rate to wait until at least mid-2020. Risks to this view are skewed towards a later start to hikes.

Coming back to Australia, in the absence of any data, RBA discussion of the labour market was the focus.

Following the unemployment rate’s jolt lower to 5.0% in September, historically the benchmark for ‘full employment’ in Australia, Deputy Governor Debelle remarked this week that “We [the RBA] have an open mind on the question of what actually constitutes full employment”. 

Westpac’s own view is that the unemployment rate consistent with full employment is actually likely to be well below the current 5.0% figure, hence wage growth and inflation are unlikely to pick up anytime soon.

This fits with the experience of the US where, with the unemployment rate now a percentage point below historic estimates of ‘full employment’, wages are only just starting to accelerate robustly.

Looking ahead, we see the Australian unemployment rate holding near 5.0% through 2018 and 2019, and hence wages growth and inflation remaining benign.

The next key update for Australia will be the September quarter CPI report, due next week.

On all fronts, it is expected to highlight the absence of inflation pressures and justify the RBA remaining on hold through 2019 and 2020.    

Elliot Clarke is a senior economist at Westpac and can be contacted here.