Uncertainty in the global economy is rising by the day. The pre-Christmas concern about slowing inflation has turned into a conversation about looming deflation.
The risks for Australia are mounting: price declines in the nation’s biggest export, iron ore, have resumed again in recent days and the big story of the day on Asian markets is the plunge in another major export, copper, which some believe is due to a coming slowdown in demand from China.
Tomorrow we get the first Australian employment report of the year and the market’s expecting a gain of 5,000 jobs for December with the unemployment rate to stay steady at 6.3%. There are more than a few major banks, however, projecting thousands of job losses.
If that comes to pass it will be a grim start to a year in which there are already well-known headwinds facing the economy from falling commodity prices and the reduction in mining investment. Growth is already tracking slower than expected, with GDP data last month showing a measly 0.3% growth for the September quarter when the market was expecting a rudely healthy 0.7%.
With all this happening it’s worth revisiting some recent commentary on Australia from Gerard Minack, the former Wall St analyst who has been in the news this week because of his customarily gloomy market outlook for 2015 outlined in an interview with the AFR.
The Australia outlook was in a December edition of his note Downunder Daily, the circular he took with him when he left Morgan Stanley as its global chief equities analyst last year and set up his own consultancy, Minack Advisors, back at home in Australia.
In the note, titled “2015: Australia Runs Out Of Luck”, Minack, a noted bear, estimated Australia faced a 40% chance of recession this year and said the only reason it was not his base case was that the leading indicators of employment – job ads, readings from sectoral PMI reports and so on – remained strong.
Minack, whose data wizardry is one of the reasons Downunder Daily has such a following, combines these job indicators with employment data to produce the following chart:
The past decade, he argues, “saw a once-in-a-century boom in Australia’s commodity prices and mining investment. It was completely predicable that the twin booms would not last, even if it was not easy to say exactly when they would peak, or how fast they would reverse. The terms of trade (ratio of export prices to import prices) are now falling fast. They remain well above long-run averages, so further declines are likely.”
The twin booms produced what he calls a “fiscal magic pudding” (great phrase) which led to surpluses in the federal budget that were more attributable to economic conditions surprising to the upside than to policy decisions.
The federal budget is always put together on a number of technical assumptions including the value of the Australian dollar and commodity prices. (This is still happening: as we reported last month, the technical assumptions underpinning the federal budget delivered in May were completely wrong by December.)
So look at this chart, where Minack compares the bottom-line impact on the budget of changes in the economic cycle to the effects of spending and saving decisions by various governments over the years. This doesn’t entirely negate the importance of decisions by governments but it does underline how the economic cycle can have a dramatic effect on budget outcomes for governments of all stripes.
Ominously for federal treasurer Joe Hockey, struggling to find policy measures that will address the budget deficit before even countenancing further downward revisions to the economic fundamentals, Minack writes:
The magic pudding is gone. Economic revisions are now worsening the forecast budget balance by around 1½% of GDP per year, matching the size of the beneficial revisions in the prior cycle. The cumulative downgrades are less than the aggregate upgrades that went before, suggesting more downgrades to come.
In terms of what’s happening to Australian companies, Minack points to declining sales growth as a pressure point for businesses, saying that it “has fallen by two-thirds: from 15% nominal growth through the last cycle to 5% now”. He says the recent reduction in domestic demand that we saw in the September GDP figures, as well as “sluggish corporate sales [and] demand declines in mining-driven states… are likely to persist for some time.”
He adds three things are likely to compound the sagging in growth this year: planned job losses in manufacturing will finally materialise, the fall in mining-related investment will speed up, and (he argues) housing investment will contribute less to growth.
It’s a gloomy outlook. The more optimistic case for the Australian economy is that the Aussie dollar chasing commodity prices downwards (it has been smashed again on the copper fall) will make non-mining exports more competitive, creating more jobs in skilled sectors and tourism. And the strong economic growth in NSW will spread to other non-mining states as construction activity increases and brings a strong multiplier effect across retail and other sectors. Falling oil prices putting hundreds of dollars back into household budgets could boost consumer confidence (though we’re still waiting for that to happen).
“The main reason I do not yet have recession as a base case is that leading indicators of employment appear reasonable,” Minack wrote. “If the employment leading indicators turn lower, then the risk of recession would commensurately increase.”
Data out today showed vacancies at a two-year high. That’s a very good sign. And the latest official employment data is out tomorrow morning at 11.30am. Amid all the turbulence of this week and the continuing need for consumers to feel comfortable splurging on a few things, it will be a number watched even more closely than usual.