As the year draws to a close, the attention turns to how 2021 might play out in a year where expectations are set high after the pandemic-induced disruptions of 2020. In the markets, the key reflation theme is where the focus will be as the development of vaccines is expected to lead to wider and more sustainable reopenings, enabling global economic activity to recover. Through it all will be major central banks including the Fed, ECB, BoE, BoJ and RBA promising to adhere to forward guidance not to tighten policy from emergency settings after the onset of the pandemic saw policymakers cut rates to their effective lower bounds and ramp up asset purchases significantly. With these actions holding front-end rates down, markets look for yield curves at the long end to steepen as inflation expectations build. If this scenario plays out, the dynamics will continue to be favourable for risk assets as real yields will be driven ever lower, boosting private sector balance sheets in the process, while keeping pressure on the US dollar — this market's other key consensus trade. But standing in the way of that optimistic outlook is elevated uncertainty over the path of the pandemic that will continue to damage economies until it can be stemmed. Next year promises much but only time will tell if it can deliver.
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Key developments in Australia this week were around the labour market and federal finances. After regaining momentum in October, the labour market recovery increased pace as employment lifted by a much stronger-than-expected 90.0k in November, reflecting the wider reopening of the domestic economy (reviewed here). The composition of the gain was led by strong growth in full-time employment (+84.2k) in a continuation of the theme that was evident in the month prior. With the earlier declines in employment and hours worked in the part-time segment having already been restored, the recovery now appears to be widening out with momentum in the full-time segment accelerating. Overall, employment has staged a quicker rebound than many had expected to be within 1.1% of its pre-pandemic level, while hours worked have lifted at a rising pace as the impacts of restrictions have become less material to be 1.5% below the level in March (see chart of the week, below). Reflecting the improvement in underlying economic activity, spare capacity in the labour market appears to be declining with the unemployment rate falling from 7.0% to 6.8% and broader measures of underutilsation continuing to move down from their peaks earlier in the year. Notably, this is occurring alongside a sharp rise in the participation rate, which at 66.1% is now above its pre-pandemic level.
Chart of the week
This week's minutes from the RBA's December policy meeting reiterated the Board's determination to keep accommodative settings in place to help ensure progress in the economic recovery continues, most notably in the labour market. Indeed, the conditionality attached to the Board's forward guidance to not increase rates for at least 3 years is for a return to a "tight labour market" where employment has risen to levels that have generated strong wages growth leading to the inflation data consistently printing within the 2-3% target band. The Board also continues to note that it is keeping the size of its bond purchase program "under review" and that is "prepared to do more if necessary". Purchases under the program currently stand at $32bn of its $100bn envelope, leaving it on track to be completed by around April/May next year, depending on what happens with the pace of purchases. In a global context where central bank asset purchases will remain prominent in 2021, the same reasons that prompted the RBA to move to a quantitive easing program — to lower borrowing costs and place downward pressure on the exchange rate — seem very likely to form the basis for extending the facility next year.
Meanwhile, the support will continue to come from the fiscal side as underscored by the mid-year update to the Federal Budget (reviewed here), with policy announcements since the crisis equating to around 8% of GDP in the current financial year. The faster than anticipated rebound in the economy since reopening and elevated commodity prices have improved the deficit metrics by a total of $29.3bn over the forward estimates. The forecast for GDP growth in 2020/21 was revised up to 0.75% from a contraction of 1.5%, with the economy to return to its pre-pandemic size by the end of the period, before expanding by 3.5% in 2021/22. In response, a more constructive assessment attends the outlook for the labour market with employment growth revised up and the unemployment rate declining at a faster pace.
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Switching the focus offshore, events were highlighted by the latest meeting by the US Federal Reserve's policy committee. As expected, the FOMC made no changes to its existing settings, though it did provide some additional guidance around its asset purchases. The Fed is committed to purchases of at least $120bn/mth ($80bn of Treasuries and $40bn of mortgage-back-securities) that it now says will continue "until substantial further progress has been made toward the Committee's maximum employment and price stability goals", whereas previously it had only been advising that this run-rate would be maintained "over coming months". Published alongside the decision was the updated set of committee members' forecasts which broadly conveyed a more optimistic outlook for GDP growth and unemployment over the next couple of years, while at the same time the median estimate for the fed funds rate was unchanged from the current level (0-0.25%) out to at least 2023, reinforcing the signal to markets that it does not anticipate it will be pushing back against the strong economic conditions it eventually expects will emerge once the pandemic crisis dissipates. But in the meantime, it is the pandemic that holds sway and the data flow showed further signs of strain through the week as retail sales pulled back sharply in November with a 1.1% fall, while initial jobless claims increased by more than expected to 885k. This underscores the importance of Congress agreeing to a new fiscal support package, which appears to be close after further progress was made in cross-party negotiations this week.
Over in Europe, the effects of containment measures on economic activity in the bloc appeared to be moderating based on a rise in the flash PMI reading from 45.3 to 49.8 in December, though whether an improving trend can form is in question with Germany and the Netherlands moving to tighter restrictions. The manufacturing sector continues to stand out; output elevating at a faster pace from 53.8 to 55.5 on the tailwinds from strong export orders as demand conditions offshore improve. In contrast, the services sector remains heavily affected by the restrictions, though with the output index lifting from 41.7 to 47.3 the rate of deterioration has eased. In the UK, the Bank of England's Monetary Policy Committee left current settings unchanged this week, though it did announce a 6-month extension of its term funding scheme, as it awaits more clarity on both the path of the pandemic under the government's three-tier system of local restrictions and on Brexit developments as talks between both sides continue ahead of the December 31 deadline. Following the MPC's decision at its previous meeting to grant its quantitative easing program with a £150bn expansion to £895bn, it noted at this week's meeting that it stood ready to "take whatever additional action is necessary to achieve its remit". Lastly, the Bank of Japan (BoJ) also held its final policy meeting for 2020 this week, with the Policy Board announcing a 6-month extension of its emergency funding scheme that facilitates the flow of credit from banks to pandemic-hit firms, while rates and asset purchases were left unchanged. The main development from the meeting was the announcement that the BoJ will be conducting a review of its approach to monetary policy relative to its elusive inflation goal that is expected to be completed by March 2021.
* This sounds the closing bell for the year at Macro View. Wishing readers a merry Christmas and all the best for a better 2021.
