AM Notes: No change for RBA

Not much going on overnight: risk sentiment looking a tiny bit negative, and USD in demand but nothing overly concerning.

Japan & China markets remain closed.

  • The Bank's central scenario for GDP growth has been revised up further, with growth of 4Âľ per cent expected over 2021 and 3½ per cent over 2022.

  • A pick-up in business investment is expected and household spending will be supported by the strengthening in balance sheets over the past year.

  • The unemployment rate is expected to continue to decline, to be around 5 per cent at the end of this year and around 4½ per cent at the end of 2022.

  • Despite the strong recovery in economic activity, the recent CPI data confirmed that inflation pressures remain subdued in most parts of the Australian economy.

  • A pick-up in inflation and wages growth is expected, but it is likely to be only gradual and modest. In the central scenario, inflation in underlying terms is expected to be 1½ per cent in 2021 and 2 per cent in mid 2023.

  • In the short term, CPI inflation is expected to rise temporarily to be above 3 per cent in the June quarter because of the reversal of some COVID-19-related price reductions.

When will they hike?

The Board is committed to maintaining highly supportive monetary conditions to support a return to full employment in Australia and inflation consistent with the target.

  • It will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range.

  • For this to occur, the labour market will need to be tight enough to generate wages growth that is materially higher than it is currently.

  • This is unlikely to be until 2024 at the earliest.

What does this mean for AUD?

While the RBA did note that the "Australian dollar remains in the upper end of the range of recent years", we see it as cheap to fair value given the aggressive rise in commodity prices and easing in measures of market volatility.

The RBA point that "the economic recovery in Australia has been stronger than expected and is forecast to continue" adds to this view.

Thus, we stick to the view that the A$ is a good buy on dips through 0.7700; but given it remains well capped at 0.7780/ 0.7820 for now, we would be patient and wait for dips. - Westpac

The inflation debate continues: Transitory or sustained?

Don't know how many times this needs to be said, but even if we see one year of inflation chugging above 2%, it still fits the definition of transitory (i.e. not permanent)

For now, firms have generally been able to pass those increased costs onto their customers

“We are seeing very substantial inflation,”

“We are raising prices... People are raising prices to us and it’s being accepted.”

That's all well and good while people are cashed up on government stimulus and 'forced' savings...

What needs to happen for these price increases to continue?

A far stronger labour market to support wage increases (otherwise firms can't pass those price increases on)

It's vital that we look at a wide range of indicators to gauge the health of the labor market. One measure that I find useful is the employment-to-population ratio, or "EPOP" as it's affectionately known.

EPOP is the share of the population that have jobs according to a monthly survey of households

Before the pandemic, when the labor market was quite strong, EPOP was about 61 percent.

By April of last year, it had fallen nearly 10 percentage points, which translates to 25 million fewer people working—an  astounding drop.

Fortunately, EPOP has risen considerably since then, but it's still more than three percentage points below pre-pandemic levels.

That difference translates to about eight and a half million fewer people working, close to the statistic I cited on the number of lost jobs that is based on a survey of employers.

 "The statistics I use — and I do this just because it's convenient — is to go back to where we were right before the pandemic ... Clearly, we could have a strong labor market like that without creating inflationary pressures," New York Fed's John Williams tells reporters— Matthew B (@boes_) May 3, 2021 

Friday's NFP print is expected to show more than a million of those jobs recovered...

Fed officials are continually hammering home the same message: full employment is key before we care about inflation.

There's a lot going on with supply chains, reopening, base effects and so on, yet some believe that everything has changed for good...

Mohamed El Erian argues that the Fed framework holds central bank hostage and that the 'framework was designed a couple of years ago when no one anticipated the current huge structural transformations. Today, it holds the Fed hostage and increases the risk of a policy mistake'.

For quite a while now, the Fed has worried about a balance of risk tilted towards deflation. That balance of risk has flipped.

I think he misses the point here - that's exactly what the Fed want.

If inflation runs a bit too hot for comfort, that's not so bad... they can fix it by hiking rates.

Persistent deflation is a far scarier prospect, especially when they have already cut rates to (basically) zero.

Excessive inequality is also seen as an important problem to solve 👇

 Powell: "The Fed is focused on these long-standing disparities because they weigh on the productive capacity of our economy. We will only reach our full potential when everyone can contribute to, and share in, the benefits of prosperity."— Dr. Julia Coronado (@jc_econ) May 3, 2021 

It still seems (to me at least) that a lot of financial commentators haven't grasped this new framework and what the Fed are trying to achieve/avoid...

A deflationary, stagnating environment with increasing inequality could not be fixed with the old approach. The odds are still stacked against the Fed reversing this in the long term (due to structural disinflationary pressures) but they're going to give it a solid go anyway.

Inflation is (relatively) easy to fix, but stagnant deflation really isn't.

In my humblest opinion, the avoidance of the worse outcome is the motivation behind this.

In the coming months, the headlines and opinions on the Fed and their irresponsibility will surely intensify.

Keep in mind that the Fed actually fear 'sticky' unemployment far more than 'sticky' inflation...

Looking ahead, nothing to really get the juices going...