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Economics | December 2 2019 - Economic Insights The Big Issues of 2020

Economic InsightsThe Big Issues of 2020Economics | December 2 2019

BIG ISSUES OF 2020United States-China relationsFull employmentThe future of monetary policyFiscal policy: stimulus or surplus?The road ahead for the Chinese economyOil pricesEast Coast DroughtUS Presidential Election

The Big Issues of 2020• For the past 18 years we have produced “The Big Issues” report – a report that has sought to highlight the issues that are

expected to influence the economy and financial markets over the forthcoming 12 months.

• This is not a crystal ball gazing exercise. The aim is not just to forecast where certain economic variables are likely to be in a year’s time. Rather the focus has been to highlight trends, issues and ‘big picture’ influences that act as threats or opportunities for consumers, investors and businesses alike.

• The aim has been to produce an informative document that is jargon-free. The intention over time has been to produce a commentary that causes people to think and ask the ‘so what’ question – that is, to determine what this means for their own circumstances. If one or a number of the Big Issues were to prevail over 2020, what would this mean for you or your customers/clients?

• We undertake this analysis by balancing the text with a healthy spattering of graphs and pictures to best highlight the issues we think will prove important in 2019.

• Certainly one of the great innovations over recent years has been use of infographics and other visual developments that have sought to bring subject matter ‘alive’.

• You may not agree with all of our choices of Big Issues for 2020. But hopefully the discussion prompts you to come up with issues that you will be watching closely over the coming year.

• We offer the following thoughts for your consideration.

Craig James Chief Economist, CommSecTwitter: @CommSec

Ryan Felsman Senior Economist, CommSecTwitter: @CommSec


Review of the Past Year• In addition to our ‘Big Picture’ analysis of key economic

issues, we feature a recap of the past year’s economic performance together with an outlook for the economy for the coming twelve months.

• This economic assessment largely sets the scene for the discussion of the Big Issues. Because there are themes and trends that have evolved over the past year to affect economic performance, a valuable starting point is to establish whether the same factors or indeed new factors are likely to dominate in the coming year.

• The economic forecast table below is exactly the same table used last year to assess the outlook for 2019. It is clear that our assumptions proved too optimistic. Why? Well there are two principal reasons. Uncertainty about the Federal Election caused Aussies to delay spending, investment and employment decisions. Second – at a global level – the US-China trade dispute caused companies to delay business decisions, resulting in a marked slowing of global economic growth. Central banks cut interest rates and governments lifted spending to try and boost economic activity.

• The Australian economy grew by 1.9 per cent in 2018/19 and current annual economic growth stands at 1.4 per cent. The inflation rate remained below the Reserve Bank’s 2-3 per cent target range, but the unemployment rate has generally held near 5.2-5.3 per cent.

• Interest rates and the Australian dollar were both lower than expected, but these results assisted the sharemarket to lift to levels above our forecast range.

FORECASTS

2017/18 2018/19

Economic Growth 2.8% 3.00-3.50%

Underlying inflation 1.9% 2.00-2.50%

Unemployment 5.3% 4.75-5.25%

mid 2019 end 2019

Cash rate 1.50% 1.50-1.75%

Sharemarket (All Ords) 6,200-6,500 6,450-6,750

Australian dollar US73-80c US73-80c

The Year Ahead• As we approach the end of the 2019 calendar year,

uncertainties remain about the year ahead.

• The global scene remains dominated by the US-China trade talks and Brexit – the proposed exit of the UK from the European Union.

• But forecasters are hopeful about better times ahead. The International Monetary Fund tips global economic growth of 3.4 per cent in 2020 after expected growth of 3.1 per cent in 2019.

• Apart from US-China trade and Brexit, the US Presidential Election and impeachment proceedings against the US President will be watched by businesses and investors over 2020.

• The good news domestically is that the Federal Election is out of the way. While consumers are still cautious about spending, home prices are again lifting in response to stronger demand.

• In 2019/20, the Australian economy is expected to grow by 2.4 per cent, returning to the long-term average near 2.75 per cent later in the 2020 calendar year. Inflation is tipped to remain below the 2-3 per cent target band over 2020. And the jobless rate may continue to hug 5.25 per cent.

• A quarter per cent rate cut is pencilled in for February, reflecting stubbornly-low inflation and a jobless rate still perched above the perceived 4.5 per cent ‘full employment’ target level.

• Consumer spending remains one of the major uncertainties for 2020. Much may depend on the resolution of the US-China trade impasse. If that issue receded from the limelight and Australian interest rates were left unchanged for an indefinite period, consumers would be more likely to embrace the stimulus being applied to the economy and lift spending. Higher home prices should support consumer spending over the year despite tepid wage growth.

FORECASTS

2018/19 2019/20

Economic Growth 1.9% 2.25-2.75%

Underlying inflation 1.6% 1.50-2.00%

Unemployment 5.2% 5.00-5.50%

mid 2020 end 2020

Cash rate 0.50-0.75% 0.50-0.75%

Sharemarket (All Ords) 6,900-7,200 7,100-7,400

Australian dollar US66-70c US67-71c

…But First…The Economic ‘State of Play’


United States-China relations

• This Big Issue returns from last year’s 2019 list. And with good reason. The US-China trade and technology issues dominated in 2019 and the path to a trade agreement hasn’t become any easier.

• Consider the opening paragraph from last year’s report: “At the time of writing, there is greater optimism that a trade deal can be secured between China and the United States. In fact the White House reported that the US and Chinese leaders concluded a “highly successful meeting” between themselves and their most senior representatives” on the sidelines of the Group of 20 (G20 meeting) in Buenos Aires, Argentina.”

• So much for a ‘successful meeting’. Indeed over 2019 we’ve heard all manner of platitudes that have delivered very little progress – ultimately a disappointment.

• At the time of writing, the two protagonists were trying to put together a supposed “Phase One” deal. But sticking points remain, including how much US agricultural produce China will commit to purchase. China wants the US to roll back some of the tariffs already applied by the US on Chinese goods. And political issues may influence the deal such as Hong Kong human rights and Taiwanese elections.

• So what has been the impact of the dispute so far? Arguably – and perhaps surprisingly to many – the US economy seems to have weathered the storm. The economy continues to grow at a 2.0-2.5 per cent annualised rate, the jobless rate is near 50-year lows and inflationary pressures are restrained.

• But only about 7 per cent of all US exports go to China. Other countries are more exposed to China. And businesses across the globe have trimmed investment and employment, causing economies to slow. In response, central banks have been forced to cut interest rates.

• The Chinese economy has also slowed – but determining how much of the slowdown has been caused by the trade dispute is the hard part. Because China has also responded by stimulating its economy. For Australia the infrastructure spending and increased demand for steel has also meant firmer iron ore prices. Australian agricultural exports have also been supported by a larger and wealthier Chinese middle class. China has also lifted demand for Australian livestock in the wake of African swine fever affecting Chinese herds. Just how long the impact remains ‘muddle through’ is the $64 question.

Graphic source: Marketwatch


• A few days after the Federal Election, that is on May 21, the Reserve Bank Governor delivered a speech. It turned out to be a seminal speech. Governor Philip Lowe laid out the case for lower interest rates. Central to that case was a new target rate for unemployment.

• The Governor put it this way: “what rate of unemployment is achievable in Australia without generating inflation concerns?” That is, what is “full employment” or the non-accelerating inflation rate of unemployment (NAIRU)? In the past the Reserve Bank had thought it was 5 per cent. But Governor Lowe said: “…I think we can do better than this. My judgement of the accumulating evidence is that the Australian economy can support an unemployment rate of below 5 per cent without raising inflation concerns.”

• The Governor indicated that if the jobless rate didn’t fall from current levels and if inflation was judged likely to remain below the target band, the Reserve Bank Board would consider the case for a rate cut. The rest is history. Rates were cut in June, July and October.

• So unemployment has taken a new role in the setting of interest rates. In following speeches from Reserve Bank officials the level of “full employment” was set as 4.5 per cent. But that level wasn’t set in concrete, it has been more correctly defined in fuzzier terms of around 4.5 per cent.

• It is clear that inflation is expected to remain below the Reserve Bank’s 2-3 per cent target band for longer. And the Reserve Bank has turned its attention to jobs. The aim is to run the economy at a faster rate in the hope of creating more jobs and lowering the jobless rate.

• In 2020 the discussion of “full employment” is likely to be debated even further. Is it a 4.5 per cent jobless rate or is it lower? If employment growth remains strong but the participation continues to rise, implicitly the job market is tightening but it may not be reflected in a lower jobless rate. And what about jobless rates in states and territories? If jobless rates fall in NSW, Victoria and the ACT, driving the national rate lower, is 4.5 per cent still regarded as “full employment” if jobless rates in other states remain high. Throw in discussion of underemployment and underutilisation and it is clear that “full employment” will be debated in 2020.

Full employment


The Future of Monetary Policy

• Across the globe, we see more evidence of ‘triple L’ – low unemployment, low inflation and low interest rates. Historically having all three of these factors at the same time doesn’t line up with the economic textbooks. If the job market is tight, then this places upward pressure on wages, upward pressure on inflation and upward pressure on interest rates.

• A key reason for the new world order is e-commerce or the global marketplace. Businesses and consumers can get tasks done or transact across borders. For instance, an Aussie business can get book-keeping tasks done in Asia overnight. Consumers can buy goods wherever they are and whenever they want through technology like the internet. So there is an expansion of supply to meet demand.

• Central banks like the Reserve Bank have cut interest rates to stimulate growth and unemployment and lift stubbornly-low inflation, but with little success. Interest rates are negative in Europe and Japan. The US Federal Reserve lifted rates from late 2015 to 2018, worried that the ‘tighter’ job market may lead to inflationary pressures and eventually cause the expansion to end. Inflation remains low and the record US expansion continues. The federal funds rate has been cut three times in 2019. And the US President believes rates are still too high and that rates should fall to European levels.

• So what is the future for monetary policy? The Reserve Bank Governor has laid out so-called ‘unconventional monetary policies’ that could be used in the future in Australia. While ‘unconventional’, could these policies become more ‘conventional’ over time? Indeed, should policies like purchases of bonds be used in preference to interest rate cuts? The Reserve Bank Board recognises “the negative effects of lower interest rates on savers and confidence.”

• It may be that we are just in the transitory period to borderless competition and that more ‘normal’ conditions (like economies in the 1990s) will return. But in the meantime there will be discussion about how monetary policy should be conducted in the present day and whether a mix of monetary, fiscal and administrative policies are best suited in keeping achieving and maintaining economic expansions.


Fiscal policy: Stimulus or Surplus?

• With the Federal Budget all but balanced, one of the big questions is where do we go from here. And to some extent this issue will be discussed in conjunction – or alongside – another Big Issue for 2020, that being the “The Future of Monetary Policy”.

• Certainly the Government has made substantial progress in reducing the budget deficit over time. In the year to February 2015 the deficit was just over $58 billion. In the year to June 2018 the deficit was $10.1 billion. The latest figures for the year to October 2019, the deficit was just $78 million. Over this current financial year ending June 2019, the Government projects a surplus of $7 billion (or $7,054 million to be precise).

• The Government wants to stay on the current course towards a budget surplus this financial year. The Prime Minister and Treasurer both argue that if debt was reduced or eliminated then it would free up money for more productive purposes. Currently the Government spends just $1.4 billion a month or just under $17 billion a year in meeting the interest bill on its debt.

• But the key question is whether now is the right time to be running a budget surplus. Economic growth is below the “normal” or long-term average. At the same time, the official cash rate stands at a record low of 0.75 per cent. So arguably, there is limited stimulus to be achieved from monetary policy. Indeed rate cuts are already seen by many as counter-productive – the rate cuts are making people less confident and less inclined to spend. Reserve Bank officials have been urging governments to take on a greater role in stimulating the economy.

• The Government has indeed brought forward the tax offset payments. Tax refunds in the four months to October totalled $24.2 billion, almost $5.5 billion more than a year ago. The Government has also brought forward $3.8 billion in infrastructure projects. Perhaps more projects can be brought forward, but then the question is whether Australia has the workers and construction materials to do all the projects under-way. Some also argue for the bringing forward of tax cuts slated for 2022.

• Clearly the question of the size and nature of fiscal policy will be debated over 2020.


The road ahead for the Chinese economy

• Depending on which measure you use, the Chinese economy is either the biggest or second biggest economy on the planet. If you use the size of the economy (gross domestic product) measured in US dollar terms, then China is No.2, behind the United States. If you use purchasing power parity – measuring the “basket of goods” that can actually be purchased in each country, China is out in front of the US.

• China is expected to pass the US on all common measures of economy size in the next 5-10 years. However, it will take far longer for China to pass the US on per capita (per person) measures like GDP per capita.

• China is Australia’s largest trading partner. In fact many countries have China as their largest trading partner. So the future pace of the Chinese economy and the level and dispersion of income are keenly watched by countries across the globe.

• The fastest annual pace of Chinese GDP was recorded In March quarter 1993 at 15.3 per cent. As recently as March 2010 the Chinese economy was growing at a 12.2 per cent annual rate. The latest growth rate (September quarter 2019) was 6 per cent, the slowest pace since 1990.

• Naturally as the Chinese economy gets bigger it can’t continue to grow at 10-15 per cent a year. So growth will slow over time. But the far bigger Chinese economy from a decade ago is still providing the largest contribution to world economic growth. China and India will vie with one another for the role of prime growth contributor in coming years.

• Chinese incomes will also rise over time as the economy matures and that spending power will prove important for businesses wanting to sell goods and services to the Chinese people.

• But one challenge that China will face in coming years is common to advanced economies. It is an ageing population. The working age population has already peaked. And the overall Chinese population will peak in 2020. Chinese authorities will want to avoid the “Japanese disease” – keeping its economy and incomes growing while ensuring that Chinese people are looked after in their old age.


• Over the years, the subject of oil prices has regularly featured in the Big Issues report. Sometimes it has been a concern that oil prices are ‘too low’, putting pressure on oil producing countries, energy companies and emerging sectors and the implications for the global economy.

• Of course at other times, concerns centre on oil prices being ‘too high’. While the higher prices support fortunes of energy companies and energy exporting nations, the concern is that higher prices serve to reduce consumer spending power, and again there are the implications for the global economy.

• Over 2019, oil prices have largely held between US$45-65 a barrel. In historical terms, that is a tight range. In fact, so far that range has been even smaller than the previous year’s range of US$42-76 a barrel. And that is remarkable. Some of the factors at play over the year have been the US-China trade dispute; global economic slowdown; restricted supply from OPEC oil nations; tensions between Iran and western nations; and drone attacks on Saudi Arabian oil installations.

• So how are oil prices likely to fare in 2020? In the next few days, OPEC oil ministers will meet to decide the strategy to be followed. And by ‘strategy’ the central issue is whether to continue to restrain output to maintain oil price stability. And, of course, a key aspect is that the policy is not just limited to the OPEC oil nations. Rather it is the OPEC+ grouping – a grouping that involves OPEC and Russia as well as other smaller non-OPEC producers.

• It has been estimated that the 14-member OPEC group and 10 non-OPEC nations that form the OPEC+ group account for 55 per cent of global oil supplies. It hasn’t always been clear sailing since the oil producers pledged co-operation to restrict global oil supplies with the aim of achieving “market stability. But certainly over the past year, OPEC+ can claim success given the array of factors that could have driven crude prices both higher and lower.

• OPEC+ is widely expected to extend the agreement to restrict global oil supplies until June 2020. The concern is that major producers outside the group – such as the US – are likely to keep oil supplies plentiful in the coming year. But producers are also mindful that the costs of production of alternative energy sources like wind, solar and thermal power will keep falling, providing challenges to crude oil producers in coming decades.

Oil prices


East Coast Drought

• An issue that rose to prominence over the past year was the East Coast Drought. Many regions of north-western NSW and south-western Queensland are experiencing their worst drought conditions on record. Other regions are experiencing the driest conditions since the Millennium Drought with water having to be carted into some towns such as Stanthorpe in the Southern Downs.

• Of course the issue will fall from prominence when it rains. But just when that will happen, even the long-range weather forecasters are in the dark.

• The Government’s chief commodity forecaster, the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) said in September that the value of farm production was likely to decline 5 per cent in 2019/20. The result “is driven by the third consecutive decline in the volume of farm production since favourable seasonal conditions delivered the largest winter crop on record in 2016/17.” The next forecasts from ABARES are released on December 10.

• The US Presidential Election will be held on November 3 2020. Clearly the issue will be in focus over the year but will probably only start impacting financial markets and the economy from election-day. As witnessed four years ago, it is risky for investors to pre-empt the actual result. But still many investors will form a response strategy. And the strategy not only will be crafted on a view about the successful Presidential candidate but also the expected composition of Congress.

• At this stage there is still a Melbourne Cup field of challengers for the Democratic nomination with Senator Joe Biden and Senator Elizabeth Warren the front runners. President Trump is unlikely to face a challenger for the Republican Party nomination.

• Investors are likely to be most interested in the policies advocated by Senator Warren including proposed taxes on the wealthy, high income employees, financial transactions and big banks.

• The US is currently enjoying its longest economic expansion. And the hope is that whoever takes the reins in November will extend the expansion by another four years.

US Presidential Election


Rewind: The Big Issues for 2019• As we noted at the start of this report, we

have been producing the Big Issues report for the past 18 years. It is interesting – and perhaps even instructive – to rewind over the past year and assess what we had on the radar in December 2018.

• Looking ahead into 2019, we highlighted eight issues. And the first issue was “United States-China relations”. As we noted above, this issue has made a return in 2020. Simply, the trade war is not over. There is much more for the two sides to discuss and agree on, including vexed components such as intellectual property.

• The second issue was Inflation – an issue that has regularly graced Big Issues lists over the years. It was again centre-stage in 2019 for its stubbornness to remain below 2 per cent in many advanced economies.

• Number three on the Big Issues list for 2019 was: “Jobs and wages”. And indeed it more or less took over the monetary policy discussion in Australia over the year.

• Housing has also dominated our Big Issues list for a few years. And with good reason. Home prices rose sharply in cities like Sydney and Melbourne in 2015 and 2016. And then prices began to correct from late 2017 and through 2018. For the third year we featured the question: “Housing: Hard landing or soft landing?” The answer was ‘soft landing’ courtesy of the Federal Election result and rate cuts.

• A new Big Issue was “Federal Election”. And with good reason – there was a clear choice between the Coalition and Labor on housing and sharemarket policies. The result came as a surprise to many – especially the opinion pollsters. But it was clearly a Big Issue.

• Issue 6 for 2019 was “Oil prices”. This didn’t feature as much as expected in economic and financial market commentary. Simply, OPEC nations maintained good control over production. But Iraqi sanctions and drone attacks on Saudi Arabia meant that discussion of oil prices was never too far from prominence.

• Also on the list of Big Issues for 2019 were “Australian Interest Rates” and “Managing Population Growth”. Interest rates were certainly debated long and hard. Reserve Bank policy shifted from a tightening bias to rate cuts over the year as the US-China Trade War caused advanced economies to slow, necessitating central banks across the globe to change tack.

IMPORTANT INFORMATION AND DISCLAIMER FOR RETAIL CLIENTS

The Economic Insights Series provides general market-related commentary on Australian macroeconomic themes that have been selected for coverage by the Commonwealth Securities Limited (CommSec) Chief Economist. Economic Insights are not intended to be investment research reports. This report has been prepared without taking into account your objectives, financial situation or needs. It is not to be construed as a solicitation or an offer to buy or sell any securities or financial instruments, or as a recommendation and/or investment advice. Before acting on the information in this report, you should consider the appropriateness and suitability of the information, having regard to your own objectives, financial situation and needs and, if necessary, seek appropriate professional of financial advice. CommSec believes that the information in this report is correct and any opinions, conclusions or recommendations are reasonably held or made based on information available at the time of its compilation, but no representation or warranty is made as to the accuracy, reliability or completeness of any statements made in this report. Any opinions, conclusions or recommendations set forth in this report are subject to change without notice and may differ or be contrary to the opinions, conclusions or recommendations expressed by any other member of the Commonwealth Bank of Australia group of companies. CommSec is under no obligation to, and does not, update or keep current the information contained in this report. Neither Commonwealth Bank of Australia nor any of its affiliates or subsidiaries accepts liability for loss or damage arising out of the use of all or any part of this report. All material presented in this report, unless specifically indicated otherwise, is under copyright of CommSec.This report is approved and distributed in Australia by Commonwealth Securities Limited ABN 60 067 254 399, a wholly owned but not guaranteed subsidiary of Commonwealth Bank of Australia ABN 48 123 123 124. This report is not directed to, nor intended for distribution to or use by, any person or entity who is a citizen or resident of, or located in, any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or that would subject any entity within the Commonwealth Bank group of companies to any registration or licensing requirement within such jurisdiction.

BIG ISSUES OF 2019United States-China relations

InflationJobs & wages

Housing: Hard landing or soft landing?Federal Election

Oil pricesAustralian interest rates

Managing population growth

Craig James Chief Economist, CommSecTwitter: @CommSec

Ryan Felsman Senior Economist, CommSecTwitter: @CommSec

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