Recap 2014-07-23


BoE minutes were interesting. There were two interpretations discussed for why the correlation between wage growth and employment has fallen, but it is likely that both explanations are at play, as the minutes also suggested. Increased bifurcation of the labor market means that survey indicators of tighter labor mkts translated to lower earnings growth than in the past. And the effective supply of labor has increased… but mainly in lower income occupations. In aggregate, this may mean that tighter labor markets are mainly affecting income growth for higher income occupations, with the average income growth dragged lower by lower income occupations. With respect to the BoE’s inflation mandate, which focuses on average inflation, this may mean a lower neutral rate for any given Unemployment level relative to the previous cycle. In any case, the BoE’s thinking on this in the August Inflation Report will be very pertinent.

GS published a piece on Oil and Geopolitics that was quite interesting:

  • This surge in non-OPEC supply growth over the past year has not only been led by growth in North American “shale oil” production, but also by the broad recovery from the one-off impact of the Macondo spill in the Gulf of Mexico (GoM), which forced the industry to review all of its offshore facilities worldwide and led to a global collapse in productivity.
  • Based on Goldman Sachs’ proprietary Top 400 analysis of the world’s largest new oil and gas fields, shale oil has added 66 bn barrels of crude oil resources and 8 mmbd of future peak production, making higher cost fields redundant. This leads to a flattening of the cost curve around US$80-85/bbl Brent breakeven, effectively splitting the cost curve into an attractive part (<US$80/bbl Brent breakeven) and a redundant part (>US$85/bbl Brent). The current premium of spot oil prices relative to long-dated oil prices on the Brent forward curve provides further incentive to accelerate quick payback investments (shale) vs. other developments (traditional, deepwater, heavy oil).
  • The rise of shale has displaced an estimated $700 bn of capex that sits high on the cost curve, forcing a flattening of capex outside of North America at a time of material expansion of oil service capacity across the chain. This has the potential to lead to 5%-15% cost deflation across oil and gas developments after a decade of 10%+ inflation, and to an improvement of productivity. Coupled with changing supply dynamics, this points to a structural shift that will leave the oil market better equipped to deal with any future disruptions – from the Middle East, Russia or elsewhere.
  • As recently as 2012, the International Energy Agency (IEA) expected Iraq to account for 45% of global production growth through 2030, bringing it on par with the world’s largest oil producers. Iraq’s production gains depend heavily on political stability, as well as physical security. And there is no political scenario coming out of the current crisis in Iraq that would allow it to meet those expectations now.
  • In terms of the rest of the country, the Sunni areas that IS largely control today have some energy resources but are generally unexplored and are not producing much oil. So there is a concern that this Sunni middle would be very poor if the political dynamics changed in a way that halted oil revenue sharing throughout the country. In contrast, the southern Shia part of Iraq is home to the majority of current oil production. If those provinces took control of that oil and considered its sale and development to be a regional prerogative rather than a national one, it could open the door for neighboring Shiite Iran to gain significant sway over Iraqi oil policy.
  • Traditionally, Iran, Turkey, and Syria – all of which have substantial Kurdish populations – have seen an independent Kurdistan carved out of Iraq as a dangerous precedent for more fragmentation in the region. This has been a primary concern for Turkey in particular. But views in the region are changing and the Iraqi Kurds and Turkey have become very close in recent years, largely driven by Turkey’s recognition that the Iraqi Kurds could potentially meet a large share of Turkey’s energy needs. The Turks may now see an independent Iraqi Kurdistan as better than the alternative – an Iraq incapable of providing energy.


  • AU CPI rose 3.0% as exp vs 2.9% exp. The Trimmed mean CPI jumped to 2.9% vs 2.7% exp and 2.6% prev
  • BoE Minutes:
  1. Given the strength of survey indicators, it remained unclear whether growth would slow modestly in the second half of the year, as envisaged in the May Inflation Report. But there were some indications that a gradual slowing might take place.
  2. In an accounting sense, this increase in employment had been met by both an increase in labour force participation and a fall in unemployment; the unemployment rate had fallen to 6.6%. When combined with activity growth at or above longer-term averages, this implied further disappointment in productivity, with measured output per hour likely to have changed little in the first half of the year.
  3. In contrast to the strength of employment, wage growth had been surprisingly weak… Regular pay growth had fallen to 0.9% over the same period, around half a percentage point lower than expected at the time of the May Inflation Report. Half a percentage point of the weakness in AWE growth reflected a compositional effect: employment growth over the past year had been concentrated in lower-paid sectors.
  4. The Committee considered two possible explanations for the contrasting wage and employment data. The first was that the lags between any tightening in the labour market and an increase in wages were longer than the Committee had previously judged… An alternative explanation was that the effective supply of labour had increased, resulting in a greater degree of slack and so restraining wage growth… It was possible that elements of both explanations were at play to different extents in different parts of the labour market. The Committee would consider these and other possible explanations more fully in its preparations for the August Inflation Report.
  5. The Committee considered alternative interpretations of the data that might have different implications for monetary policy. On one interpretation, the risk of a small rise in Bank Rate derailing the expansion and leaving inflation below the target in the medium term was receding as that expansion became more established. Some survey indicators of wage growth had already picked up materially and, although the degree of slack was highly uncertain, it was likely that it was being absorbed more rapidly than had been envisaged in the May Inflation Report projection. Because estimates of the level of spare capacity had become more uncertain there was a case for setting policy with some reference to the rate at which it was being used up. A rise in Bank Rate at a time when the economy was growing strongly would facilitate a more gradual path thereafter
  6. On an alternative interpretation, although the domestic economy was growing at or above longer-term average rates, there was little indication of inflationary pressures building and there was uncertainty as to whether there had been a more structural change in the relationship between the labour market and inflation. Moreover, there were early signs that global growth was weakening, and an unexpected increase in interest rates when real wages were not yet rising could lead to an outsized reaction in asset prices and destabilise the recovery. On the central projection from May, conditioned on very gradual increases in interest rates, inflation had been forecast to return to the 2% target only after three years. A premature tightening in monetary policy might leave the economy vulnerable to shocks, with the effectiveness of any further stimulus uncertain.

The Fed is worried about the effects of the reverse repo facility on financial markets. They had originally planned on this facility being a key monetary tool but now it probably won’t play more than a supporting role because they’re nervous about the effects it could have on financial markets. Plosser said “there’s a lot of things that might happen to the plumbing of the money markets, and people have gotten…concerned that there’s a lot we don’t know.” WSJ

According to a Congressional hearing Tuesday, up to 25 additional US firms are considering tax inversion deals.

The Bank of Spain Monthly Bulletin raised both 2014 and 2015 GDP growth forecasts. Raises 2014 GDP growth forecast from 1.2% to 1.3% and raises 2015 GDP growth outlook from 1.7% to 2.0%. it noted that activity was recovering faster than expected.

Foreign ministers of the EU failed to agree yesterday on new EU sanctions against Russia, following the downing of the Malaysian plane last week. However, they opened the door for stage 3 sanctions if Russia does not cooperate with the West in the future.

JPM: The most noteworthy macro trend has been the continuing rotation into Europe and back into Emerging Markets as the Great Moderation is back in play… Issuance and inflows into European credit have reached record levels. Inflows into European High Yield reached an all-time high at nearly 19% of total assets under management in 1H14. Outflows from money market funds have surged but stayed within bond markets, fueling inflows into other fixed income asset classes, including emerging markets and municipal bonds. EM fixed income inflows have fully reversed $15bn of 1Q14 outflows, with a solid $20bn of inflows since April


  • Wed: EU Consumer Confidence, RBNZ, NZ Trade Balance, Japan Trade Balance, PMI, China HSBC Mfg PMI
  • Thu: EU PMI, UK Retail Sales, Italy Consumer Confidence, US Jobless Claims, US Markit Mfg PMI, New Home Sales, Japan CPI, NZ Business Confidence
  • Fri: GfK Consumer Confidence, IFO, Turkey Trade Balance, US DGO
  • Mon: US Markit PMI, US Pending Home Sales, Japan Unemployment, Australia New Home Sales, UK House Prices
  • Tue: US Consumer Confidence, NZ Building Permits