We all know the US has had a downturn. What really matters is the depth and duration of the downturn, and doomsday cultists are likely to be perversely disappointed.

Debt markets gyrated wildly this week, with Australian 90-day bank bill futures collapsing up to 30 basis points on Tuesday, only to rally by a similar amount Thursday, before selling off again on Friday. Global debt markets are re-pricing the US and thus the global economic outlook. Most notably, Fed funds rate futures are now pricing a 30 per cent chance of a 25 basis point tightening in US monetary policy at this month’s US FOMC meeting. There is also a growing expectation for a further tightening from the European Central Bank at its July meeting. Prediction markets such as Intrade put the probability of two consecutive quarters of
negative growth in the US this year as low as 27 per cent.

This is not to say that the US will necessarily escape a ‘recession’, at least not in terms of the definition favoured by the National Bureau of Economic Research (NBER) Business Cycle Dating Committee. With NBER President Martin Feldstein having been a prominent propagandist for the US recession view, the committee now has a strong vindication bias in declaring that a ‘recession’ has taken place. But this amounts to little more than saying there has been a downturn in activity, something already evident in the data. What matters is the depth and duration of the downturn, and on this score, the doomsday cultists are likely to be perversely disappointed.

This week’s local data proved to be a mixed bag. April housing finance came in weaker than expected, pointing to a further contraction in housing supply, which is a negative for the inflation and interest rate outlook. Consumer confidence fell to its lowest since December 1992, but this is being driven in large part by media reporting on inflation, hardly the basis on which to forecast a moderation in future inflation.

This concern is even more readily apparent in the consumer 12-month inflation expectations survey, which rose to a new 15-year high of 5.9 per cent in June. Those who think consumers are over-estimating future inflation might care to annualise the rate of underlying inflation seen in the TD-MI survey in recent months. Much of the RBA’s credibility on inflation control has now been squandered in the eyes of the public. With June 2009 30-day inter-bank futures implying an official cash rate around 7.60 per cent , the expected real cash rate for the median consumer is under 2.00 per cent . RBA Governor Glenn Stevens said this week that ‘a tight monetary policy setting is essential,’ but on this metric, policy remains too easy.

Thursday’s short-end rally was driven by the first monthly decline in employment since October 2006, bringing to an end the longest uninterrupted run of monthly employment growth in the history of the current labour force series dating back to 1978. This was well below expectations, although partly reflected a large upward revision to the April estimate. We suspect all of these jobs and then some will be reclaimed in June, although this is still likely to leave employment growth on a moderating trend.

The unemployment rate is still only 0.3 percentage points above its recent generational lows of 4.0 per cent and will need to rise further if the RBA is contain, much less reduce, inflation pressures. Turning points in the unemployment rate and official cash rate are closely correlated historically, suggesting the RBA will look to the unemployment rate to confirm a turning point in activity.

There is only a limited local calendar next week, including the release of the minutes of the RBA’s June Board meeting. The May minutes revealed that the market was badly dudded by the RBA’s post-May Board meeting statement and the May Statement on Monetary Policy. The June minutes may once again see some discussion of the need for further tightening, but recent growth and inflation outcomes speak much more loudly on that score.

Dr Stephen Kirchner is an independent financial market economist. His blog can be found at http://www.institutional-economics.com

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