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Why World’s Most Enduring Growth Story Is Starting to Wobble

Investors are giving up on the developed world’s most enduring economic growth story.

Why World’s Most Enduring Growth Story Is Starting to Wobble
A man looking at his phone is reflected in a wall as an electronic board displays stock information at the Australian Securities Exchange, operated by ASX Ltd., in Sydney,, Australia. (Photographer: Brendon Thorne/Bloomberg)

(Bloomberg) -- Investors are giving up on the developed world’s most enduring economic growth story.

Australia hasn’t recorded two straight quarters of economic contraction since the first half of 1991, meaning it’s just a month away from overtaking the Dutch record and posting 28 years of continuous expansion.

With home prices sinking, households swimming in record debt and the escalating U.S.-China trade war eroding confidence, bond and foreign exchange traders are betting that streak is now in jeopardy.

Why World’s Most Enduring Growth Story Is Starting to Wobble

The Reserve Bank of Australia’s cash rate last stood this far below the Federal Reserve funds rate in 1983 -- when Paul Volcker was wrapping up his campaign to slay inflation and an economic reform era Down Under was just about to begin. And it’s headed lower: Traders are betting RBA Governor Philip Lowe will cut at least twice to underpin employment and return inflation to target, with the first move expected Tuesday.

“Australia’s had the housing boom and commodity boom and there’s a question mark hanging over what drives growth next,” said Su-Lin Ong, head of economic and fixed-income strategy at Royal Bank of Canada in Sydney.

“U.K. and European investors in particular expect Australia to lower rates much further,” she said. “After all, they’ve been there -- to zero or the lower bound -- they’ve seen that movie, and they doubt Australia is really any different.”

Why World’s Most Enduring Growth Story Is Starting to Wobble

Just like all the rest. That’s something Australia isn’t used to hearing, particularly after it managed to avoid being swept up in the Asian financial crisis, the early 2000s tech wreck and the 2009 global recession.

“The next world shock, we don’t escape,” said Bob Gregory, a professor at Australian National University in Canberra who has studied the economy for half a century. “But even without that, I’d say there’s a 90% chance the economy and employment growth slow from here because our boost from China and immigration is waning.”

The Australian dollar reflects similar doubts among investors about the economy’s prospects. It has slumped 25% in the past five years, and while that should aid exporters and import-competing industries, there’s a sense of stasis among many firms that haven’t had to fight for survival for a long time.

The Persuader

Lowe, who has kept the cash rate at 1.5% since taking the helm in September 2016, used the record pause to try to deflate asset prices and stem a surge in household debt in order to increase the resilience of the financial system. They are key components in his view on what constitutes a healthy economy.

He’s also harnessed the bully pulpit to press other actors to take some of the load off monetary policy: urging firms to invest to take advantage of Australia’s opportunities; governments to embrace a reform agenda to help prolong the current expansion; and workers to set aside fears over job security to demand higher wages to ensure a well-functioning economy.

But outside persuading governments of the wisdom of investing in infrastructure -- particularly when finance is so cheap -- to boost economic capacity and hiring, there has been little success. That doesn’t mean the RBA chief hasn’t won admirers along the way.

“Those speeches have been very interesting, sort of ‘get your act together you guys,’ which is remarkable for a bank governor because 20 or 30 years ago that would’ve caused a stir,” said Gregory, who served on the RBA’s board for 10 years. “It’s interesting why there hasn’t been a backlash, partly I think because you’re not getting realistic discussion out of the other economic agencies.”

The Believer

Yet if there’s one economist who still believes in the Australian growth story, it seems to be the world’s most important central banker. Fed Chairman Jerome Powell has consistently rebutted questions about the inevitability of the record U.S. expansion coming to an end by pointing Down Under.

Most recently, during a Q&A session at the Economic Club of New York in late November, he opined: “Business cycles don’t last forever, I guess unless you’re Australia, where they’re in year 27 of their expansion, which sounds like forever.”

It’s not all doom and gloom. The shock re-election of Australia’s center-right government provides potential for productivity-enhancing reforms as Prime Minister Scott Morrison’s victory gives him immense authority within his party. It also draws a line under the past decade’s leadership instability that made it tough to carry off complex policy.

In the short term, sentiment should improve from the removal of risks related to the opposition’s plan to scrap property investment incentives as well as a boost from the government’s pending tax cuts. Putting a floor under the housing market -- where prices are down almost 15% from their peak in Sydney -- and more cash into households’ pockets will help stabilize demand.

Growth decelerated sharply in the second half of 2018 to just a quarter of the pace recorded in the first half. In the first three months of this year, the economy is forecast to have expanded an annual 1.8%, almost a percentage point below its estimated speed limit.

Why World’s Most Enduring Growth Story Is Starting to Wobble

For the central bank, this isn’t strong enough to drive unemployment lower and lift inflation. Money markets and economists are all but unanimous Lowe will need to cut twice, starting Tuesday, bringing the policy rate to 1%. A growing group are forecasting three or even four reductions.

There are disturbing signs emerging in the labor market: a private report Monday showed job advertisements plunged 8.4% in May, the biggest drop in more than nine years. While the slump might have been exacerbated by May’s election and a series of public holidays in late April, it doesn’t augur well for the period ahead.

The escalating trade war further clouds the outlook: Australia is the most China-dependent economy in the developed world. Meanwhile, there are rising expectations the Fed will give back some of its rate hikes as the U.S. economy slows in response to rising tariffs.

Why World’s Most Enduring Growth Story Is Starting to Wobble

Sally Auld, a senior strategist for interest rates at JPMorgan Chase & Co. in Sydney, predicts Lowe will have to cut the benchmark to 0.5% by mid-2020.

“One way of thinking about the outlook for Australian monetary policy over the next year is as the beginning of the end of a decade-long convergence trade,” she said, referring to Australian and developed-market rate spreads. The cash rate will be “close to the effective lower bound and remain there for some time. For medium-term investors, this is the punchline.”

--With assistance from Garfield Reynolds.

To contact the reporter on this story: Michael Heath in Sydney at mheath1@bloomberg.net

To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, ;Nasreen Seria at nseria@bloomberg.net, Chris Bourke

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