$60bn forecast miss is huge positive, not negative, surprise (for some)...

Christopher Joye

Coolabah Capital

The AFR reveals today that the Treasury's gargantuan $60bn forecast miss on the JobKeeper wage subsidy was entirely attributable to the government's reliance on the flawed epidemiological projections and medical advice that alleged the economy would need to be shut down for an unprecedented six months. At the time, this motivated the prime minister's repeated messaging that Australian businesses would have to go into a "six month hibernation". 

Put differently, the forecasting failure here was an artefact of the equally immense success Australia has had in containing COVID-19 much more effectively than the epidemiologists (but not all analysts) expected, which in turn means we are not having to shell out as much money as had been originally planned. That's a good, not bad, thing.

Some may recall that on March 23 we argued these forecasts were wrong and that the Australian and US infection curves would peak in early April, months ahead of what the epidemiologists were advising government

This formed the basis of our March 28 proposition that the government's six month lockdown was both unnecessary and highly destructive, which attracted some vigorous criticisms (a minority claimed that only the epidemiologists were qualified to opine on this debate). And a million academic economists signed a silly letter, which we rebutted here, saying that the lockdown should continue for a considerable time because there were no overwhelming costs associated with putting the economy into a full-blown depression.

The essential mistake the epidemiologists' theoretical models made was to dramatically underestimate the efficacy of Australia's actual containment strategies and their impact on COVID-19's reproduction rate. 

Coolabah's models deliberately avoided these theoretical assumptions and instead actively exploited the empirical containment efficacies observed in countries that were ahead of the rest of the world---in particular China and South Korea---to develop live projections of the infection trajectories for the target nations in question. These estimates have proven to be incredibly accurate.

In this sense, the $60 billion saving on JobKeeper is a nontrivial victory for the Prime Minister Scott Morrison and the Treasurer Joshua Frydenberg, because they have significantly underpromised and overdelivered with their execution of Australia's COVID-19 response strategy. 

I find it odd that the media has claimed this is an enormous bungle/mistake: we should be celebrating the fact that Australia has outperformed most other countries around the world, and will not need to take on $60 billion of extra debt that future generations of Australians, including our children, will have to repay.

This also has wide-ranging consequences for other important issues: Standard & Poor's put Australia's prized AAA sovereign credit rating on "negative outlook" for a 1-in-3 probability of a downgrade to AA over the next two years on the basis of the government's published fiscal response and the assumed deterioration in our finances that flowed from it. 

S&P then also automatically put bank credit ratings on the same negative outlook given these ratings partially hinge on the sovereign's rating. And yet it turns out that the government's fiscal spending will be a fraction of what was originally proposed because of its outstanding success. In theory, S&P should mark-to-market their own analysis accordingly, and acknowledge the government's victory in this respect, although inevitably there will be some ratings inertia.

We have been consistent in our view that Australia will not, in our central case, lose its AAA rating, especially under the current Coalition government that has been unusually staunch in protecting it. (In 2016 S&P put the rating on "negative outlook", only to upgrade it again years later to AAA "stable" when its fears failed to materialise.)

Today the AFR's always excellent John Kehoe writes:

Treasury overestimated the cost of JobKeeper largely because the medical advice upon which it was based and the assumed need for prolonged business shutdowns turned out to be massively pessimistic.
As one senior official observes, chief medical officer Brendan Murphy was "the only voice being listened to in March".
Treasury was wrong because the epidemiological theoretical models were wrong in projecting a potential 50,000 to 150,000 virus deaths and that daily demand for intensive care beds could hit 5000, 17,000 or 35,000, depending on social distancing restrictions.
The planned six month "hibernation" of the economy that Prime Minister Scott Morrison was preparing for, based on medical advice, was factored in to Treasury's forecast...
Commentators were declaring Australia was two to three weeks behind Italy in becoming the next coronavirus catastrophe...
Now, after less than two months, businesses are resuming as states ease restrictions.
Far fewer companies than expected will suffer the required 30 per cent fall in monthly revenue to qualify their staff for JobKeeper.
So far just over 100 people have died and daily intensive care unit demand peaked at below 100, not the best-case scenario of almost 5000.
The epidemiologists advising the government turned out to be too pessimistic. Perhaps more contrarian voices needed to be heard around the national cabinet table and inside Treasury when they were undertaking their economic policy planning.
Some private forecasters were more accurate.
Coolabah Capital portfolio manager and columnist for The Australian Financial Review, Christopher Joye, wrote on March 23 that his financial modelling based on real-time international virus data showed Australian infection numbers would peak in early April.
To be sure, Treasury's forecast was still a bad miss.

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Disclaimer: This information has been prepared by Smarter Money Investments Pty Ltd. It is general information only and is not intended to provide you with financial advice. You should not rely on any information herein in making any investment decisions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Past performance is not an indicator of nor assures any future returns or risks. Smarter Money Investments Pty Limited (ACN 153 555 867) is authorised representative #000414337 of Coolabah Capital Institutional Investments Pty Ltd, which holds Australian Financial Services Licence No. 482238 and authorised representative #001277030 of EQT Responsible Entity Services Ltd that holds Australian Financial Services Licence No. 223271.

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Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs $7 billion with a team of 33 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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