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Shane Oliver
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Shane Oliver is head of investment strategy at chief economist at AMP Capital.

RBA expected to cut and budget preview

Monday, May 02, 2016

By Shane Oliver

Investment markets and key developments over the past week

Australian inflation (or deflation) has set the RBA up for a rate cut on Tuesday, or at least it should have. While it would be wrong to conclude that Australia is on the brink of sustained deflation – as falls in petrol and fruit prices won’t be repeated – the big surprise in the March quarter inflation data was that price weakness was broad based with underlying inflation running at its lowest annual rate on record. Both headline and underlying inflation are now running well below the RBA’s 2-3% inflation target. The risk is that thanks to a combination of deflationary pressures globally, soft demand domestically and very weak wages growth, inflation could remain well below target for an extended period. This is a risk the RBA cannot ignore and is best to address early before inflation expectations fall too far and under target inflation becomes entrenched. As a result, we think that the RBA should, and most likely will, cut the official cash rate by 0.25% taking it to 1.75% when it meets on Tuesday.  But it’s not just low inflation that justifies a rate cut. Other reasons include the risk of a soft spot in growth later in the year as housing slows, the still too strong $A and to offset upwards pressure on bank mortgage rates from higher bank funding costs. Will the banks pass a cut on in full? Probably not – “funding cost” arguments may see only 0.15% or so of a 0.25% cut passed on.

Most share markets pulled back a bit over the last week not helped by some disappointing earnings results from US tech stocks and surprise inaction by the Bank of Japan. Shares had become overbought so were due a bit of a pause or pull back. US shares fell 1.3%, Eurozone shares lost 2.5%, Japanese shares fell 5.2% and Chinese shares fell 0.7% but Australian shares gained 0.3%. This wrapped up a mostly positive month for shares with Australian shares up 3.3% and modest gains in US and Eurozone shares but falls in Japanese and Chinese shares. Bond yields were mixed over the last week: up in the Eurozone, but down in the US and Australia. Commodity prices rose as the $US fell, but the $A got hit by heightened RBA rate cut expectations.

The big surprise over the last week was the decision by the Bank of Japan to not undertake more monetary easing despite soft economic data, inflation well below target, strength in the Yen and the earthquakes. Maybe the BoJ is waiting to assess a fiscal response from the Japanese Government and get the May 26-27 G7 summit to be held in Japan out of the way. Our assessment is that more BoJ easing is just a matter of time. Failure to do more soon though risks unwinding all the progress on inflation expectations seen under Abenomics, particularly with the Yen breaking to ever higher levels.

By contrast the Fed’s April meeting delivered no surprises, with the Fed remaining gradual. A June rate hike is unlikely as US data probably won’t have improved enough by then and markets may be nervous given the Brexit vote on June 23. The US money market’s assessment of just a 26% probability of a July hike appears a bit low though – I would think it’s around 50%. The key message from the Fed is that it will not do anything that upsets the outlook for global and US growth.

Major global economic events and implications

Here we go again - another weak start to the year for the US economy with March quarter GDP up just 0.5% annualised. This was as expected and needs to be seen in perspective given that weak March quarter growth has been the norm over the last 20 or so years with average growth of 1% annualised ahead of a rebound to average 3% growth in the June quarter. So far the evidence is mixed though as to whether growth in the current quarter is rebounding. In the past week we have seen weak readings for new home sales, durable goods orders, personal spending and consumer confidence but solid readings for the services conditions PMI, pending home sales and the goods trade deficit and continued very low readings for jobless claims. Combined with ongoing low growth in wages, it’s all consistent with the Fed remaining very gradual. 

US Q1 earnings have seen some mixed results for high profile tech stocks but have generally been better than expected. 62% of S&P 500 stocks have now reported with 77% beating on earnings and 57% beating on sales. 

Eurozone data was good with an acceleration in March quarter GDP growth, another fall in unemployment and a tick up in bank lending and economic sentiment both of which are consistent with ongoing growth. A fall in core inflation to just 0.8%yoy will keep the ECB ultra easy though.

Japanese data was messy with strong labour market readings (although this may be due partly to a declining labour force) and a rebound in industrial production but a dip in inflation back into negative territory, a fall in core inflation to just 0.7% year on year, poor household spending and a fall in small business confidence. The impact from the Kumamoto earthquakes won’t be helping and so further monetary easing is still needed.

What to watch over the next week?

In the US, the big focus will be on the ISM manufacturing conditions index Monday and labour market data Friday. Regional surveys point to a fall back in the April ISM manufacturing index to around 51, leaving it still well above the low of 48 seen in December but April jobs growth is likely to remain solid with a 200,000 gain in payrolls, unemployment remaining at 5% and wages growth edging up slightly.

In China, a further slight increase is expected in the official manufacturing conditions PMI (Sunday) for April and the Caixin manufacturing PMI (Tuesday).

In Australia, after the RBA Board meeting (see above), the focus will shift to the 2016-17 Federal Budget on Tuesday night. This budget is more significant than usual for two reasons. First, it will likely be the Government's main economic statement ahead of a likely July 2 election and as such the Government will want to include some sweeteners. Second, because it comes after several years that have seen the return to surplus pushed out further and further, the ratings agencies are losing patience with the threat of a downgrade to our sovereign AAA rating if they are not happy. And the ratings agencies have a point. We are now looking at a 12-13 year run of budget deficits which swamps the 7 years seen in the 1990s and the 5 years in the 1980s. And this despite not even having had a recession. Rather we have done this thanks largely to a “dumb country” combination of politicians ramping up spending commitments on a whole range of things without facing up to how they will be paid for.

These two considerations point in opposite directions. And so it will be a difficult balancing act for the Government.

Fortunately some improvement in the jobs outlook and the iron ore price should offset lower wages growth to allow this Budget to be the first in several years to more or less hold the line on the last set of budget projections, which in this case are the MYEFO projections from late last year. As such, we expect the 2016-17 deficit projection to come in around $34bn (2% of GDP) and that for 2017-18 to be around $23bn. The return to surplus could be pushed out to 2021-22 though. The Government is likely to forecast 2016-17 GFP growth of 2.75%.

Key measures are likely to include: raising the $80,000 income tax threshold slightly; removal of the deficit levy on schedule next year; a crackdown on tax avoidance by multinationals to fund cutting the corporate tax rate; reduced superannuation concessions for high income earners; a hike in tobacco excise; and more funding/inducements for infrastructure spending likely involving some form of partnership with private sector partners that want to take advantage of the Governments low borrowing costs. Overall, the Government is expected to aim for a cap on revenue as a share of GDP and to limit spending growth in contrast to the Labor opposition which is more likely to focus on growing tax revenue (via reduced access to negative gearing, the capital gains tax discount and superannuation) to fund increased spending.

Should the Government worry about maintaining its AAA rating? Yes. Its loss may not ultimately have much impact on government borrowing rates. And if a downgrade knocks the $A down that would be good. So no worries here. Rather the real concern would be that the loss of the rating would signal an undoing of all the work in the 1980s and 1990s by political leaders on both sides of politics to set public finances onto a sustainable path. 

On the data front in Australia, expect the CoreLogic RP data home price index to show continued modest growth in home prices in April and the AIG manufacturing conditions PMI and NAB business conditions index to fall back slightly from the high levels seen in March (all Monday), building approvals (Tuesday) too fall slightly, a 0.3% gain in March retail sales and a fall in the March trade deficit to a still big $2.9bn (both Thursday). The RBA will release is quarterly Statement on Friday which will be watched for downwards revisions to inflation forecasts.

Australian economic events and implications

Apart from the much lower than expected March quarter inflation data, export and import prices both fell more than expected pushing the terms of trade down yet again, producer price inflation remained low and credit growth remained moderate. In fact annual growth in credit to property investors is now less than that to owner occupiers.

Outlook for markets

Expect short term share market volatility to remain high as we head into May (“sell in May and go away, come back on St Leger’s Day”), global growth remains fragile and the Fed eventually starts to soften markets up for another rate hike. However, beyond near term volatility, we still see shares trending higher this year helped by a combination of relatively attractive valuations, further global monetary easing and continuing moderate global economic growth.

Very low bond yields point to a soft medium term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity and low inflation.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

Capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but price growth is likely to pick up in Brisbane.

Cash and bank deposits are likely to provide poor returns.

The ongoing delay in Fed tightening poses further short term upside risks for the $A, particularly if the RBA does not ease rates soon. However, any further short term strength in the $A is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the RBA resumes cutting the cash rate and the Fed eventually resumes hiking, commodity prices remain in a secular downswing and the $A undertakes its usual undershoot of fair value.

Eurozone shares fell 2.4% on Friday and the US S&P 500 lost 0.5% amidst mixed economic data and earnings reports and as Apple continued to weigh (falling 11% over the last week). Reflecting the weak global lead, ASX 200 futures fell 6 points or 0.1%. While strength in commodity prices helped limit the decline, it nevertheless suggests a soft start to trading for the Australian share market today.

 

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Share recovery continues

Tuesday, April 26, 2016

By Shane Oliver

Share markets mostly continued to move higher over the last week as growth fears continued to recede and the oil price managed to push another 8% higher despite the failure of OPEC and Russia in Doha to agree a production freeze. US shares only rose 0.5%, but European shares (+2%), Japanese shares (+4.3%) and Australian shares (+1.5%) played catch-up with the Australian share market almost getting back to where it ended 2015. Chinese shares fell 3.9% though on concerns that there won’t be more policy stimulus. Reflecting the “risk on” tone bond yields continued to move higher, most commodity prices rose and the $A reached $US0.78 before falling back to $US0.77. Even the iron ore price hit $US70/tonne – what happened to the global steel glut?

The ability of oil and share markets to rally despite the failure of key producers to agree an oil production freeze is a positive sign. The Doha meeting was mainly about appearances anyway with Saudi Arabia and Russia already at capacity, Iran never likely to participate and many other factors driving the rebound in oil and growth assets since the panic of earlier this year. Regardless of the Doha debacle the oil market is gradually rebalancing as global oil demand slowly climbs and other producers, including the US, are slowing supply.

While we remain of the view that the broad trend in share markets is likely to remain up, the next scare is likely to come as Fed hikes return and bond yields continue to back up, pressuring equity valuations. Markets cycling back and forth between deflation/growth scares and then higher bond yields/Fed scares has been the story of the last few years now!

The New York presidential primary victories for Hilary Clinton and Donald Trump further cement the former as the Democratic presidential candidate but still leave Trump open to challenge at the Republican convention in July. Trump needs to win 53% of remaining delegates to the convention to get a majority but so far he has only been winning 49% so a contested convention could still occur. Interestingly so far he's only been getting 38% of the popular vote at the primaries so he is still getting less than majority support. The next set of GOP primaries are on April 26, but the June 7 California primary with its 172 delegates may end up being key. So a long way to go yet.

Australia is another step closer to a July 2 double dissolution election with constitutional triggers now in place. Of course it won't be declared till just after the May 3rd Budget, but just like in 2013 when the election date was announced way in advance (albeit to be changed later) we are now in another longer than normal de facto election campaign. It's too early to talk precise policy differences between the two alternatives – but it is clear that the Labor Party will focus more on budget repair via various tax hikes (restricting negative gearing, super and the capital gains tax discount) and while the Liberal/National coalition will have a bit of that too it will mainly focus on spending restraint. However, in terms of the near term impact of the election itself the risk is that some spending decisions by households and businesses are put on hold through the election campaign - with a higher risk for long de facto campaigns like this one. Qantas has already suggested this may be happening. However, there is no clear evidence that election uncertainty effects economic growth in election years as a whole. Since 1980 economic growth in election years has averaged 3.7% which is greater than average growth of 3.2% over the period as a whole. That said, growth was below average at 2.3% in 2013 which also saw a long de facto election campaign. In terms of the share market, there is some evidence of it tracking sideways in the run up to elections but on average it has gained 4.9% in the three months after elections -  so it's good to get them out of the way.

 

It's hard to disagree with RBA Governor Glenn Steven's view that there are limits to what monetary policy can do. Monetary policy can help offset cyclical fluctuations in growth but it can't solve the so-called “secular stagnation” phenomenon. There is a role here for government in removing impediments to growth (supply side reforms of the sort the G20 summit in 2014 supposedly committed too) and encouraging investment in productive assets. The trouble for central banks though is that their mandate is to achieve certain inflation targets over time - usually around 2% - and when these look like being chronically missed on the upside or the downside they invariably have to intervene. Which is what they have been doing in recent times and why "helicopter money" (ie using printed money to directly finance government spending/tax cuts) is being talked about in some countries where other monetary policy options have been exhausted, Japan being a noticeable example. Fortunately we are a long way from that in Australia, where if inflation looks like coming in under target for a lengthy period (which is a risk now) there is still plenty of scope for conventional monetary easing.

Major global economic events and implications

US housing data was a mixed bag with falls in starts and permits but solid readings for home builder conditions and existing home sales. Other US data was also mixed with a fall in the manufacturing conditions PMI for April, but gains in home prices, leading indicators and another fall in jobless claims. March quarter earnings results showed 82% of companies beating on earnings and 59% beating on sales with 26% of S&P 500 companies having reported so far.

No surprise after its huge March effort to see the ECB on hold at its latest meeting, with President Draghi indicating  it remains ready to do more if needed. Meanwhile, the ECB's bank lending survey revealed solid growth in loan demand and the composite business conditions PMI for April remained solid.

Japan’s manufacturing PMI fell further to a weak reading of 48, possibly impacted by the recent earthquake.

Chinese property prices continued to increase in March led by Tier 1 cities. While this is consistent with other indicators of improved growth in China, it also warns of renewed measures to slow bubble fears in some Chinese cities.

Australian economic events and implications

It was a quite week on the data front in Australia. Skilled vacancies did fall in March though for the second month in a row suggesting jobs growth may start to slow but too early to read too much into this.

What to watch over the next week?

In the US, the key focus will be on the Fed (Wednesday) which is very unlikely to raise interest again rates again just yet, but may try to start warning the market that another hike is in prospect for the June or July meetings consistent with its dot plot signalling two hikes this year. Recent comments from Fed Chair Janet Yellen stressing caution in raising interest rates suggests that there is close to zero chance of a hike in the week ahead. However, market pricing of just 20% probability of a June hike and just 34% for July seem too low and the Fed may try to raise these probabilities a bit. That said the combination of risks in June around Brexit and Greek debt relief negotiations suggest the Fed may choose to avoid any hike in June.

On the data front in the US expect a gain in new home sales (Monday), a rebound in durable goods orders, continued gains in home prices but flat consumer confidence (all Tuesday), March quarter GDP growth of just 0.5% annualised (Thursday), growth in employment costs remaining low at around 2%yoy, and a slight fall in inflation as measured by the core consumption deflator for March to 1.5%yoy (both Friday). While March quarter GDP growth of just 0.5% annualised is very low just bear in mind the seasonal distortion over the last 20 years that has seen March quarter growth average just 1% annualised followed by June quarter growth of 3% on average. March quarter earnings reports will also continue to flow.

After the Fed the focus will shift to the Bank of Japan (Thursday) where there is a good chance of further easing focussed on more QE around ETFs, REITs and corporate debt and a negative lending rate to banks given recent strength in the Yen, soft growth and inflation readings and the recent earthquake. Japanese data for inflation, household spending and industrial production will also be released on Thursday.

Eurozone March quarter GDP (Friday) is likely to show growth of 0.4%qoq, economic confidence data (Thursday) is expected to show a slight improvement after slipping in March and inflation is likely to have remained low in April (Friday).

In Australia, the focus will be on March quarter CPI inflation (Wednesday) which is expected to show an increase of just 0.3% quarter on quarter or 1.8% year on year as lower petrol prices and ongoing weak pricing power offset seasonal increase in prices for health and education. The underlying measures of inflation are expected to rise by 0.5% qoq or 1.9% yoy. Inflation continuing to run at or below the low end of the RBA’s target zone is one reason why we expect another RBA rate cut this year but it would need to be significantly weaker than expected to drive a May rate cut. Data for export and import prices, producer prices and credit will also be released.

Outlook for markets

Expect short term share market volatility to remain high as we head into May (“sell in May and go away, come back on St Leger’s Day”) and the Fed eventually starts to soften markets up for another rate hike. However, beyond near term volatility, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate global economic growth.

Very low bond yields point to a soft medium term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation. Bonds in higher yielding countries like Australia, the US and China are relatively attractive.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but price growth is likely to pick up in Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with the RBA expected to cut the cash rate to 1.75%.

The ongoing delay in Fed tightening and stronger data in Australia pose further short term upside risks for the $A, possibly up to $US0.80. However, any further short term strength in the $A is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the RBA eventually resumes cutting the cash rate and the Fed eventually resumes hiking, commodity prices remain in a secular downswing and the $A undertakes it’s usual undershoot of fair value.

Eurozone shares fell 0.3% on Friday, but the US S&P 500 was flat as gains in energy and bank shares offset falls in tech stocks. Despite the flat US lead, ASX 200 futures gained 26 points or 0.5% helped by a further rise in energy and metal prices.

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Rising risk to Australia’s AAA rating?

Monday, April 18, 2016

By Shane Oliver

Investment markets and key developments over the past week

Share markets pushed higher over the last week helped by better than feared US earnings results, good economic data and a continued unwinding of disaster fears from early this year. US shares rose 1.6%, Eurozone shares gained 4%, Japanese shares rose 6.5%, Chinese shares rose 3.1% and Australian shares gained 4.5% The US share market is now up 1.8% year to date. The “risk on” tone saw bond yields and commodity prices (except gold) rise with even the iron ore price making it back to around $US60/tonne. While the US dollar rose slightly the $A pushed back to around $US0.77 helped by stronger commodity prices and Australian data.

Surprise, surprise – the IMF has downgraded its global growth forecasts yet again to 3.2% for this year from 3.4% and to 3.5% in 2017 from 3.6% - adding to headline concerns about the global growth outlook. But just bear in mind that the IMF is just catching up to investor concerns that drove the financial turmoil early this year and in any case the IMF has been perpetually downgrading its growth forecasts for years now. See the chart below. Invariably the IMF starts off forecasting global growth for the year ahead to be around 4% and then progressively revises it down to around 3%. In other words the latest IMF growth downgrades are nothing new.

Source: IMF, AMP Capital

More significantly, a lot of the fears that drove markets lower earlier this year are still receding: Chinese economic data is looking healthier; those that really matter at the Fed are continuing to indicate that it will be cautious and mindful of global conditions in raising interest rates; the $US has come off the boil relieving pressures on emerging markets; the Chinese Renminbi is proving to be stable on a trade weighted basis; and fears around Eurozone banks appear to be fading.

It’s coming up to Budget time again in Australia (May 3rd) and as always everyone is having their say, including the ratings agencies. The perpetual delay in returning the budget to surplus (see next chart) has not threatened Australia’s AAA sovereign rating so far, but comments by Moody’s expressing scepticism about the limited scope for meaningful spending cuts or tax reform suggest that ratings agencies may be losing patience. Despite a commitment from both sides of politics to return to surplus it’s hard to be optimistic about spending cuts unless the government faces a more cooperative Senate and meaningful tax reform looks dead in the water (again).

However, there is some reason for optimism in that the cycle of each successive budget update pushing out the return to surplus may not be repeated in the May Budget as a higher iron ore price (it’s now around $US60/tonne versus the MYEFO assumption of $US39) and stronger employment growth provide a bit of a boost to revenue. This is all about “parameter” changes though and the absence of an improvement in the structural deficit may continue to test the patience of the ratings agencies so the risk to the AAA rating may still rise. Would a downgrade to AA1 really matter? The experience of other countries suggests the impact on bond yields would be limited but it could boost private sector borrowing costs marginally. And it would be a blow to the national psyche and a sad outcome given that it took 16 years to regain the AAA rating after it was last lost in 1986.

Source: Commonwealth Treasury, AMP Capital.

Major global economic events and implications

US economic data was mixed but okay. Jobless claims fell to their lowest since 1973 (the year Elvis appeared via Satellite from Hawaii), retail sales were softer than expected in March but previous months were revised up so not so bad, industrial production fell more than expected in March but manufacturing conditions improved in the NY region, small business confidence fell and inflation readings were weaker than expected. Weak inflation readings support Fed Chair Janet Yellen’s caution regarding signs of a pick-up in inflation and give it plenty of scope to go easy in raising rates. March quarter profit reports are off to a good start with 81% of results so far beating on earnings and 61% beating on sales. But its early days with only 33 S&P 500 companies having reported! Market expectations remain for a 9% yoy fall in earnings for the March quarter, but it’s likely to come in a bit “better” at around -5%.

The trickle of data suggesting Chinese growth is stabilising or improving has now become an avalanche. Chinese GDP growth for the March quarter slowed as expected to 6.7% year, reflecting the weak start to the year. But the list of data showing stabilisation or improvement in March expanded further to include: PMI’s, producer price inflation, exports, imports, electricity consumption, railway freight traffic, industrial production, retail sales, fixed asset investment and total financing. The bottom line is that the incremental stimulus measures of the last year or so are now helping growth. This in turn is being reflected in a stronger tone in commodity prices.

Australian economic events and implications

Australian data was surprisingly strong with solid February gains in housing finance for both owner occupiers and investors, a surge in business conditions to an 8 year high and stronger business confidence according the NAB business survey and better than expected jobs growth pushing the unemployment rate down to 5.7% in March. It’s not all positive though as consumer confidence fell again in April to be well below its long term average and trend monthly employment growth has slowed to around 8000 a month from a high point of around 30,000 a month last year and hours worked are slowing. However, the fall in unemployment looks like a trend and it’s hard to see the RBA easing against this backdrop. So a May rate cut looks unlikely. However, we continue to see a rate cut as likely for later this year to support growth particularly if the Australian dollar remains strong at a time when the contribution to growth from housing is slowing, the slump in mining investment is continuing, inflation remains around 2% or below and banks continue to put through out of cycle rate hikes.  

According to the RBA’s latest six monthly Financial Stability Review the actions of regulators have led to reduced risks around housing lending but there are risks around apartment developments (notably in inner city Melbourne and Brisbane and increasingly Perth), some commercial property markets and around resource related companies. The bank’s exposure to the resources sector is low though and risks around non-resources businesses are low.

What to watch over the next week?

First up in the week ahead will be reaction to OPEC and Russia’s meeting on Sunday regarding an oil production freeze.  The oil price has rallied strongly on indications a freeze will occur, but there is clearly a risk of disappointment because such a move is unlikely to include Iran and if so total OPEC supply will still be rising. Regardless of the outcome of the meeting it does look as if the global oil market is gradually heading back towards balance, which should help the oil price continue to stabilise. 

In the US, the key focus will be on March quarter earnings reports, which will ramp up over the week ahead. On the data front expect to see a slight rise in the NAHB’s home builders’ index (Monday), a slight fall in housing starts (Tuesday) after a big gain in February, gains in home sales (Wednesday) and home prices (Thursday) and a further slight rise in the manufacturing conditions PMI for April (Friday). The New York Republican primary with 95 delegates is on Tuesday.

In Europe, the ECB (Thursday) is unlikely to unveil further changes to monetary policy given the significant additional easing it announced in March but post meeting comments will no doubt be watched as a guide to how its seeing the Eurozone economy proceeding. Business condition PMIs for April (Friday) are expected to show a slight improvement.

In Australia, the focus will no doubt be on the Minutes from the last RBA Board meeting and a speech by RBA Governor Glenn Stevens (both Tuesday) for any clues on the outlook for interest rates. The Governor’s speech will perhaps be of more interest as it’s timelier. While the RBA is likely to retain its easing, recent data is likely to have added to its comfort regarding the rebalancing of the economy. Skilled vacancy data will be released Wednesday.

Outlook for markets

Expect short term share market volatility to remain high as we head into May (“sell in May and go away, come back on St Leger’s Day”) and the Fed eventually starts to soften markets up for another rate hike. However, beyond near term volatility, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate global economic growth.

Very low bond yields – with 25% of the global sovereign bond index now having negative yields - point to a soft medium term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation. Bonds in higher yielding countries like Australia, the US and maybe even China are relatively attractive.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but price growth is likely to pick up in Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with the RBA expected to cut the cash rate to 1.75%.

The ongoing delay in Fed tightening and stronger data in Australia pose further short term upside risks for the $A. However, any further short term strength in the $A is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the RBA eventually resumes cutting the cash rate and the Fed eventually resumes hiking, commodity prices remain in a secular downswing and the $A undertakes it’s usual undershoot of fair value.

Eurozone shares fell 0.3% on Friday and the US S&P 500 lost 0.1%. As a result ASX 200 futures fell 4 points or 0.1% pointing to a flat to soft start to trade for the Australian share market today.

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Global growth worries return

Monday, April 11, 2016

By Shane Oliver

Shares markets fell over the last week as global growth worries seemingly returned despite mostly okay economic data and the minutes from the Fed's last meeting affirming that it will be cautious in raising interest rates. Japanese shares fell 2.1%, getting hit by a further 7% rise in the value of the Yen. US, European and Australian shares all fell 1.2%, with worries about banks continuing to weigh on the Australian share market, and Chinese shares fell 0.8%. The growth worries and “risk off” tone saw bond yields fall, the Yen rise and the $A fall. Metal prices fell sharply but oil rose on optimism that OPEC will agree to freeze oil supply at its April 17 meeting.

While comments by the IMF’s Christine Lagarde about global growth being too slow and fragile added to investor nervousness, there was nothing really new in this. IMF forecasts for global growth of 3.4% this year are still too optimistic and likely to be revised to around 3%. While her comments are likely aimed at encouraging governments to undertake more supply side economic reforms, it is noteworthy that a broad based gain in business conditions PMIs in March suggest global growth momentum may have improved a bit lately, or at least stabilised. 

Source: AMP, ABS data

The rise in the value of the Yen (+14% against the $US since last year’s low) is worth keeping an eye on. Not only is it bad for Japanese growth but it can also be seen as a negative sign for the global economy to the extent that it may signal unwinding carry trades (where investors borrow cheap in Japan and invest elsewhere) and hence less risk taking in capital flows. The flipside though is that a rising Yen is just a normal phenomenon of periods of investor nervousness and in any case the higher the Yen goes the greater the pressure on the Bank of Japan to undertake more monetary stimulus.

In the US, Donald Trump's loss in the Wisconsin primary suggests his campaign may be finally starting to falter under the weight of his “open mouth approach”. To reach the 1237 majority of delegates to the Republican convention in July he needs to win 56% of the delegates in remaining primaries but so far he has only been winning 47% of delegates. This is a particular challenge with big states like New York (April 19) and California (June 7) ahead where he is not polling so well. It's also virtually impossible for Ted Cruz to win the 1237 majority as he would need to win 82% of remaining delegates against a win rate so far of just 33%. So a contested convention looks highly likely - better than putting up a bad candidate. On the Democratic side Hilary Clinton remains on track to win her party's nomination requiring only 32% of remaining delegates against a win rate so far of 62%. Common sense could yet win out in the US presidential election!

In Australia, the RBA left interest rates on hold as expected but expressed discomfort at the rise in the value of the Australian dollar indicating it "could complicate the adjustment under way in the economy". The clear implication is that the rise in Australian dollar has increased the chance that the RBA will act on its bias to ease interest rates again. With growth set to slow a bit as mining investment continues to unwind and the contribution to growth from housing slows, unemployment likely to remain around a relatively high 6%, inflation likely to remain low, the banks likely to raise mortgage rates again independently of the RBA (the Bank of Qld already has) and the bounce in the $A threatening growth in globally focussed sectors like tourism and higher education our view remains that the RBA will cut interest rates again. A soft March quarter inflation report due April 27 could drive this in May - but it may not occur until the June quarter.

Major global economic events and implications

In the US the trade deficit expanded in February, but job openings, hirings and the quit rate (a guide to worker confidence in the job market) remain strong, jobless claims remain low and the non-manufacturing conditions ISM improved in March. The Atlanta Fed's GDPNow data tracker now puts March quarter GDP growth at just 0.4% annualised but recall the seasonal pattern over the last 20 years that has seen growth average just 1% in the March quarter but 3% in the June quarter so this and the improvement in March PMIs suggests there is no reason to get fussed. Meanwhile, the minutes from the Fed's last meeting affirmed that it would be cautious in raising interest rates with Fed officials overall having little inclination to raise interest rates again at its April meeting. Comments by Fed Chair Janet Yellen that she still sees some labour market slack are consistent with this.

Eurozone data was mixed with weak German factory orders and a fall in the services conditions PMI in March, however the level of the services conditions PMI still remains consistent with moderate growth and unemployment fell again in February (albeit the level remains high).

The worse could be over for Chinese capital outflows. Chinese foreign exchange reserves rose in March for the first time in five months. After adjusting for valuation effects the pace of decline in reserves has slowed to $US42bn in March from $US142bn in December, suggesting capital outflows are slowing. Maybe there is more confidence that the Renminbi and the Chinese economy are not going to crash after all. In terms of the latter, China's Caixin services conditions index improved in March adding to confidence that growth momentum improved.

The Reserve Bank of India cut interest rates again, highlighting yet again that global monetary conditions are still becoming easier.

Australian economic events and implications

Australian data was on the soft side. Building approvals bounced 3% but this followed a 6.6% decline and the trend is clearly down pointing to slowing housing investment in the year ahead (see the next chart), retail sales were weaker than expected in February and look to have lost momentum, the trade deficit widened in February, services and construction conditions PMIs softened in March (in contrast to manufacturing sector strength) and the Melbourne Institute's Inflation Gauge for March showed both headline and underlying inflation running below 2% year on year.

Building approvals

Source: ABS, AMP Capital.

What to watch over the next week?

In the US expect to see better growth in March retail sales (Monday), CPI inflation of 1% year on year and core inflation of 2.3% yoy (Wednesday) and another slight fall in industrial production (Friday). The Fed’s Beige Book of anecdotal evidence (Wednesday) will also be released. Meanwhile, Alcoa will unofficially kick off the March quarter earnings reporting season. With consensus estimates expecting an 8-9% yoy fall in profits there is some scope for upside surprise.

Chinese March quarter GDP growth (Friday) is likely to show a further slight loss of momentum to 6.7% yoy, from 6.8% in the December quarter consistent with soft data seen at the start of the year. But more timely March data is likely to show continued strength in credit growth and money supply, some improvement in export and import growth (Wednesday) and stable or improved growth in industrial production, retail sales and fixed asset investment (all due Friday). Inflation for March (Monday) is likely to show a slight rise to 2.4% yoy reflecting higher food prices.

An OPEC meeting on April 17 to discuss freezing supply will be watched closely with the main issue being whether Iran is included in any supply freeze. It's hard to see why Iran would want to freeze its output as it’s still recovering from the removal of sanctions, so it's hard to be optimistic as to the impact of an oil supply freeze if it just includes the other members (assuming Saudi Arabia agrees to that anyway) because overall supply from OPEC would still be rising as Iran ramps up its production.

In Australia, expect to see a rise in housing finance for February (Monday), little significant change in business and consumer confidence (Tuesday and Wednesday respectively) a 20,000 jobs gain for March and a slight rise in unemployment to 5.9% (Thursday). The RBA’s half yearly Financial Stability Review (Friday) will be watched for an update of the RBA’s assessment regarding risks around the property market.

Outlook for markets

After strong gains from their February lows global are overbought and vulnerable to a pull back, which could further weigh on Australian shares. Beyond the near term uncertainties though, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate global economic growth.

Very low bond yields – with 25% of global sovereign bonds now having negative yields - point to a soft medium term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation. Bonds in higher yielding countries like Australia, the US and maybe even China are relatively attractive.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but price growth is likely to pick up in Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with the RBA expected to cut the cash rate to 1.75%.

The ongoing delay in Fed tightening and stronger data in Australia pose further short term upside risks for the $A. However, any further short term strength in the $A is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the RBA eventually resumes cutting the cash rate and the Fed eventually resumes hiking, commodity prices remain weak and the $A undertakes it’s usual undershoot of fair value.

After falls earlier in the week, European shares gained 1.4% and the US S&P 500 rose 0.3% on Friday helped by gains in energy shares as the oil price rose 6.6% on optimism of an OPEC supply freeze. The positive global lead saw ASX 200 futures gain 20 points or 0.4% pointing to a positive start to trade on Monday for the Australian share market.

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Bank worries still weighting on share market

Monday, April 04, 2016

By Shane Oliver

Investment markets and key developments over the past week

The “risk on” rally fired up again in US shares over the last week helped by dovish comments from Fed Chair Janet Yellen and good news on US jobs and manufacturing, the combination of which pushed the $US and global bond yields down and US shares up 1.8% for the week. Chinese shares also rose 1% for the week helped by optimism that the Chinese economy may be stabilising. However, European shares lost 0.6%, Japanese shares fell 4.9% and Australian shares fell 1.7% with worries about more bank bad debt charges weighing in the case of the latter. The weaker $US saw the $A rebound making it above $US0.77 at one point, although oil prices fell on supply concerns and metal prices also fell.

For March shares had a good rebound ranging from 2% in Europe to 9.9% in China with Australian shares up 4%, after the rough start to the year in January and February as global growth worries receded, the $US and Renminbi stabilised and commodity prices improved. Historically, April has been a good month from a seasonal perspective but the period from May can be rough.

Source: Bloomberg, AMP Capital

The key message from Janet Yellen remains that the Fed will be cautious in raising interest rates reflecting global risks, weak US inflation expectations and the asymmetric ability of the Fed to respond to downside as opposed to upside threats. Quite clearly Janet Yellen would rather risk being too easy than too tight because the Fed’s ability to respond to lower growth and inflation is more limited that its ability to respond to higher growth and inflation. In this sense she doesn’t want to do anything to exacerbate global risks because of the potential blow back to US growth and inflation. While some regional Fed presidents lean hawkish as we heard immediately after the last Fed meeting, its likely Yellen has the support of a clear majority including the Fed governors and the New York Fed President. An April hike looks very unlikely and a June hike remains our base case but the probability is only around 55% in my view, particularly with the Brexit vote coming a week after the June meeting so the next hike could even be delayed till the July meeting if there is much market tension ahead of the Brexit vote.

US payrolls rose a healthy 215,000 in March telling us that the jobs market is still solid despite a decline in manufacturing jobs. However, rising labour force participation resulted in a rise in unemployment to 5% from 4.9% and should help ensure that the upswing in wages growth, currently running at just 2.3% year on year, will remain gradual. All of which is consistent with the Fed only gradually raising interest rates. 

Bad debt worries are clearly weighing on Australian banks and Australian shares generally. While the extra $100m in bad debt charges announced by one bank due to the resources slump is small, investors naturally worry the bad debt cycle has now bottomed and like cockroaches if there is one downgrade there are likely to be more. So the concerns could linger for a while. Putting it all in context though resources related loans are only around 2% of total loans for the big four banks.

Major global economic events and implications

US economic news was good. Sure the goods trade deficit expanded in February and household spending data for January and February were soft. But against this payroll employment growth was a solid 215,000 in March, the ISM manufacturing conditions index rebounded in March led by a surge in new orders suggesting the worse may be over for manufacturing, pending home sales rebounded and consumer confidence improved. No signs of recession here. While the Atlanta Fed’s data tracker points to just 0.7% annualised growth for the March quarter just passed its noteworthy that over the last 20 years annualised March quarter GDP growth in the US has averaged just 1% only to bounce back to an average 3% in the June quarter. (Looks like a seasonal glitch that the Bureau of Economic Analysis is failing to adjust for. Maybe they are still to work out that it’s usually cold in January and February!). Meanwhile, the core private consumption deflator which is the Fed's preferred inflation measure slowed again in February leaving annual inflation at 1.7%.

Eurozone economic confidence fell in March but remains at levels consistent with reasonable growth and private lending growth picked up in February which is a positive sign given pressure on banks at the time.

Japanese economic data was mostly favourable with a surprise gain in real household spending, solid jobs data and a rise in small business confidence. Industrial production fell sharply in February but this mainly appears to related to lunar New Year distortions and a temporary shutdown at a car plant. March quarter Tankan business conditions and confidence readings were disappointing though.

There was also some good news out of China with the official and Caixin business conditions PMIs in March by more than expected and consumer confidence rising to its highest since September last year. It’s looking like Chinese growth is stabilising and policy stimulus measures are starting to impact.

Australian economic events and implications

Australian data was mostly good. Credit growth remained moderate in February with housing lending to owner occupiers continuing to accelerate but lending to investors continuing to slow, new home sales fell 5% in February and remain in a downtrend consistent with slowing building approvals, home prices rose modestly in March with ongoing confirmation of a loss of momentum compared to last year but job vacancies continue to run around levels consistent with solid employment growth and the AIG’s manufacturing conditions PMI rose to a booming reading of 58.1. In fact, the Australian manufacturing PMI is amongst the highest in the world, testament to the boost provided by the fall in the $A since 2011. The qualifier though is that it’s likely dependent on the $A remaining low in contrast to its recent rebound.

The loss of momentum in national average house price is clearly due to Sydney which has really come off the boil. A further slowing is likely ahead with a modest cyclical decline in prices likely around 2017-18. In the absence of significant rate hikes or a recession it’s still hard to see a property crash though.

Source: CoreLogic RP Data, AMP Capital

[Thought bubbles and tax kites. While I can understand where the Federal Government is coming from in suggesting states could levy their own income taxes (it could help promote accountability at a state level) reverting to the multiple state based tax rates of the past would not be good if we want to promote tax efficiency across the economic union that is Australia.

What to watch over the next week?

In the US, the minutes from the Fed's last meeting (Wednesday) will be rather dated given Chair Janet Yellen's comments in the last week, but another speech by her on Thursday will no doubt be watched closely. On the data from the non-manufacturing conditions ISM is likely to show a slight improvement and February trade data and labour market indicators will also be released (all on Tuesday).

In Australia, the RBA (Tuesday) is likely to leave interest rates on hold for the 11th month in a row. We continue to see another rate cut in the months ahead: as mining investment continues to unwind; the contribution to growth from housing looks like it will slow; to offset possible further out of cycle bank interest rate hikes; as inflation remains low; and to help push the $A back down. However, it’s doubtful that the RBA is ready to make a move just yet particularly with recent good readings on GDP growth and unemployment. However it is likely to retain an easing bias and most interest will focus on whether it responds to the 7% gain in the value of the $A since its last Board meeting by a bit a jawboning to try and get it lower again consistent with Governor Steven's comment that it "might be getting ahead of itself".

On the data front in Australia expect February data to show a 0.4% gain in retail sales, a 1% bounce in building approvals but in an ongoing downwards trend (both Monday) and another large trade deficit of around $2.8bn (Tuesday).

Outlook for markets

After strong gains from their February lows shares are overbought and vulnerable to a pull back. Beyond the near term uncertainties though, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate global economic growth.

Very low bond yields – with 25% of global sovereign bonds now having negative yields - point to a soft medium term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation. Bonds in higher yielding countries like Australia, the US and maybe even China are relatively attractive.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but growth is likely to pick up in Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with the RBA expected to cut the cash rate to 1.75%.

The ongoing delay in Fed tightening and stronger data in Australia pose further short term upside risks for the $A. However, any further short term strength in the $A is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the RBA eventually resumes cutting the cash rate or at least resorts to jawboning and the Fed eventually resumes hiking, commodity prices remain weak and the $A undertakes it’s usual undershoot of fair value.

While Eurozone shares fell 1.4% on Friday as a 4.3% fall in oil prices weighed on energy stocks, the US S&P 500 reversed an initial 0.7% slide to close with a gain of 0.6% thanks to solid employment and manufacturing data. Thanks to the positive US lead, ASX 200 futures rose 23 points or 0.5% suggesting a positive start to trade for the Australian share market on Monday.

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Fed officials still upbeat

Tuesday, March 29, 2016

By Shane Oliver

Investment markets and key developments over the past week

The “risk on” rebound took a bit of a breather over the last week. The rebound in shares, commodities and commodity currencies like the $A had been so fast that it had taken them to a point where they were technically overbought and in many cases up against resistance and on the flipside the US dollar had become oversold. So we were primed for a pullback and the trigger has been provided by various Fed officials expressing confidence in the US economy and the Fed’s desire to continue raising interest rates with its April meeting being “live”. As a result the US dollar reversed a bit of its recent fall and most share markets, commodities and the Australian dollar pulled back a bit. For the week US shares fell 0.7%, Eurozone shares lost 1.9% and Australian shares also lost 1.9%. Against this though Japanese shares rose 1.7% and Chinese shares rose 0.8%. Bond yields were little changed.

On the Fed, it was inevitable that after the March meeting various Fed officials would express their individual views. But so far we have only heard from a handful of mainly non-voting Fed officials and there is nothing to indicate the Fed has suddenly become more hawkish. Our assessment remains that while the April meeting is live, it won’t see a hike but that a June hike remains a reasonable base case. The US money market is currently attaching a 6% probability to an April hike and a 38% probability to a June hike which looks a bit too low.

While the short term pull back in shares may have further to run, we see it as just that, ie a pull back, and still see the broad trend as up. Supportive of this are slightly better March business conditions readings globally, lessening concerns regarding China and confidence that the Fed is aware of global risks and doesn’t want to accentuate them by tightening too aggressively and reigniting significant upwards pressure in the US dollar which would only renew pressure on oil prices, the Chinese Renminbi and the emerging world.

The horrible attacks in Brussels have provided a reminder of the terrorist threat. This is first and foremost a human issue and my thoughts are with those affected. However, from an investment perspective the reaction in Eurozone shares to the Brussels attacks was pretty muted which is consistent with the muted share market reaction to the Paris attacks last November. Two things are worth noting. First, recall that parts of Europe have lived with terrorism in decades past, eg the IRA campaign regarding Northern Ireland, the Red Army Faction in Germany. After a while these came to be seen as the norm and people just went about their lives around them. Secondly, the experience of the last decade or so has highlighted that terrorist attacks on soft targets like buildings and sports venues don’t really have a lasting economic impact. So while the 9/11 attacks in the US had a big short term share market impact with US shares initially falling 12%, they had recovered in just over a month, the Bali and Madrid bombings had little market impact and the impact on the UK share market of the London bombings of July 2005 was reversed the day after. So while the terror threat is negative for confidence, there is unlikely to be a significant economic or financial market impact.

Australia back in election mode? Well not quite but it seems that way with the Government moving another step closer to a July 2nd election by bringing the Budget forward to May 3rd so it has plenty of time to pass supply bills ahead of calling such an election on May 11th if it gets a double dissolution trigger.   The downside for the economy is the uncertainty that election campaigns create. The upside may be more rational policy making out of Canberra if the Senate gets cleaned up with a double dissolution election. In terms of the economic impact of Federal elections on the economy while there is some evidence that people adopt a more cautious approach to spending during campaigns there is no clear evidence that election uncertainty affects growth in election years as a whole. Since 1980, economic growth in election years has averaged 3.7% pa which is stronger than the 3.2% average growth over the period as a hole. For shares there is some evidence of the Australian share market tracking pretty much sideways in the run up to elections but on average it has gained 4.9% in the three months after elections since 1983.

Source: Thomson Financial, AMP Capital

Major global economic events and implications

US economic data was mixed. Underlying durable goods orders fell more than expected in February and existing home sales fell sharply, although this may be partly related to limited supply. On the positive side though new home sales rose, the Markit manufacturing and services conditions PMIs both rose with the composite PMI up 1.1 points in March to 51.1, more regional manufacturing indexes rose in March adding to evidence that the worst may be over for US manufacturing and jobless claims remained low. December quarter 2015 GDP growth was revised up to 1.4% annualised from 1% thanks to stronger consumer spending and trade. A worry is that profits fell 11.5% through last year but this was concentrated in the energy sector and made worse by a penalty payment from BP.

A rebound in Eurozone business surveys for March add to confidence that the falls seen in February were driven more by share market turmoil rather than fundamentals. The March business conditions PMI and German IFO index rose to levels associated with good growth.

Japan’s manufacturing conditions PMI for March was less favourable though, falling 1 point to 49.1. February core inflation remained low at 0.8% year on year highlighting on going pressure on the Bank of Japan to ease further.

Australian economic events and implications

In Australia, ABS data confirmed a loss of momentum in home price growth in the December quarter last year consistent with what private surveys had already shown – since then timelier data suggests that it has picked up again but is still down from last year’s highs. Meanwhile, largely due to lower immigration levels, population growth continued to edge down to 1.3% for the year to the September quarter last year which is well down from the recent high of 1.8% in 2012. This will mean a slight slowing in underlying demand growth for housing, but that said population growth is still solid and the slowdown may be being offset by a pick-up in short term student arrivals on the back of the lower $A. The latter are not included in the population stats for obvious reasons but they still need to be housed.

Meanwhile, RBA Governor Glenn Steven’s commented that Australia is adjusting well to the end of the mining boom, that it has more room to ease monetary and fiscal policy than most other countries and that the rise in the value of the $A may have got a bit ahead of itself. All of which I agree with. The Governor’s comments on the $A clearly indicate a degree of discomfort with its recent rise and echo similar sentiment from other RBA officials over the last few weeks. The Australian dollar’s ascent though has not been enough yet on its own to provide a trigger for another rate cut, although it does add to the case.

What to watch over the next week?

In the US, a speech by Fed Chair Janet Yellen (Tuesday) will be watched for clues on interest rates particularly after some recent hawkish comments from Fed officials. Meanwhile, it’s back to watching payrolls and the ISM manufacturing conditions index with both due on Friday and expected to show the US economy doing okay. Expect to see a solid 200,000 gain in March payrolls with unemployment unchanged at 4.9% and wages growth picking up slightly and the ISM manufacturing conditions index bouncing back to around 50.5 (from 49.5) consistent with stronger regional surveys. Meanwhile the core private consumption deflator (Monday) for February is expected to show a further rise to 1.8% year on year, pending home sales (also Monday) are expected to move up as are home prices and consumer confidence (both Tuesday).

In the Eurozone, money supply and credit data for February (Tuesday) will be watched for any impact of the turmoil in bank shares seen early this year and March inflation data (Thursday) is expected to remain low.

Japanese data is expected to show labour market strength but soft household spending (all due Tuesday) and industrial production (Wednesday). The Tankan business conditions survey will also be released Friday.

Chinese business conditions PMI’s due Friday are expected to show a slight improvement in conditions for March.

In Australia, expect to see continued modest credit growth (Thursday) and it will be interesting to see whether the recent strength in the value of the Australian dollar has dented the AIG’s manufacturing conditions PMI due Friday. Core Logic RP Data house price data is expected to show continued modest growth in national home prices for March.

Outlook for markets

After strong gains from their February lows shares are overbought and vulnerable to a pull back. Beyond the near term uncertainties though, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate global economic growth.

Very low bond yields – with something like 25% of global sovereign bonds now having negative yields - point to a soft medium term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation. Bonds in higher yielding countries like Australia, the US and maybe even China are relatively attractive.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but growth is likely to pick up in Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with the RBA expected to cut the cash rate to 1.75%.

The ongoing delay in Fed tightening and stronger data in Australia pose further short term upside risks for the $A. However, just as we saw with the early 2014 9% bounce in the $A, any short term strength in the $A is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the RBA eventually resumes cutting the cash rate or at least resorts to jawboning and the Fed eventually resumes hiking, commodity prices remain weak and the $A undertakes it’s usual undershoot of fair value.

At this stage the lead in for the Australian share market next week is flat to slightly positive. US shares were basically flat on Thursday but Chinese and Japanese shares rose on Friday and there will be another day’s trading in US and Asian shares before the Australian share market reopens again on Tuesday.

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Rising $A is a concern

Monday, March 21, 2016

By Shane Oliver 

Investment markets and key developments over the past week

The recovery rally continued over the last week helped by a combination of the Fed further delaying interest rate hikes, mostly good economic data and stimulus expectations in China. For the week this saw US shares up 1.4%, Chinese shares up 5.2% and Australian shares up 0.3%. European shares were flat though and Japanese shares fell 1.3% with strength in the Euro and Yen acting as a bit of a drag. US shares are now actually up 0.3% year to date after being down 10.5% year to date at their February 11 low and Australian shares have cut their year to date loss to 2.1% after being down 10% at their February 12 low. The Fed’s more dovish interest rate outlook also saw bond yields fall and helped drive the $US lower which in turn drove commodity prices higher which along with a fall in unemployment saw the Australian dollar push up to around $US0.76.

A lot of the worries on the worry list from early this year have faded: the $US has stopped rising; the Chinese Renminbi has reversed its losses against the $US; the Fed has become more dovish; fears of a US recession have faded with some better manufacturing data; oil and commodity prices have moved higher; credit spreads have narrowed a bit as fears of significant corporate defaults have receded; and concerns about China have settled a bit following indications it will provide more stimulus support. And in Australia the economic news has been okay.   

The Fed turns even more dovish. While the Fed continues to see moderate growth in the US, the key was that it acknowledged ongoing global and financial market risks and as a result lowered its so-called "dot plot" of meeting participants' interest rate expectations to show just two 25 basis point rate hikes this year down from four. In addition Fed Chair Janet Yellen signalled a greater willingness to tolerate upside surprise on inflation as opposed to seeing it continue to run below 2%. The Fed appears to have no inclination to hike at its April meeting, but a June hike does look like a reasonable base case, particularly given the recent upwards momentum in US inflation, but with only around a 55% probability. And it is dependent on global threats and financial market turbulence continuing to settle down.

By continuing to indicate that it is conscious of global risks and that US rate hikes will be data dependent and gradual, the Fed is clearly indicating that it is not going to do anything to consciously threaten the global and US outlook. Critical here is the stabilisation/softness that we are now seeing in the US dollar which has helped reduce the threats of even lower commodity prices, a funding crisis in emerging countries and pressure on US manufacturers that would have flowed if the $US continued to rise. So the Fed's latest decision is supportive for shares and growth assets and should lead to an ongoing stabilisation in the value of the US dollar.

So while the Bank of Japan decided to make no changes to monetary policy just yet, we have now seen two of the developed world’s big three central banks move further in a dovish direction in the last two weeks, ie, the ECB and the Fed. The bottom line is that when ultra-easy monetary conditions in Japan and further easing in China are allowed for global monetary conditions are continuing to get easier. Norway and Indonesia also cut interest rates in the last week.

In the US presidential primaries, Donald Trump still looks on track to pick up a majority of  delegates (which requires 1237) to the Republican convention in July, but John Kasich's victory in the "winner take all" Ohio primary indicates that it is far from assured so the nomination could still end up being contested and highly fractious for the Republicans. It's worth noting that Trump is only averaging around 35% of the votes at Republican primaries...so 65% are voting for someone else.

Is Brazil a buy? The political and economic crisis in Brazil is going from bad to worse. Meanwhile, its share market is up 35% from its January low with investors anticipating that the impeachment of President Rousseff would turn around Brazil’s outlook. At this stage the impeachment process still has some time to go (maybe up to six months), but it’s doubtful that it will solve Brazil’s problems which run much deeper than the president. Replacing her with the vice-President would probably mean more of the same and would be unlikely to usher in wholesale economic reform. The best outcome would be a new election but that would be a long time off. So I remain a bit cautious on Brazil.

Australia soon to be in election mode? With Senate reforms now passed the way has been cleared for a double dissolution election and a possible early election on July 2nd, which would probably also mean an early Budget on May 3rd. The downside for the economy is the uncertainty that election campaigns create (although this tends to be minor and we have to do it this year anyway). The upside may be more rational policy making out of Canberra if the Senate gets cleaned up with a double dissolution election.

Major global economic events and implications

Apart from soft retail sales figures, US data was mostly good. Housing indicators were generally solid with home builder conditions remaining strong and housing starts up, manufacturing production gained in February with a couple of regional business surveys also looking a lot healthier suggesting that the worst may be over for manufacturing and labour market indicators remained strong. 

Meanwhile, inflation data showed a further gain in core inflation supporting the Fed's plans to ultimately continue raising interest rates.

Eurozone data for construction and industrial production in January both came in stronger than expected indicating that Eurozone growth is continuing.

The Bank of Japan made no further changes to monetary policy and looks to be in wait and see mode after the further easing it announced back in January. Weak growth and inflation way below target indicate it faces ongoing pressure to do more though.

Australian economic events and implications

In Australia, we saw a messy jobs report for February. Jobs were flat with stronger full time employment offsetting a fall in part time jobs and the unemployment rate fell back to 5.8% but this was due to reduced participation. The basic message is that jobs growth has slowed from the unbelievable pace seen last year and unemployment has spent the last five months stuck around 5.8 to 6% which is not too bad, but it’s not great either. Labour underutilisation, ie unemployment plus underemployment, is down from its recent high but at 14.2% remains very high.

Source: ABS, AMP Capital

On interest rates, the Minutes from the RBA's last Board meeting offered nothing new. It did highlight the degree to which the RBA is now focussed on risks around China though although its conclusion on China risks is relatively sanguine (as is mine).

A concern for Australia is the continuing rise in the value of the $A at a time when we are partly relying on a further recovery in trade exposed industries like tourism and higher education to offset the mining downturn. Expect to see stepped up RBA jawboning if it continues to rise.

What to watch over the next week?

In the week, ahead the global focus is likely to be on flash March business conditions PMIs for the US, Europe and Japan (Thursday) which will be watched for an improvement after weakness seen in February that was possibly related to financial market turmoil at the time. Expect the US manufacturing PMI to rise to 51.5 (from 51.3) and the Eurozone composite PMI to rise to 53.5 (from 53.3).

In the US, expect to see a fall in existing home sales (Monday), continued strength in home prices (Tuesday), a rise in new home sales (Wednesday) and a slight fall back in durable goods orders (Thursday) after a strong gain in January.

Japanese inflation data to be released Friday is expected to show that headline inflation remains around zero and that core inflation remains very low at around 0.7% year on year which is well below the Bank of Japan’s 2% target.

In Australia, a speech by RBA Governor Glen Stevens (Tuesday) will be watched for any clues on the interest rate outlook. Of particular interest will be his views on the rising $A. Meanwhile, ABS data  also Tuesday) is likely to show that home prices were flat in the December quarter last year consistent with various private sector surveys. Data on skilled vacancies and population growth will also be released.

Outlook for markets

After strong gains from their February lows shares are overbought and vulnerable to a pull back. Beyond the near term uncertainties though, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate economic growth.

Very low bond yields – with something like 25% of global sovereign bonds now having negative yields - point to a soft medium term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation. Bonds in higher yielding countries like Australia, the US and maybe even China are relatively attractive.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but growth is likely to pick up in Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with the RBA expected to cut the cash rate to 1.75%.

The ongoing delay in Fed tightening and stronger data in Australia pose further short term upside risks for the $A, which is already up 12% from its January low. However, just as we saw with the early 2014 9% bounce in the $A, any short term strength in the $A is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the RBA eventually resumes cutting the cash rate or at least resorts to jawboning and the Fed eventually resumes hiking, commodity prices remain weak and the $A undertakes it’s usual undershoot of fair value.

 

Eurozone shares gained 0.5% on Friday and the US S&P 500 rose 0.4% as the post Fed rally continued. The positive global lead saw ASX 200 futures rise 29 points or 0.6% pointing to a positive start to trade for Australian shares on Monday.  

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The ECB delivers and shares rebound

Monday, March 14, 2016

By Shane Oliver

Investment markets and key developments over the past week

What a difference a day makes. On Thursday most global share markets were underwater for the week partly due to a silly knee jerk reaction to ECB President Mario Draghi’s out of context comment that he doesn’t anticipate more interest rate cuts. 

But Friday saw European and US shares surge higher as investors realised the full extent of the ECB’s stimulus measures. So for the week US shares gained 1.1%, Eurozone shares rose 1% and Australian shares gained 1.5%. However, Japanese shares lost 0.5% and Chinese shares fell 2.2%. The delayed favourable reaction to the ECB also saw bond yields rise, except in peripheral Europe, and the $A push above $US0.75.

Also helping was a fall in the value of the $US over the week and a rise in the Chinese Renminbi back to around levels it started the year at, which is important given the role that a falling Renminbi played in driving share market turmoil earlier this year.

Whichever way you look at it the ECB delivered much more than generally expected: its monthly quantitative easing (QE) program was increased from €60bn to €80bn; it will now include buying corporate debt in its QE program; it announced new cheap financing programs for banks (what the ECB calls TLTRO) that will start in June with an interest rate as low as -0.4%; and it cut the rate of interest on bank deposits at the ECB to -0.4% (from -0.3%).

While there was an initial negative reaction to President Draghi’s comment that he doesn’t anticipate more rate cuts, it would be wrong to make too much of this. First, Draghi’s comment was likely aimed at limiting expectations for any squeeze on bank margins, following the negative reaction to the Bank of Japan’s move to negative rates in January. Second, given concerns about banks his real message is that “the emphasis will shift from [negative] rates...to other non-conventional instruments [like QE and TLTRO]” and it’s likely that ECB officials will stress this in the period ahead. Third, the overall easing announced by the ECB is much bigger than expected and buying corporate debt should help bring the recent blow out in corporate bond yields back down with a flow on to bank borrowing costs. The focus on corporate debt and cheap bank financing is all about making sure that the recent turmoil around Eurozone bank shares is not allowed to mess with the monetary transmission mechanism in Europe.

Finally, the ECB and Draghi signalled even more determination to get inflation back up to its mandate “without undue delay” and Draghi even flagged a willingness to let inflation run above the 2% target for some time if it spends a long time below it. This is all about boosting inflation expectations. But it also alludes to making its quantitative easing program open ended as the US QE3 program was. So overall we give the ECB a big tick.

Closer to home the Reserve Bank of NZ also eased over the last week cutting its official cash rate to 2.25% from 2.5%. While New Zealand is in a different position to Australia having come from a brief tightening cycle, it does have similar concerns regarding its currency being too strong.

In Australia, consumer sentiment data highlighted a renewed degree of caution when it comes to investing. When asked what is the wisest place for savings, the March survey showed a dip in those nominating shares (from an already low 9.9% in the December survey to 7.6%), a sharp fall in those nominating real estate (from 23.4% to 14.7%) and an increase in those nominating either bank deposits or paying down debt (from 44% to 51.8%). Quite clearly share market volatility has weighed on sentiment towards shares but it also looks like all the latest talk about a property crash has weighed on sentiment towards property. There could be a contrarian signal in there, given that it’s usually best to do the opposite to the crowd at extremes!

Source: Westpac/MI, AMP Capital.

Major global economic events and implications

It was a quiet week on the US data front with a slight fall in small business optimism and a continuing rise in inventories highlighting the more difficult environment for US manufacturers, but a sharp fall in US jobless claims to a five month low telling us the jobs market remains strong. Meanwhile the message from Fed officials was mixed with Vice Chair Fischer pointing to what may be “the first stirrings of an increase in inflation”, but Governor Brainard sounding much more cautious and arguing for patience until the outlook becomes clearer.

Japanese data was soft with falls in economic sentiment, consumer confidence, machine tool orders and slower growth than expected in money supply and bank lending.

German industrial production rose much more than expected in January and factory orders fell by less than expected.

Chinese economic data was disappointing with February exports and imports falling more than expected, January/February growth in industrial production and retail sales slowing and a sharp fall in February growth in money supply and credit.

However, it’s worth noting that: there is a danger in reading too much into January and February data in China due to distortions caused by the floating Lunar New Year holiday; the softness in February money supply and credit data looks like payback after very strong January data and average growth across the two months is still much stronger than seen late last year; and finally a slight pick-up in fixed asset investment suggests stimulus measures may be starting to impact.

Nevertheless, the overall impression is that economic growth in China has started the year on a softish note which probably explains the recent stepped up official focus on stimulating the economy. Our forecast for Chinese economic growth this year remains 6.5%.

Meanwhile, the Chinese Government looks like it will allow banks to convert bad loans in debtor companies into equity holdings in a move to deal with rising levels of bad debts. A similar approach was used successfully in the 1990s.

Australian economic events and implications

Australia saw softness in housing finance and confidence measures continue to bounce around long term average levels. The message from January housing finance commitments is that investor finance is continuing to slow and owner occupier finance, which was filling the gap, may be too. That said it's premature to read too much into one month's worth of data. Meanwhile, consumer confidence fell slightly in March - perhaps not surprising given all the talk about cuts to tax concessions - and business confidence was unchanged in February. Hard to get excited though with both around long term average levels. But business conditions actually improved in February (consistent with various PMIs) with employment and capex intentions running around solid levels.

What to watch over the next week?

The focus in the week ahead will remain on central banks with both the Bank of Japan and the Fed meeting. The Fed (Wednesday) won’t be raising interest rates – with the market attaching just a 4% probability to a hike in the week ahead – but it is likely to indicate that while it intends to raise interest rates further this year it is aware of the risks of slower global growth and so will proceed cautiously. In particular, the Fed’s median “dot plot” showing Fed decision makers’ expected path for interest rates going forward is likely to show more interest rate hikes this year, but only three 0.25% hikes down from four. This compares to market expectations for no more than one, but the Fed and the market are likely to come closer together.

On the data front in the US expect to see a further gain in US retail sales (Monday) after allowing for the impact of falling gasoline prices, strength in homebuilding conditions (Tuesday) and housing starts (Wednesday) and a fall in industrial production (also Wednesday). Inflation data to be released Wednesday will likely show a fall at the headline level due to lower gasoline prices but will be watched for a further pick up at the underlying level. Manufacturing conditions surveys will also be released for the New York and Philadelphia regions along with data on job openings. 

Meanwhile, the Bank of Japan is unlikely to cut its deposit rate further into negative territory after the bad reaction to its January cut, but it could undertake an expansion of its quantitative easing program.

In Australia, it’s back to the monthly employment lottery on Thursday. For what it’s worth we expect a 10,000 gain in jobs and unemployment staying at 6%. The RBA will also release the minutes from its last meeting on Tuesday, but they are a bit dated given GDP and other data released since then.

Outlook for markets

Shares have had a good bounce, but having become overbought are now vulnerable to a pull back. Worries about the Fed will no doubt dominate in the week ahead and of course uncertainty remains regarding China. So whether we see a retest of February lows remains to be seen. Beyond the near term uncertainties though, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate economic growth.

Very low bond yields – with many sovereign bonds now having negative yields - point to a soft medium term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation. Bonds in higher yielding countries like Australia, the US and maybe even China are relatively attractive.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but growth is likely to pick up in Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with the RBA expected to cut the cash rate to 1.75%.

The delay in Fed tightening and stronger data in Australia pose further short term upside risks for the $A. However, just as we saw with the early 2014 9% bounce in the $A, any short term strength in the $A is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the RBA eventually resumes cutting the cash rate or at least resorts to jawboning and the Fed eventually resumes hiking, commodity prices remain weak and the $A undertakes it’s usual undershoot of fair value.

Eurozone shares gained 3.3% on Friday and the US S&P 500 rose 1.6% as investors rethought their initial negative reaction to the ECB’s stepped up stimulus program. The positive global lead saw ASX 200 futures gain 42 points or 0.8% pointing to a positive start to trade for the Australian share market on Monday, although this could be dampened a bit by mixed Chinese economic activity data released on Saturday.

 

 

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Australia keeps on keeping on

Monday, March 07, 2016

By Shane Oliver 

Investment markets and key developments over the past week

The past week has seen the recovery in risk assets continue with shares pushing higher, bond yields backing up, credit spreads narrowing, commodities rebounding and even the $A pushing back over $US0.74. For the week US shares rose 2.7%, Eurozone shares gained 3.5%, Japanese shares rose 5.1%, Chinese shares rose 3.9% and Australian shares gained 4.3%. From their recent lows US and global shares are up 9%, Australian shares are up 7%, oil is up 37%, the $A is up 8% and iron ore is up 34%. Maybe these rallies are telling us that all the handwringing over global growth was overdone.

So what’s helping drive the rebound in shares and other risk assets? It’s a whole bunch of things. 

First, while global growth looks to have slowed a bit it’s not crashing. This is most evident in the US where economic data suggests no sign of the recession share markets seemed to be moving to factor in earlier this year. This was highlighted by a “just right” jobs report for February which saw payrolls up 242,000 telling us the economy remains solid, but at the same time rising labour force participation and slowing wages growth indicating plenty of scope for the Fed to hold back in raising interest rates.

Second, central banks are helping sooth market fears. In the past week, New York Fed President Dudley was dovish on interest rates – indicating concern about inflation expectations and an awareness of the impact of global developments – adding to confidence that the Fed won’t be hiking rates at its March meeting. And the People’s Bank of China relaxed monetary policy again by cutting banks’ required reserve ratios.

Thirdly, policy uncertainty in China appears to have settled down, helped in particular by relative stability in the value of the Renminbi (after its depreciation earlier this year was a major factor in unnerving investors).

Finally, here in Australia, economic growth surprised on the upside allaying fears about local banks and the housing market.

Of course, it’s still too early to now expect smooth sailing (to the extent financial markets are ever smooth anyway) as fears around the Fed and global growth are likely to continue to periodically test the bulls and give us volatility. But at least things look a lot less bleak than they did in the dim dark days of the northern hemisphere winter.

There was one development over the past week that was a bit concerning – the rise and rise of Donald Trump. Post the Super Tuesday primary votes it’s more and more like it will be a Clinton versus Trump contest in the final vote later this year. Trump is still only getting 30-40% of the Republican primary vote, but the failure of the “not-Trump” Republican vote to clearly settle on one candidate is working in his favour. It needs to soon and the Republican establishment does now seem to be starting to fight back, which may yet help end Trump’s rise.

A Clinton presidency would probably mean more of the same, particularly with a Republican congress likely to help keep policy rational. (Or maybe I have fond memories of the Bill Clinton presidency years). What is less clear is how a Trump presidency would pan out. What precisely Trump stands for is a bit hard to work out. He is committed to building a wall on the Mexican border (because “They’re bringing drugs. They’re bringing crime. They’re rapists.”) and looks to be a glued on protectionist (watch his 1988 interview with Oprah), wants to crack down more on banks and he has crazy foreign policies and plans to deal with terrorists (“take out their families”). But apart from those things and lots of whacky outbursts, it’s hard to know precisely what his policies as president would be. Hopefully Congress would keep him on a sensible path if he were to gain the presidency. Or that may be just wishful thinking. But before it even gets to that one must hope that common sense will prevail amongst the median American voter.

Major global economic events and implications

US economic news was good with a gain in the manufacturing conditions ISM for February of 1.3 points to 49.5 with new orders remaining solid, the non-manufacturing ISM remaining solid, construction spending gaining more than expected in January and good February jobs data.

Eurozone retail sales for January rose by more than expected in January, unemployment continues to trend down and final business conditions PMIs for February were revised up a bit suggesting economic conditions may have improved as the month progressed (and share markets recovered).

Japanese economic data was mixed. Industrial production rose more than expected and labour market indicators remain strong. Against this real household spending remains weak.

China’s February round of business conditions PMIs were all disappointing suggesting that growth may have slowed a bit further early in the year. While this may be partly due to distortions associated with the Lunar New Year holiday, further monetary easing in the form of a 0.5% cut to 17% in the banks’ required reserve ratio indicates that the authorities are still focussed on boosting growth. With the reserve ratio remaining high further easing is likely ahead. Meanwhile, property prices continued to gain with the 100 city Soufun index seeing an average 0.6% gain in February. A risk is that a renewed speculative bubble in Tier 1 cities could be forming, which in turn could detract from equity holdings as the see sawing between shares and property continues.

Australian economic events and implications

Australian economic data was remarkably robust with GDP up a much stronger than expected 3% through 2015, manufacturing and services PMIs rising solidly in February, and January data showing gains in retail sales and new home sales and a narrowing in the trade deficit. While GDP growth is expected to slow back to around 2.5% this year as mining investment continues to contract, slowing wealth gains weigh on growth in consumer spending and as slowing building approvals lead to a slowing contribution to growth from home building its nevertheless likely to remain well supported. Low interest rates and the fall in the $A are clearly helping to support non-mining activity highlighted by surging export earnings from tourism and higher education, the coming on line of LNG export projects will also help sustain export volume growth and growth is likely to remain strong in the population rich states of NSW and Victoria.

While the RBA retained an easing bias at its March Board meeting and arguably strengthened it slightly by saying that “continued low inflation would [as opposed to may] provide scope for easier policy, should that be appropriate..” it’s hard to see them acting on it with growth running above their own forecasts and until unemployment rises more significantly. As such while I remain of the view that the RBA will need to cut interest rates again it has become a very close call.

Meanwhile, capital city home price growth was a moderate 0.5% in February with annual price growth of 7.6%, down from a recent peak of 11.1% last July. Momentum continues to slow in Sydney. For Sydney and Melbourne we continue to see a profile looking something like that seen in the chart below.

Source: Core Logic/RP Data, AMP Capital

What to watch over the next week?

We are now heading into a two week period that will see key central bank meetings in Europe (Thursday), Japan (Tuesday week) and the US (Wednesday week). The ECB (Thursday) is expected to respond to an intensification of deflation and bank risks in Europe by expanding its monthly quantitative easing program from €60bn to around €70bn possibly by including corporate debt. Another round of cheap bank financing (LTRO) is also possible, but doesn’t look necessary given that interbank lending rates remain low. The ECB may also consider another cutting its deposit rate by another 10 basis points (from -0.3% currently), but should think twice after the Bank of Japan’s bad experience.

In China, February economic data will be released but bear in mind that data around this time of year is often distorted by the Lunar New Year holidays. Trade data (Tuesday) is likely to show continued softness, inflation (Thursday) is likely to remain at 1.8% year on year with PPI deflation continuing to moderate slightly, credit flows are likely to slow from the huge surge seen in January and industrial production data may moderate a bit but retail sales pick up a bit (both due Saturday). Meanwhile, the fourth session of the National People’s Congress (March 5-10) may see more stimulus measures announced with a bigger budget deficit (it was 3.5% of GDP in 2015) and some details around supply side reforms.

In the US, a speech by Fed Vice Chair Fischer will be watched for any clues on interest rates.

In Australia, expect to see continued modest growth in ANZ job ads (Monday), a slight rise in business confidence according to the NAB business survey (Tuesday), consumer confidence (Wednesday) to reverse some of last month’s rise on the back of uncertainty about taxation and a slight fall back in housing finance (also Wednesday) after a solid gain in December.

Outlook for markets

Shares have seen a decent rebound from oversold levels which may have further to go. But with the Fed still thinking of raising rates this year and global growth worries remaining the ride is likely to remain volatile in the short term. Beyond the near term uncertainties, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate economic growth.

Very low bond yields point to a soft medium term return potential from sovereign bonds, but it’s hard to get too bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but growth is likely to pick up in Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with the RBA expected to cut the cash rate to 1.75%.

 

An ongoing delay in Fed tightening and stronger data in Australia pose further short term upside risks for the $A, which has already managed to push above $US0.74. However, any short term strength in the $A is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the RBA eventually resumes cutting the cash rate or at least resorts to jawboning and the Fed eventually resumes hiking, commodity prices remain weak and the $A undertakes it’s usual undershoot of fair value.

 

Friday saw Eurozone shares gain 0.6% and the US S&P 500 rise 0.3% as news of strong US jobs growth and slow wages growth added to confidence that the US economy is doing well but that the Fed can hold back in raising interest rates. The positive global lead saw ASX 200 futures gain 36 points or 0.7% pointing to a positive start to trade for the Australian share market on Monday.

 

 

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Will Australian property prices crash?

Monday, February 29, 2016

By Shane Oliver 

The bounce back in global shares continued over the last week led by the US share market which broke above its 50 day moving average and cut its year to date decline to -4.7% from -10.5%. For the week US shares rose 1.6%, Eurozone shares gained 1.8% and Japanese shares rose 1.4%. This was helped by a 10% gain in oil prices and metal prices also gained. However, Australian shares fell 1.5% and Chinese shares lost 3.3%. Bond yields rose marginally in the US on higher inflation data, but fell elsewhere. Higher than expected US inflation pushed the $US up slightly and this saw the $A fall back towards $US0.71.

Will there be a crash in Australian property prices? Foreign hedge funds and various commentators have been calling such an event for a decade or so now and have proved wide of the mark. Yes Australian home prices are likely to see yet another 5-10% cyclical fall at some point in the next few years and yes home prices are overvalued posing a downside risk, but a 50% crash is unlikely. The latest crash call aired on 60 Minutes has raised nothing that wasn’t already well known. Australian property is no more overvalued than it was a decade or so ago. The ratio of household debt to income is about the same as it was prior to the GFC, but interest costs have collapsed and there are no signs that Australians are having trouble servicing their debts.

Source: ABS, RBA, AMP Capital

Sure there has been some easing in lending standards – but I just don’t accept that Australian banks don’t regularly check for proof of income (mine does) in processing loan applications, particularly with APRA breathing down their necks on “bubble” worries. More fundamentally, Australia has not seen the growth in low doc and sub-prime loans that don’t even require people to lie about their lack of income which were central to the US housing crisis that triggered the GFC. To get a crash we will either need a massive rise in interest rates (which is unlikely because the RBA is not stupid) or a deep recession in the economy which seems unlikely. Seems to me that some people have just seen the Big Short and want to be film stars (or least are desperate to find the next big short). The trouble is that shorting Australian banks is becoming a rather crowded trade.

Major global economic events and implications

US economic news was a mixed bag. On the down side February data showed falls in consumer confidence and the Markit manufacturing and services conditions PMIs. These could all be in response to recent share market turbulence and bad weather or they could be indicative of a fundamental deterioration in the economy. On the upside though, durable goods orders rebounded in January, consumption spending was strong in January, consumer confidence appears to have improved in late February, existing home sales and home prices are solid and the trend in unemployment claims is continuing to reverse the rise seen into January. December quarter GDP growth was revised up to 1% annualised from 0.7%, but it was driven by inventories. Finally a stronger than expected gain in inflation as measured by the core private consumption deflator for January adds to evidence that deflationary pressure are receding in the US supporting the case for the Fed to raise interest rates. Given the mixed data though and ongoing global uncertainties it still makes sense for the Fed to back off on raising rates for now. The market is attaching a 12% probability to a March hike, but a 52% probability to a hike by December.

Eurozone PMIs and confidence readings also dipped in February adding to the case for the ECB to ramp up its stimulus next month, even though the level of the PMIs is still consistent with reasonable growth. Bank lending picked up in January but it’s too early to see the effect of recent market turmoil on bank lending.

Japan’s manufacturing conditions PMI also fell in February, and with core inflation falling to 0.7% year on year pressure remains on the Bank of Japan to provide more stimulus.

China’s stimulus efforts can be seen in a blow out in its budget deficit to a record -3.5% of GDP last year from -1.8% of GDP in 2014. Over the year to January public spending is up 24% year on year versus just 6% for revenues. Meanwhile, PBOC Governor Zhou has described China’s monetary policy as having an “easing bias” for the first time this cycle indicating that more monetary easing is more likely than not.

Australian economic events and implications

In Australia, wages growth slowed further in the December quarter and the business investment outlook remains weak, but it’s not all bad. Low wages growth partly reflects the loss of high paying mining jobs but the creation of lower (more normally) paid jobs in Sydney and Melbourne. It means that there is no inflation pressie from labour costs but has also allowed jobs growth to be higher than might otherwise have been the case. The message from business investment plans is that the unwind of the mining investment boom is continuing at the rate of about -35% pa. However, by the end of the next financial year this will have largely run its course with non-mining investment back to its pre boom level as a share of GDP, so the drag on GDP growth will abate.   

The Australian December half profits reporting season is now basically done. As always the quality of the results tailed off through the last week, but overall results were much better than feared. 47% of results have bettered expectations (against a norm of 44%) with only 21% coming in worse than expected (against a norm of 25%), 65% have seen profits up on a year ago and 63% have raised their dividends (against a norm of 62%). It’s tough out there for resources stocks but no more than expected. Meanwhile, most of the big banks are seeing reasonable results and stocks exposed to the Australian economy, led by housing and the consumer, are doing well. The better than feared nature of the results to date has been reflected in 65% of stocks seeing their share price outperform the market the day results were released. Overall profits are on track to fall around 5% this financial year but this is due to a 65% slump in resources profits. Outside of resources, profits are rising by around 5%.

Source: AMP Capital

Source: AMP Capital

Source: AMP Capital

What to watch over the next week?

In the US, various business surveys and jobs data will be watched for clues as to how the US economy is progressing. Expect the manufacturing ISM (Tuesday) and non-manufacturing ISM (Thursday) to show slight improvements and growth in payroll employment to pick up to around 195,000 after January’s softer result. Data for pending home sales (Monday), construction spending (Tuesday) and trade (Friday) will also be released along with the Fed’s Beige Book of anecdotal evidence.

Eurozone inflation data for February to be released Monday is expected to have remained low, with January unemployment data remaining around 10.4%.

In Japan, expect January industrial production (Monday) to rebound after a poor December, labour market data to remain solid and household spending (both Tuesday) to have remained weak.

In China, the fourth session of the National People’s Congress starting Saturday may see more stimulus measures announced with a bigger budget deficit (it was 3.5% of GDP in 2015), more infrastructure and social spending, new investment projects and some details around supply side reforms. Ahead of this the monthly round of business conditions PMIs starting Tuesday will be watched for signs of stabilisation with expectations for a slight rise but some private surveys pointing to weakness.

In Australia, the RBA is expected to leave interest rates on hold yet again. While it has an easing bias, there has not been enough bad news since the last meeting to cause it to act on it. Australian economic data has mostly been okay and financial markets have settled down a bit. However, I remain of the view that the combination of sub-par growth, low inflation and the threat of a rising $A as the Fed delays easing will prompt the RBA to ease again around May.

Meanwhile we will see the usual Australian data avalanche that accompanies the release of quarterly GDP data. Expect continued moderate credit growth (Monday) as owner occupiers replace investors in housing loans, building approvals (Tuesday) to fall 5% after a strong December, modest growth February home prices (also Tuesday), December quarter GDP growth (Wednesday) to have slowed back to 0.4% quarter on quarter or 2.5% year on year after the strong trade driven contribution seen in the September quarter, a continued large trade deficit (Thursday) and 0.3% growth in January retail sales (Friday).

Outlook for markets

Shares have seen a decent rebound from oversold levels which may have further to go. But with global growth worries remaining it’s still premature to say we have bottomed. Beyond the near term uncertainties, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate economic growth.

Very low bond yields point to a soft medium term return potential from sovereign bonds, but it’s hard to get bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but growth is likely to pick up in Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5% and the RBA expected to cut the cash rate to 1.75%.

An ongoing delay in Fed tightening poses short term upside risks for the $A. However, any short term strength in the $A is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the RBA eventually resumes cutting the cash rate, commodity prices remain weak and the $A undertakes its usual undershoot of fair value. We continue to expect a fall to around $US0.60 by year end.

Eurozone shares rose 1.6% on Friday, but the US S&P 500 gave up a modest 0.6% gain initially to end down 0.2% with strong readings on growth helping confidence but a higher than expected reading on inflation reigniting speculation around Fed tightening. However, the basically flat lead from US shares saw ASX 200 futures gain 7 points or 0.1% pointing to a basically flat start for the Australian share market on Monday. There was more action in the Australian dollar though which fell 1.5% to $US0.7130 in response to the stronger US economic data.

 

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Weekly market and economic update

The critical role of asset allocation for investors

The Australian economy – looking beyond the gloom

Investment markets and key developments over the past week

The US reinvents itself, again!

Investment markets and key developments over the past week

Chinese debt worries and growth

Why investors need to be wary of crowds

The threat from emerging markets – how serious?

The risk of a correction or new bear market in shares

Australia’s inflation rate surprised on the upside again

2014 - a list of lists

The Fed tapers - what it means for investors

Review of 2013, outlook for 2014

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