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The Experts

Shane Oliver
Financial markets
+ About Shane Oliver

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

Is there a Democrat in the House?

Monday, September 17, 2018

The US trade threat has progressively increased all year, but every so often it takes a bit of a step back and that’s what occurred over the last week, with news that US/China trade talks may resume at the invitation of Treasury Secretary Mnuchin. Share markets reacted favourably, as they have to previous news of trade talks, but I wouldn’t get too excited. Talks are better than no talks, the latest round of talks, if they proceed, looks like they could be at a more senior level than the last round and it’s in the interests of both China and Trump to find a solution. In particular, Trump’s approval rating is under some pressure again, indications are firming that the Democrats will retake the House in the mid-term elections, business groups are reportedly mounting public campaigns against the tariffs and its now hard for the US to increase tariffs without causing higher prices for consumers, which in turn risks a backlash. So it would be wrong to write new talks off. However, given the failure of the last four attempted US/China trade negotiations to make much progress, and in particular Mnuchin’s last attempt back in May, it’s doubtful that much progress will be achieved this time. It may all just be a negotiating tactic on the part of the US to make it look like it’s reasonable and help build a coalition of allies against China. And in any case, Trump has reportedly issued instructions to proceed with the proposed next round of tariffs on $US200bn of imports from China despite the offer of talks. This could be more negotiating tactics, but who knows? All up, it does seem that both sides remain dug in and our base case remains that more tariffs will be applied (albeit the $US200bn may be implemented in tranches) and that a negotiated solution is unlikely until after the mid-term elections.

Notwithstanding the better trade news over the last week, we remain cautious of a short-term share market correction as we go through this seasonally weak part of the year and given risks around the emerging world, trade and tariffs, Trump and the Mueller inquiry and US political risks, Chinese growth and tech stocks.

In terms of US political risks, there is the threat of another government shutdown from October 1 when current government funding runs out again (yep, that issue is back again!) and the mid-term elections in November will create nervousness because if the Democrats get control of the House (as appears likely) investors will worry about an impeachment of President Trump and that it will put an end to major pro-market economic policies. On the last two: yes, the Democrats will probably try and impeach Trump but as with Clinton it’s unlikely that the 67 Senate votes will be found to remove him from office unless he has done something really bad and in any case Mike Pence will have the same economic policies but with just less noise; and Trump has already done the bulk of his pro-business policies (like tax cuts) anyway. None of this will stop markets worrying about it initially though.

The US remains in “Goldilocks” mode (not too hot, not too cold), with strong economic data and benign inflation. The past week has seen another run of strong data, with US small business optimism rising to its highest level ever recorded in August, job openings and hiring remaining very strong, the rate of workers quitting for other jobs rising to a 17-year high and jobless claims remaining ultra low. While retail sales rose less than expected in August, this was partly due to lower price rises and, in any case, previous months were revised up, so overall they remain very strong. Of course, the danger is that things can be so good that they are bad because the only way to go is back down – but at least inflation pressures (as a trigger for a more aggressive and growth threatening Fed) are not excessive, with producer and consumer price inflation actually dipping a bit in August. That said, with the US economy running hot and fiscal stimulus continuing, it seems there are more Fed officials saying the Fed Funds rate may have gone above its estimates of the long run neutral rate (between 2.5-3%) over the next year or so. Barring a blow up e.g. around trade or emerging markets, this looks highly likely but will take a while to play out at the ongoing rate of one Fed rate hike every three months.

Damage from Hurricane Florence is very unlikely to dissuade the Fed from its next hike later this month. While the human and property impact from such events is horrible, associated rebuilding activity will, if anything, boost overall economic growth in the short term. Hurricane Katrina in 2005 had no impact on Fed rate hikes that were coming every six weeks at the time.

Meanwhile, in the land down under…

Australian data was a mixed bag with strong jobs data and business conditions but falling confidence. 

Jobs, jobs, jobs…

Jobs data has been a source of strength in the Australian economy. The good news here is that full-time jobs growth has also been solid, this has helped reduce underemployment and strong jobs growth is an ongoing source of strength for household incomes. Against this though, the combination of unemployment and underemployment remains very high at 13.4% and points to the pick-up in wages growth being very gradual. 

What about interest rates?

Meanwhile, although the NAB business survey for August showed continued strength in business conditions, business confidence slipped further and September consumer confidence fell sharply, with political turbulence in Canberra and falling home prices in the case of consumer confidence not helping. Against this mixed backdrop, we remain of the view that an RBA rate hike is still a long way off.

Source: NAB, Westpac/MI, AMP Capital

Is the property market heading downhill?

ABS data due Tuesday is likely to confirm the slide in home prices already reported in private surveys for the June quarter with a decline of around 1%. The minutes from the RBA’s last board meeting (also Tuesday) is likely to reiterate that it expects that the next move will more likely be up than down but for now, there is no urgency to move. March quarter population data (Thursday) is likely to show continuing strong population growth.

National capital city residential property prices are expected to slow further, with Sydney and Melbourne property prices likely to fall another 10% or so, but Perth and Darwin property prices bottoming out, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.

And the share market?

We continue to see the trend in shares remaining up as global growth remains solid, helping drive good earnings growth and monetary policy remains easy. However, we are now into a seasonally weak period of the year for share markets and threats around trade and emerging market contagion at a time of ongoing Fed rate hikes, the Mueller inquiry in the US, the US mid-term elections and Italian budget negotiations point to a potential correction ahead. Property price weakness and approaching election uncertainty add to the risks in relation to the Australian share market.

Low yields are likely to drive low returns from bonds. Australian bonds are likely to outperform global bonds helped by the relatively dovish RBA.

Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.

Where’s the Aussie dollar heading?

The $A is likely to fall to around $US0.70 and maybe into the high $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Solid bulk commodity prices should provide a floor for the $A though in the high $US0.60s. Being short the $A remains a good hedge against things going wrong in the global economy e.g. around trade and emerging markets.

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Are we on the down side of the roller coaster ride?

Monday, September 10, 2018

The past week saw share markets fall on the back of worries around emerging markets, trade wars and the potential regulation of US social media stocks. After being resilient to global threats over the last few months, Australian shares also got hit and fell 3.1% to their lowest since June. 

While the iron ore price rose, oil and metal prices fell. 

The $A fell a bit further, despite the $US falling slightly.

This time of year is well known for financial market volatility and this year looks like it will be no different, with risks around the emerging world, global trade and tariffs, Trump and US politics, Chinese growth and tech stocks.

How bad is the EM crisis?

The emerging market crisis is continuing to ramp up, with emerging market shares in local currency terms down 14% from their January high and emerging market currencies down 16% since their February high, as investors fear other blow ups beyond Turkey and Argentina in emerging countries with current account deficits. 

Emerging market shares are cheap trading on a forward PE of around 11 times and are a good buy on a long-term view. Their decline so far is mild by the standard of past emerging market crises (e.g. they fell 27% in 2015-16) and they could easily fall further, as long as the US dollar remains in an uptrend (threatening debt servicing problems in the emerging world), Chinese growth continues to slow and the trade threat continues to ramp up. So far, the impact on advanced countries – via banks, etc. – has been minimal but as we saw in 1997-98, the deeper the EM crisis goes the bigger the risks.

Will there be a solution?

The US trade conflict still looks like escalating, with no breakthrough so far in US/Canadian negotiations increasing the risk that NAFTA will be terminated and more significantly the US moves towards implementing the next round of tariffs on China - up to 25% on $US200bn imports from China. If fully implemented, it will mean that around half of imports from China will be affected - albeit it’s only 10% of total US imports – so we’re still a long way from 1930. But it could still knock up to 0.5% off Chinese growth and maybe 0.1-0.2% off US growth. Some sort of negotiated solution is still likely but not until after the US mid-term elections.

How strong is global growth?

Our base case is that global growth will remain strong and that this along with rising profits and still easy monetary policy will keep the broad trend in share markets up, but these issues suggest a significant risk of a short-term correction in developed country share markets. So far, the US share market and until recently the Australian share market have shown little concern, but the Australian share market has started to come under pressure. And as we saw in the global growth scare of 2015-16, while the US share market remained resilient for a while in the face of falls in other global share markets, eventually it too came under pressure. Overall it remains a time for a relatively cautious investment strategy for investors with a short-term investment horizon. 

What's happening to rates here?

Back in Australia, the ANZ and CBA, as widely expected, followed Westpac in raising their standard variable mortgage rates all by an average 0.15% to recoup higher money market funding costs. This is a bit more than I would have thought, as the rise in funding costs on average looks to be around 0.09%. It’s a defacto monetary tightening equal to say a 0.25% RBA hike 15 years ago given the higher debt load. It will add to the weight on home prices and is another reason why the RBA won’t be raising rates any time soon.

How’s our growth going?

The Australian economy grew strongly over the year to the June quarter, but it’s likely to slow from here. June quarter GDP growth of 0.9% quarter on quarter or 3.4% year on year (as previous quarters were revised up) was much stronger than expected. Going forward, though declining building approvals point to slowing housing investment, falling home prices will weigh on consumer spending at a time when the household saving ratio is just 1% at a 10-year low, business investment growth is likely to be modest not helped by political uncertainty and there is also a risk that drought and US trade wars will weigh on growth. So while we don’t see a slump in growth we expect it to slow back to around a 2.5-3% pace this financial year. Other data released over the last week was consistent with this with retail sales stalling in July, ANZ job ads losing some momentum, housing finance continuing to trend down and the trade surplus falling back a bit. Business conditions PMIs generally remained solid though.

Down, down, house prices are down

According to CoreLogic, capital city prices fell another 0.4% and are down 2.9% from a year ago. Our assessment remains that prices in Sydney and Melbourne will fall another 10% as tighter bank lending standards, rising supply, falling capital growth expectations and fears of changes to negative gearing and the capital gains tax discount impact.

So while economic growth perked up last financial year, the RBA is expected to remain on hold as growth moderates again, wages growth and inflation remain low and given various threats to growth from falling home prices, drought and global trade threats. We remain of the view that the RBA will be on hold out late 2020 at least and still can’t rule out a rate cut.

And share markets?

We continue to see share markets being higher by year end, as global growth remains solid helping drive good earnings growth and monetary policy remains easy. However, we are now into a seasonally weak period of the year for share markets and rising threats around trade and emerging market contagion at a time of ongoing Fed rate hikes, the Mueller inquiry in the US, the US mid-term elections and Italian budget negotiations point to a potential correction ahead. Property price weakness and election uncertainty add to the risks in relation to the Australian share market.

Will house prices drop more?

National capital city residential property prices are expected to slow further, with Sydney and Melbourne property prices likely to fall another 10% or so, but Perth and Darwin property prices bottoming out, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains. 

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.

What about the Aussie?

We continue to see the $A trending down to around $US0.70 as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory, as the US economy booms relative to Australia. Solid bulk commodity prices should provide a floor for the $A though in the high $US0.60s. Being short the $A remains a good hedge against things going wrong in the global economy – e.g. around trade and emerging markets.

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Rates on the rise

Thursday, September 06, 2018

Australian mortgage rates are on the rise, with Westpac and some smaller banks moving and other big banks likely to follow. This was no real surprise, given the rise in money market borrowing rates this year, which has seen the gap between bank bill rates and the RBA’s cash rate blow out well beyond normal levels. While bank bill rates have fallen back a bit in the last month or so, the gap remains over 20 basis points higher than it has averaged over the last decade or so. Since banks get around 35% of their funding from this or related sources, it cuts into their margins, unless they pass it on in the form of higher lending rates.

Small banks had already moved and now it looks like the big banks are starting to follow – having delayed moving in the hope that the money market will settle down, which it hasn’t (and probably won’t, given slowing growth in bank deposits, meaning more competition for money market funds). While the rise in mortgage rates on average is small at around 15 basis points, it’s still another dampener on consumer spending and homebuyer demand, particularly given many borrowers will fear that more rate hikes will follow. It will hit the homebuyer market particularly in Sydney and Melbourne at a time when it’s already down. As such, it’s a de-facto monetary tightening and is yet another reason for the RBA to remain on hold for longer.

Source: Bloomberg, AMP Capital

The Reserve Bank is expected to yet again leave rates on hold when it meets tomorrow, which will bring it to a record 25 months in a row with no change. If growth and inflation picks up as the RBA expects, then a rate hike is likely at some point down the track but with downside risks around consumer spending, the housing cycle turning down in terms of construction and prices in Sydney and Melbourne and wages growth and inflation likely to remain lower for longer, we don’t see a rate hike until 2020 at the earliest and still can’t rule out the next move being a cut, particularly as falling home prices impact. A speech by RBA Governor Lowe (also tomorrow) is unlikely to signal any changes in the RBA’s views on monetary policy.

On the housing data front, expect CoreLogic to show another slight fall in home prices for August and housing finance data (Friday) to show continuing softness in lending to investors.

National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 10% or so, but Perth and Darwin property prices bottoming out, and Adelaide, Canberra and Brisbane seeing moderate gains.

What’s happening in the US?

While the past week saw pending home sales fall continuing the run of softer housing conditions, home prices continue to rise, consumer confidence is at a new 18-year high, personal spending is rising strongly with strong income growth keeping the savings rate high, jobless claims remain ultra-low and the goods trade deficit widened in July as imports picked up. Meanwhile core inflation rose back to the Fed’s 2% inflation target. All of which is consistent with ongoing but gradual Fed rate hikes.

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Where in the bloody hell are we?

Thursday, August 30, 2018

The past week saw global share markets rise, as Turkey slipped out of the headlines, with US shares rising 0.9% to finally surpass their January high, Eurozone shares and Japanese shares up 1.5% and Chinese shares rising 3%. However, Australian shares fell 1.4% on the back of political uncertainty. The US dollar slipped as safe haven demand slowed, and this saw the $A rise slightly despite initially falling on the back of political turmoil.

Six PMs just like the Italians!

All the last four elected PMs have now been deposed by their own party and this is the sixth PM this decade, so we have now caught up to Italy. The turmoil is not great for Australia and has also seen investment markets start to get nervous about the coming Federal election. Of course, it’s dangerous to overstate the impact of the periodic bouts of leadership instability in Canberra seen this decade on the economy. It seems that as the “Lucky Country”, the economy still manages to muddle along, despite the mess in Canberra. I doubt that the latest leadership turmoil will change things that much. However, Australia should be able to do much better and the lack of durable leadership along with the problems in the Senate are making it harder to undertake serious productivity enhancing economic reforms and contributing to policy uncertainty, most notably around energy policy, which has led to world beating electricity prices.

Here are 4 implications from the latest change:

1. ScoMo win is reasonably good.

Firstly, he didn’t bring on the challenge so can’t be blamed for the instability. More importantly, he’s seen as a reasonably sensible policy maker, is respected by investment markets in his role as Treasurer and is seen as a centrist, giving the Liberals perhaps a better chance of victory in the coming Federal election. This probably explains why the share market and the $A had a bounce on the news that he will be the new PM.

2. Scope for tax cuts

While he will probably continue with the Government’s existing budgetary strategy, the abandonment of the policy to cut the tax rate for large companies along with the budget coming in a better than expected does provide scope for earlier and bigger tax cuts for low to middle income earners which could help economic growth.

3. More turmoil ahead?

The latest leadership turmoil and Scott Morrison’s relatively low margin of victory (of 45 to 40) still poses the risk that there may still be more turmoil ahead, all of which could weigh on consumer and business confidence just as it did under the last Labor Government.  The LNP victory in September 2013 provided a confidence boost as Australians looked forward to relative stability after the leadership turmoil of the Rudd/Gillard/Rudd years, but with instability clearly continuing confidence risks being eroded again. Business confidence is most at risk given the abandonment of the policy to cut the large company tax rate.

Source: Westpac/MI, NAB, AMP Capital

4. Timing of next election?

Finally, the leadership turmoil and Labor’s lead in opinion polls has focussed attention on the next Federal election and the likelihood of a change in Government. This has weighed on the share market and the Australian dollar over the last week. To keep Senate and House of Representative elections in alignment, the election needs to be no later than May but if the new PM sees a bounce in poll support, it could come before the end of the year. Labor’s main policies are increased public spending in areas such as health and education, lower taxes for low to middle earners but higher taxes for high income earners, halving the capital gains tax discount and restricting negative gearing for residential property going forward to new properties and it would possibly adopt a tougher regulatory stance in relation to the banks, energy supply and industrial relations. The tax cuts would provide a boost to consumer spending but the risk is that business confidence may dip, which could hit business investment and the housing market could take a hit from the negative gearing and capital gains tax changes at a time when it is already down. The latter (particularly if combined with cuts to immigration) risks resulting in a sharper top to bottom fall in home prices than we are assuming (a 15% decline for Sydney and Melbourne and 5% nationwide), which would be negative for banks and consumer spending.

As evident over the last week, political instability and more specifically uncertainty around a change of government is likely to weigh on bank, consumer and energy shares and possibly also the Australian dollar, as it risks adding to the forces already keeping interest rates down.

Reporting season nearly over

Source: AMP Capital

Source: AMP Capital

What to watch this week

The Australian June half earnings reporting season will wrap up, with 24 major companies accounting for around 5% of market capitalisation reporting including Spark Infrastructure (Monday), Caltex, Boral and Blackmores (Tuesday), Bellamy’s (Wednesday), Perpetual and Ramsay Health (Thursday) and Harvey Norman (Friday).

What’s ahead for markets?

While we see share markets being higher by year end as global growth remains solid, helping drive good earnings growth and monetary policy remains easy, we are likely to see ongoing bouts of volatility and weakness, as the US driven trade skirmish with China could get worse before it gets better and as worries remain around the Fed, President Trump in the run up to the US mid-term elections, China, emerging markets and property prices and election uncertainty in Australia. The August to October period is well known for share market falls and volatility.

We continue to see the $A trending down to around $US0.70 as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Solid bulk commodity prices should provide a floor for the $A though in the high $US0.60s. 

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Always on my mind

Monday, August 20, 2018


The past week started downbeat on worries about Turkey but ended a bit more upbeat on news of new US/China trade talks. This saw US shares gain 0.6% for the week and Australian shares rise 1% to a new 10 year high, but Eurozone shares lost 1.5%, Japanese shares fell 0.1% and Chinese shares lost 5.2%. Bond yields were little changed although they are back above 3% in Italy as Italian budget negotiations come into focus. Commodity prices fell further, but the $US fell back a bit and this helped the $A make it back above $US0.73 after falling to near $US0.72 earlier in the week.

All shook up

Turkey got into this mess largely thanks to populist “growth at any cost policies” and its leader’s populist rejection of higher interest rates and an international bailout (for now) and refusal to make up with the US is helping perpetuate it. Financial assistance from Qatar will help but is unlikely to be enough. While Eurozone bank exposures to Turkey aren’t big enough to cause a major problem (they are mostly small relative to balance sheets and are likely to have been hedged) and global trade exposure to Turkey isn’t big enough either to cause a major problem and most other emerging markets are in far better shape both economically and politically, financial contagion remains a risk for emerging markets – with Brazil and South Africa most at risk. After a 14% fall, emerging market shares are now quite cheap (with an average forward PE of 11 times), but they are likely to remain under pressure until contagion fears from vulnerable EMs (notably Turkey at present) stop, the $US stops rising, uncertainty regarding Chinese growth fades and the trade war threat ends.

Suspicious minds

With China sending a delegation to the US at the end of this month for renewed trade talks at the invitation of the US, with talk of a Trump-Xi Jinping summit in November. Investors would be wise to be skeptical as to whether anything can be achieved quickly enough to head off US tariffs on another $US200bn of imports from China next month given that the May agreement was quickly trashed by Trump, that these negotiations are occurring at a low level officially and that both sides have dug in. Then again as we saw with Europe you never know, and most commentators seem to be skeptical of any break through and its in both sides interest to find a negotiated solution.

When it rains it really pours

We are now coming into the seasonally weak August-October period for shares and there are a lot of uncertainties around (Turkey/emerging markets, trade war threats, the Italian budget negotiations, ongoing Fed rate hikes, the Mueller inquiry and the US mid-term elections) all of which have the potential to trigger volatility and weakness in the next few months. This will likely impact both global and Australian shares.

It’s now or never

Should RBA lower inflation target from 2-3% to 1-2%? Short answer: NO! This debate comes up regularly and back in 2007-08 when inflation was around 4% some were arguing that the target should be raised. But lowering the target would be a bad move: it would give the impression that the RBA is not committed to its inflation target and just changes the goal posts when it’s not meeting it; a lower target would provide little buffer to slipping into deflation; it would mean less flexibility to take real interest rates negative when needed in a recession; and the consumer price index overstates inflation by around 2% or so given the problems in measuring quality change so running 1-2% inflation would imply actual deflation much of the time. If the argument is that by cutting the target the RBA can then declare victory on inflation and raise rates, then it’s a nonsense because by raising rates prematurely it would knock the economy and result in even lower inflation. If anything other countries should really be raising their inflation targets to 2-3% rather than the RBA cutting its target.

Elvis has left the building

August 17 marks the 41st anniversary of the day I and others in this time zone learned Elvis had apparently left the building. Back 50 years ago in 1968, Elvis had been working on what has become known as his Comeback Special. After years making lightweight movies (which I actually like, especially Live a Little Love a Little and Change of Habit which came in 1969) Elvis was feeling nervous. The Colonel wanted to end the special, which aired on NBC on 3 December 1968 with Christmas carols. But Elvis wanted something more relevant to the times so they came up with If I Can Dream - perhaps the most powerful social commentary song Elvis ever produced. It was recorded in June 1968 just two months after Martin Luther King’s assignation in Memphis and the song references King’s words. The Elvis in white suit delivery that wrapped the Special is well-known but it was also sung by Elvis in a black leather jumpsuit.

US mail

Retail sales rose strongly in July, industrial production was weaker than expected but June was strong, jobless claims remain ultra-low, the US leading economic indicator continues to rise strongly, small business optimism is very strong but while manufacturing conditions in the New York region strengthened in August they fell in the Philadelphia region. Housings starts rose less than expected in July, but home builder conditions remain strong.

Can’t help falling

For the June quarter Eurozone GDP growth was revised up to 0.4% quarter on quarter (or 2.2% year on year) but remains down from last year’s pace.

Shake, rattle and roll

Credit, retail sales and investment all slowed slightly in July and industrial production growth was unexpectedly flat. While the slowdown is not dramatic it suggests that the cut back in shadow lending and uncertainty around trade is weighing and supports the case for further policy stimulus.

What’s happening here in Oz?

Yet again Australian data was a mixed bag over the last week, with strong jobs data but continuing weak wages growth and somewhat softer readings on business conditions and consumer confidence. While employment fell in July, this was after a strong June, which itself was revised up and full-time jobs growth remained strong in July. Unemployment fell but this reflected a fall in participation. While annual employment growth is off its highs jobs leading indicators continue to point to solid jobs growth ahead. However, wages growth remained soft in the June quarter at 2.1% year on year and were it not for a faster increase in minimum wages it would still be stuck at just 1.9%. While strong employment is good news, it’s not enough to move the RBA from being on hold given ongoing high levels of underemployment, weak wages growth, falling house prices, etc. We remain of the view that the RBA will be on hold out to 2020 and there is still a significant chance that the next move will be a cut rather than a hike. RBA Governor Lowe’s Parliamentary Testimony did nothing to change our view on this.

Reporting season here

The June half Australian earnings reporting season is now around 35% done and so far so good. 48% of results have surprised on the upside compared to a norm of 44%, the breadth of profit increases is high with 83% reporting higher profits than a year ago compared to a norm of 66%, 89% have increased their dividends or held them constant and 64% of companies have seen their share price outperform the market on the day results were released. That said its often the case that the quality of results tails off in the last two weeks of the reporting season so don’t get too excited just yet. 2017-18 earnings growth are on track to come in around 9%, with resources earnings up 25% thanks to solid commodity prices and rising volumes and the rest of the market seeing profit growth of around 5%.

5 things to watch this week

1. In the US, expect the minutes from the Fed’s latest meeting (Wednesday) to confirm that it remains on track for another rate hike next month. The Kansas Fed’s Jackson Hole central bankers’ symposium (Thursday-Saturday) will also be watched for any clues on monetary policy, with Fed Chair Powell confirmed as a speaker (Friday). On the data front expect a modest rise in existing home sales (Wednesday), a continued increase in home prices and August business conditions PMIs (both Thursday) to remain solid at around 55-56 and July durable goods orders (Friday) to show a continuing rise. On the trade front a 25% tariff on $US16bn of imports from China is due to commence on Thursday – any delay ahead of new talks with China would be a positive sign.

2. Eurozone business conditions PMIs (Thursday) will be watched for any improvement from their recent levels around 54-55.

3. Japanese data is expected to show a slight improvement in inflation, excluding fresh food and energy to around 0.4% year-on-year, but it won’t be enough to move the Bank of Japan away from its ultra-easy monetary policy.

4. In Australia, the minutes from the RBA’s last board meeting (tomorrow) are likely to show the Bank remaining comfortably on hold. RBA Governor Lowe will also deliver a speech tomorrow. June quarter construction data is expected to show another modest rise and skilled vacancy data (both due Wednesday) will also be released.

5. The Australian June half earnings reporting season will see its busiest week, with 70 major companies reporting including Woolworths, Fortescue and Primary Health Care (today), Amcor, Oil Search and BHP (tomorrow), Seven Group, Worley Parsons and Coca-Cola Amatil (Wednesday), Qantas, South32 and Nine (Thursday) and MYOB (Friday). Dividend growth is likely to remain solid.

7 more things to keep an eye on

1. While we see share markets being higher by year end, as global growth remains solid helping drive good earnings growth and monetary policy remains easy, we are likely to see ongoing bouts of volatility and weakness as the US driven trade skirmish with China could get worse before it gets better and as worries remain around the Fed, President Trump in the run up to the US mid-term elections, China, emerging markets and property prices in Australia. The August to October period is well known for share market falls and volatility.

2. Low yields are likely to drive low returns from bonds. Australian bonds are likely to outperform global bonds helped by the relatively dovish RBA.

3. Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.

4. National capital city residential property prices are expected to slow further as Sydney and Melbourne property prices continue to fall, but Perth and Darwin bottom out, and Adelaide, Canberra and Brisbane see moderate gains.

5. Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.

6. We continue to see the $A trending down to around $US0.70 as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Solid commodity prices should provide a floor for the $A though in the high $US0.60s. The fall in the $A on the back of Turkish contagion fears highlights that being short the $A and long foreign exchange is a good hedge against threats to the global outlook.

7. Eurozone shares fell 0.2% on Friday, but the US S&P 500 gained 0.3%. The positive US lead saw ASX 200 futures rise 28 points or 0.4% pointing to a positive start to trade for the Australian share market on Monday.


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Turkey currency crisis triggers contagion fears

Monday, August 13, 2018

The past week was relatively quiet until Friday when the deepening crisis in Turkey triggered worries about contagion to European banks and emerging markets. This hit share markets resulting in Eurozone shares falling 1.3% for the week, US shares losing 0.3% and Japanese shares losing 1%. However, Chinese shares bounced 2.7% higher over the week and Australian shares gained 0.7%. Safe haven buying saw bond yields fall (except in Italy).

While the iron ore price rose, oil, gold and copper prices fell not helped by another rise in the US Dollar. The surge in the US Dollar saw the Australian Dollar fall to around $US0.73, its lowest since January last year.

The latest worries about contagion from Turkey as its currency plunged as much as 17% on Friday are likely overdone, but emerging market stress will remain for a while yet. Yes, there will be some impact on Eurozone banks that are exposed to Turkish debt (which will keep the ECB cautious), but it’s unlikely to be economically significant.

More fundamentally, Turkey is not indicative of the bulk of emerging countries. Its currency has crashed 42% this year because of current account and budget deficit blowouts, surging inflation, political interference in its central bank, economic mismanagement generally and political tensions with US following the imprisonment of an American pastor followed by US sanctions on Turkey including tariff hikes.

While Brazil, Argentina and South Africa also have particular problems, the rest of the emerging world is in far better shape. That said, emerging markets will remain vulnerable until the $US stops rising (given the impact a rising $US has on foreign debt servicing costs), the global trade threat ends and uncertainty regarding Chinese growth fades. And rising inflation pressures in the US – with core CPI inflation in July at its highest since the GFC - highlight that the upwards pressure on the $US will remain as the Fed is unlikely to stop its process of gradual rate hikes soon.

Friday’s breakdown in the Australian dollar out of its recent narrow trading range around $US0.74, is consistent with our long-held view that the $A is on its way down to around $US0.70. Friday’s fall in the Australian dollar also reminds that being short $A/long $US (or Yen) is a good hedge against threats to the global growth and share market outlook.

The drip feed of increasing tariff pressure on China continued over the last week with the US announcing that it will commence a 25% tariff on another $16bn of imports on August 23rd. This is no surprise though as it’s just the remainder of the initial $50bn they said they would do but only did $US34bn in July. So was China’s announcement of same sized retaliation.

So far there is still no sign of a return to negotiation and the likelihood is that it won’t happen until after the US mid-terms. Domestically there has been some criticism of President Xi Jinping’s handling of the trade issue with the US but his position is not threatened and there is little sign of him changing direction. The big one to watch will be next month when the US has threatened a 10% or 25% tariff on $US200bn of imports.

China’s proposed retaliation of an average 13% tariff on $US60bn of imports from the US is way less than proportional, begging the question of whether its backing down a bit or preparing to move into retaliation via other means as it runs out of imports to retaliate on – this could take the form of tougher taxation or regulation of US companies or maybe allowing the market to push the Renminbi even lower (although the PBOC has said it will not actively devalue the currency), which would then beg the question as to how the US might respond, e.g. more tariffs or maybe even intervention to soften the $US, i.e. “currency wars.” I don’t expect the US to intervene in the $US, but with Trump not interested in basic economics (or showing any awareness that his own policies have pushed the $US up) it’s a risk worth watching. The trade threat clearly has a long way to go yet.

Drought is increasingly becoming a significant threat to Australian growth. Flying to beautiful Townsville and back this past week I was struck by how parched much of the east coast of Australia looks thanks to drought. There has not been a lot of talk about its economic impact so far.

Most Sydneysiders don’t worry about drought until water restrictions are imposed, but because heavy rainfall earlier last year pushed Sydney’s catchment dams to 97% full, so far there has been no need for water restrictions. But total Sydney dams have now fallen to near 66% full and the national reality is that the drought is becoming a bigger threat. In fact, farm production has already fallen for each of the last four quarters.

Of course, agricultural production as a share of GDP aint what it used to be at just 2.5%. But a 25% slump in agricultural production as seen through past major droughts will knock 0.6 percentage points off economic growth. Unfortunately, summer weather forecasts don’t hold out a lot of hope for a quick end to the drought and it would be made a lot worse if another El Niño phenomenon arrived (with the Southern Oscillation index recently falling back from a mild La Nina to neutral). Of course, beyond a short-term boost to meat supply as farmers cut their herds, the drought will also provide a boost to headline inflation via higher food prices, but the RBA, will look through this given the dampening impact on underlying inflation from weak farm sector spending power.

Source: ABS, Bureau of Meteorology, AMP Capital

For fans of The Brady Bunch, the past week or so was an exciting one with NSYNC bass singer Lance Bass announcing he had won the bid for the family home, but then getting gazumped by Discovery Inc’s HGTV who want to use the house for a reality TV show. That said I thought The Brady Bunch was reality – it certainly inspired me to buy at various points a big Chrysler station wagon, and equal sized Pontiac convertible and later on a Brady Bunch style house. It also made it virtually impossible for me to go to sleep on an angry heart. The sale does highlight the magic of compound interest over many years, generating capital growth of at least 8% since the owners purchased it in 1973, and if it had been rented out with a net rental yield of 3.5% a total return of around 11.7% pa.

Major global economic events and implications

US labour market data remains strong with ultra-low jobless claims and ongoing very high readings for job openings, hiring and workers quitting for new jobs. Producer price inflation came in slightly weaker than expected in July but core producer inflation of 2.7% year-on-year implies ongoing upward pressure on consumer inflation and inflation as measured by the core CPI rose to 2.4% yoy in July, its highest since the GFC. All of which is consistent with continued gradual Fed rate hikes. Meanwhile, the June quarter profit reporting season is wrapping up on a strong note with earnings up around 27% on a year ago. With 90% of S&P 500 companies having reported, 83% have beaten on earnings by an average beat of 5.5% and 71% have beaten on sales.

Japan saw some good news on wages, with nominal wages growth lifting to 3.6% year-on-year in June, which is its highest in years. The very tight labour market with sub 3% unemployment may at last be leading to higher wages growth. That said, a sample change early this year may be a contributor, so the Bank of Japan will treat this cautiously. GDP growth also bounced back in the June quarter, albeit low at 1.1% yoy. Not so positive though were household spending, economic confidence and machinery orders. The overall impression is that Japan continues to grow but at a relatively constrained rate – which is not so bad given its falling population.

Despite the trade war threat, Chinese exports and imports came in stronger than expected in July. However, imports may have been boosted by a cut to Chinese tariffs. Meanwhile inflation readings were benign in July, indicating that inflation provides no constraint to further policy stimulus in China.

Australian economic events and implications

In Australia, the RBA provided no surprises in leaving rates on hold for a record two years, and given the cross currents in the economy, there is a good chance they could be on hold for another two years. The RBA’s largely unchanged forecasts in their Statement on Monetary Policy portraying a “favourable outlook” (in the words of Governor Lowe) of growth around 3.25% and a gradual rise in inflation along with strong infrastructure investment, rising business investment and strong export volumes are consistent with the next move in rates being a hike.

However the peak in the housing construction cycle, uncertainty about the outlook for consumer spending, the weakening Sydney and Melbourne property markets, the worsening drought, the risks that low inflation and wages growth will continue for longer and tight bank lending standards all indicate that the next move in rates could well be a cut.

So the stand-off continues, and the RBA will remain on hold for a while to come.

On balance, we agree with the RBA that the next move in rates will probably be a hike, but we are a bit less upbeat on growth, wages and inflation than the RBA, so any rate hike is unlikely to come until 2020 at the earliest and there is a rising risk that the next move will actually be down. Maybe the Reserve Bank of NZ is showing the way in noting that “The direction of our next [interest rate] move could be up or down”!

Meanwhile, housing finance commitments continued to soften in June, mainly driven by a  decline in finance going to investors which looks to reflect both supply as banks continue to tighten lending standards and demand as investors expectations for capital growth slide in response to falling prices, suggesting that a negative feedback loop between falling prices and falling investor demand may be developing.

The flow of June half profit results picked up a notch over the last week with okay but uninspiring results. So far 47% of results have surprised on the upside but 33% have surprised on the downside both of which are higher than average, 67% of results have seen profits up on a year ago which is around average, 71% of companies have increased their dividends from a year ago but a higher than normal 21% have cut them. That said, less than 15% of companies have reported so it’s too early to conclude much.



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Economic update: Another Goldilocks US jobs report

Monday, August 06, 2018

Investment markets and key developments over the past week

  • US shares rose 0.8% over the last week helped by strong earnings results, a bounce back in tech stocks and another “Goldilocks” jobs report. However, Eurozone shares fell 1.1%, Japanese shares lost 0.8%, Chinese shares fell 5.9% and Australian shares lost 1% as trade war fears continue to escalate. Despite this bond yields were flat to up. Iron ore prices rose but oil and metal prices fell. The $US continued to push higher but the $A was little changed.
  • The drip feed of escalating tariff threats from Trump and counter threats from China continues, with the US threatening that the proposed tariffs on $US200bn of Chinese imports will be 25%, not 10%, and China announcing a list of $US60bn of US imports to be subject to tariffs should the US proceed. With a 25% tariff on another $US16bn of Chinese imports likely to commence soon Trump is clearly ramping up the pressure on China but China is digging in. A tariff of this magnitude will start to have a significant economic impact on China’s growth (potentially knocking up to 0.5% off growth) and probably also on the US as well. While there has been talk that the US and China may be trying to restart trade talks, China does not appear to be interested given the gun to its head and the May experience. It may prefer to wait till after the US mid-term elections thinking that the longer this goes on the greater the chance of a backlash against Trump and that Trump will be weakened if the Republicans lose control of the House of Representatives. In the mean-time its stepping up measures to support growth. Trump really believes China’s trade practices are unfair, but he’s also tapping a vein of anti-trade/anti-Chinese sentiment amongst his supporters and may also be motivated by a Quixotic desire to slow the ascendancy of China as an economic power. Whatever the motivation its looking likely a solution will not be reached until after the US mid-terms and that trade fears will continue to cause volatility in markets.
  • Meanwhile Trump is offering to meet Iran’s leadership and has asked US Attorney General Sessions to stop the Mueller inquiry. The former may be a good thing (but it’s doubtful as Iran is not North Korea and its leadership would regard a meeting as a media stunt) and the latter would be a Nixon like disaster (but won’t happen because Sessions can’t do it as he recused himself from the inquiry and Trump would have to fire Deputy AG Rod Rosenstein and keep firing Justice Dept officials until he finds someone who is willing to fire Mueller). Meanwhile, Trump’s desire to end the Mueller inquiry does highlight that it may be a real threat to his presidency.
  • Ultra-easy monetary policy locked in for longer by the Bank of Japan, but with more flexibility. Despite all the anticipation the BoJ left monetary policy little changed with the overnight deposit rate remaining -0.1%, the 10-year bond target at zero. While it injected more flexibility into its bond yield target by allowing an effective range of +/-0.2%, up from +/-0.1%, new forward guidance effectively locks the BoJ into ultra-easy monetary policy into 2020. Overall this is positive for Japanese shares, but not so for the Yen. While Japanese 10-year bond yields may drift up to test the 0.2% level, Japan is unlikely to be a source of significant upwards pressure on global bond yields.
  • In Australia, average home prices are continuing to fall led by the once booming cities of Sydney and Melbourne – with more to go. Our assessment remains that with tighter lending standards, poor affordability, rising supply and falling capital gains expectations Sydney and Melbourne property prices will have a top to bottom fall of around 15% spread out to 2020 which given falls already seen implies further downside of 10 to 12%. We are not there yet, but FOMO (fear of missing out) risks becoming FONGO (fear of not getting out) for some investors.  Other cities are in much better shape and most are likely to see moderate growth such that the top to bottom fall in national average home prices will be more like 5%. With falling home prices set to drive a negative wealth effect it’s hard to see the RBA raising rates anytime soon and if anything there is a significant chance that the next move will be a rate cut.

Major global economic events and implications

  • US Economic data remains strong. Personal income and spending remained robust in June and consumer confidence is high. The ISM business conditions indexes fell slightly in July but remain high. Home prices are continuing to rise. And July saw another “Goldilocks” jobs report with strong payroll growth including upwards revisions to prior months, falling unemployment and yet still soft wages growth of 2.7% year on year. Consistent with this the Fed remains upbeat describing growth as “strong” (up from “solid”) and seeing inflation near target and so it remains on track to continue with gradual rate hikes, with the next move next month.

Source: Bloomberg, AMP Capital

  • US June quarter earnings reports remain very strong. Of the 80% of S&P 500 companies to have reported so far, 85% have beaten on earnings by an average beat of 5.3% and 73% have beaten on sales. Earnings are up around 26% year on year.
  • Eurozone growth slowed further in the June quarter to 2.1% year on year, but at least core inflation rose to 1.1% in July. However, with core inflation still way below target and growth slowing we still can’t see the ECB raising rates until 2020.
  • While the Bank of England raised rates another 0.25%, they have still only made it to 0.75% (i.e. half the RBA’s 1.5%) and with Brexit uncertainty this maybe it for a while.
  • Japanese economic data is mixed supporting the continuation of ultra-easy monetary policy. While unemployment rose slightly in June, the jobs to applicants ratio rose to its highest since January 1974 helped by a falling labour force. Industrial production fell more than expected, but the manufacturing PMI for July points to a rebound.
  • Chinese business conditions PMI’s softened in July with manufacturing export orders quite weak suggesting some impact from the trade skirmish. That said the PMIs are still mostly in the range of the last year or so and are consistent with a softening in growth as opposed to a collapse. Our forecast for GDP growth this year remains for a slowdown to 6.5%. Meanwhile, the July Politburo meeting reinforced expectations for more policy stimulus mainly from fiscal policy. The meeting statement included 15 references to “stable”, “stability” or “stabilising” compared to an average of 6 such references in the previous 10 Politburo meetings, highlighting the greater focus on supporting growth in the face of the trade threat.
  • Meanwhile, policy is going the other way in India with the Reserve Bank of India raising its repo rate by 0.25% for the second meeting in a row to 6.5%. It makes sense when inflation is above the 4% target and GDP growth is around 7.4%

Australian economic events and implications

  • Australian economic data was mixed. Retail sales volumes were very strong in the June quarter indicating consumer spending will help June quarter GDP growth, but the quarterly bounce looks distorted by food, retail price inflation is non-existent and with weak wages growth, high underemployment and falling home prices retail sales are likely to soften again this quarter. Meanwhile, building approvals rebounded in June but after several weak months leaving a weak trend, the value of residential alterations & additions and non-residential approvals trending down, private credit growth continuing to slow with investor credit contracting, July manufacturing PMIs falling albeit remaining consistent with growth and home prices falling for the ninth in month in a row in July. While the June trade surplus doubled expectations most of the surprise in relation to exports looks to be price related and so it looks like net exports will contribute to June quarter GDP growth but only modestly.


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Economic update: US growth rebounds

Monday, July 30, 2018

Investment markets and key developments over the past week

  • Share markets pushed higher over the last week helped by good US earnings news and a US/European trade “agreement.” Despite disappointing results from Facebook and Twitter hitting tech stocks, US shares rose 0.6%, Eurozone shares rose 1.7%, Japanese shares rose 0.1%, Australian shares rose 0.2% and Chinese shares gained 0.8% helped by stimulus talk. Speculation the Bank of Japan may review its easy monetary policy (which I suspect is overdone) along with the “risk on” tone generally also helped push up bond yields. While oil prices fell, metal and iron ore prices rose but a slight rise in the $US and slightly softer inflation data saw the $A fall. 
  • At last some good news on trade with the US and the European Union agreeing to work towards resolving their differences on trade and hopefully head off a trade war between them. At this stage it’s only a deal to start negotiating, the negotiations will have a long way to go and don’t forget that China and the US had a “trade war on hold” deal back in May that got trashed a week later. So it’s too early to break out the champagne. However, it shows that Trump is not anti-trade per se and does actually want zero trade barriers, it’s a big move in the right direction and it will probably be easier for the US and the EU to work through their differences as they start with similar average effective tariff rates and US gripes with Europe don’t run so deep. Having started down this path there is a reasonably good chance of success leading to the removal of the auto tariff threat and the reversal of the steel, aluminium tariffs. No US/EU trade war would significantly reduce the trade threat to global growth. After “wins” in relation to North Korea and Europe, Trump will no doubt see vindication of his “maximum pressure” negotiating stance – which will embolden him to continue with his tough trade stance on China.
  • Speaking of which, there is still no sign of negotiations with China on trade and China’s non-approval of US chipmaker Qualcomm’s bid for its rival NXP (well at least so far) may signal that China is digging in further. To counter the trade threat, China’s shift to policy stimulus is continuing with a shift to “more proactive” fiscal policy with a focus on tax cuts, and infrastructure investment. Don’t expect a mega stimulus like seen in the past (there is no need) but combined with monetary stimulus the authorities are clearly determined to support growth. This is a positive for Chinese shares after their 24% fall and a forward PE of just 10.7 times.
  • Middle East tensions hotting up again – upside risk to petrol prices. President Trump’s tweet threatening Iran that it “will suffer consequences the likes of which few throughout history have ever seen before” if it threatens the US again highlights that tensions between the US and Iran are hotting up again. Attacks on Saudi tankers by Yemeni militia are arguably reflective of this. Of course, it’s worth recalling that Trump also threatened North Korea with “fire and fury” and that much of this is bluster aimed at applying “maximum pressure” to get what he wants. It may be a bit harder with Iran though, so the risk of tensions in with Iran – eg threats to close the Strait of Hormuz – at a time of constrained global oil supply pose upside risks to oil prices. This will be good for energy stocks, but not so good for Australian motorists given the risk of another up leg in petrol prices beyond their recent high averaging around $1.53.
  • Another round of US tax reform on the way, but don’t get too excited. The US House of Reps looks like having a vote on more tax reform, the main item of which will likely be to make permanent the personal tax cuts beyond their 2025 expiry. It has little chance of passing into law before the mid-terms but is an election sweetener for the Republicans.
  • If you want to see an example of the downside of momentum investing which can get amplified in passive funds, just look at Facebook. While tech stocks are nowhere near the bubble they were in 2000 (their PE is around 27x versus around 100x at the tech boom peak) they have been huge beneficiaries of the easy money environment of recent years meaning a passive investor will have seen a steady increase in exposure to them which is all good when momentum is your friend but when it turns it can turn quickly as Facebook did falling more than 20% in a flash on Thursday.

Major global economic events and implications

  • US economic data remains solid. After the usual soft March quarter GDP growth rebounded to 4.1% annualised in the June quarter driven by consumer spending, investment and trade. Home sales fell in June, but home prices are continuing to rise, the July Markit PMI remains strong, capex orders are rising and jobless claims are ultra-low.
  • Despite disappointing revenue results at Facebook, US June quarter earnings reports remain very strong. Of the 263 S&P 500 results so far 88% have beaten on earnings with an average beat of 5.1% and 73% have beaten on sales. Earnings look to be up around 26% year on year.
  • As expected the ECB made no changes in monetary policy and anticipates keeping rates unchanged at least until September 2019. We don’t see an ECB rate hike until 2020. Meanwhile, Eurozone business conditions gave up some of their June bounce, but they remain strong.
  • In contrast to the US and Europe, Japan’s manufacturing conditions PMI in July fell to its lowest since November 2016. It's still consistent with modest growth but suggests a greater sensitivity to trade fears than in the US and Europe.

Australian economic events and implications

  • Australian inflation remains subdued, no early rate hike in sight. June quarter inflation data confirmed yet again that price growth is only running around the low end of the RBA’s 2-3% target band. Core (ex food and energy) inflation is just 1.6%. And were it not for more rapid price rises for government administered or affected items like tobacco, health, utilities and education along with petrol, inflation would be running closer to 1%. There are no signs of any significant near term rise in underlying inflation pressures, particularly with subdued wages growth, competition and technological innovation remaining intense and producer price inflation running at just 1.5%. The risk is that the longer inflation stays at or below the low end of the target range the harder it will be to get it up as low inflation expectations are becoming entrenched. As such, we remain of the view that the RBA won’t raise interest rates until 2020 at the earliest and the next move being a rate cut cannot be ruled out.
  • Meanwhile falling skilled job vacancies add to signs from other jobs leading indicators that employment growth may slow a bit.



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Economic update: Cutting through Trump white noise

Monday, July 23, 2018

Investment markets and key developments over the past week

  • The past week saw a battle between Trump noise (on trade, the Fed, the $US, etc) but good economic & earnings news that saw share markets little changed. US shares ended flat, Eurozone shares rose 0.1%, Japanese shares rose 0.4%, Chinese shares were flat and Australian shares gained 0.3%. Bond yields rose in the US and Europe, commodity prices mostly fell and the $US fell after Trump complained about its strength which left the $A little changed. 
  • Trump’s comments critical of Fed rate hikes naturally raise concerns about political interference at the Fed, which could threaten its ability to control inflation. In the short term, it’s hard to see much impact. Trump is well known to be a high debt/low interest rate guy so it’s no surprise he is not happy. But the Fed answers to Congress, has a mandate to keep inflation down and will do what it sees best – which with strong growth and at target inflation means returning interest rates to more normal levels. Longer term there is a risk though that Trump and populism will weaken the institution of an independent central bank targeting low inflation and this would be a big concern. 
  • Trade war risks are continuing to increase, with Trump repeating his threat to put tariffs on all Chinese imports, a lack of progress towards the resumption of US-China trade talks, Trump considering tariffs on uranium imports (which could impact Australia – but only marginally as uranium is less than 0.2% of our total exports and we would probably get an exemption anyway) and Trump’s treatment of his NATO allies not auguring well for quick progress on the trade dispute with Europe. While Trump’s tweet complaining about Europe, China and others helping drive a rising US dollar lack economic logic - if “making America great again” means stronger US growth relative to other countries then it also means higher US interest rates and a higher $US! - it nevertheless adds to the tension. Our assessment remains that the trade dispute with China will likely get worse before it gets better. However, reports that Germany and various European car makers favour lowering EU auto tariffs are a positive sign and a trade meeting in the week ahead where proposals around doing this may be discussed between Trump and EC President Junker holds the hope of some progress. 
  • Trump’s attitude towards the Mueller inquiry evident in his meeting with Putin continues to remind of Nixon in relation to Watergate. That said we still see Trump’s removal from office as unlikely and economic conditions are far stronger today than in 1974.
  • China continuing to ease and the Renminbi sliding. While Chinese growth slowed only slightly in the June quarter the policy easing of recent months has continued with official calls to increase lending and signs of PBOC support via its medium-term lending facility. This is likely aimed at offsetting weak shadow banking credit growth and the trade threat. Of course, a tightening Fed and an easing PBOC helps drive a rising $US relative to the Renminbi and that is what we are seeing with the $US up around 8% against the Renminbi since early this year just as its up by 7.5% against a range of other currencies. As such the fall in the Renminbi is mostly a strong $US story rather than a weak Renminbi story, but the Chinese authorities are likely happy for now in seeing the Renminbi fall given the tariff threat to Chinese growth, so it likely has more downside. The falling Renminbi in turn risks maintaining downwards pressure on emerging market currencies keeping alive fears of emerging market debt servicing problems and maintaining downwards pressure on emerging market shares.

  • If the stability of the IMF’s global economic forecasts is any guide the process of economists upgrading their expectations and likewise share analysts revising up their profit forecasts that helped propel markets last year looks to have come to an end, with the IMF (and everyone else) now highlighting the obvious downside risks of a trade war and rising US inflation. That said, global growth at 3.9% is still strong and should underpin solid earnings growth even if it’s off its peak.

Source: IMF, AMP Capital

Major global economic events and implications

US economic data remains strong with good gains in retail sales, industrial production and leading indicators, the lowest level of jobless claims since when The Brady Bunch started in 1969 and solid regional business conditions surveys and home builder conditions. Fed Chair Powell’s latest comments remained upbeat consistent with continuing gradual (every three months) rate hikes “for now”.

US June quarter earnings reports are off to a strong start with 94% of results so far beating on earnings and 78% beating on sales and earnings growth expectations being revised up from 21% for the year to the June quarter to now 23%. That said its early days yet with less than 20% of results out.

Japanese inflation ex fresh food and energy surprisingly fell to just 0.2% yoy in June. While media reports suggest that the Bank of Japan may review its zero 10-year bond yield target given concerns about side effects it’s hard to see a change just yet given very weak core inflation and the trade threat.  

Chinese economic growth slowed fractionally in the June quarter to 6.7% year on year from 6.8% and June monthly data was mixed with industrial production and investment slowing but retail sales and house price growth picking up and unemployment unchanged at 4.8%. We anticipate a further slowing in Chinese growth to around 6.5% this year.

Australian economic events and implications

Australian jobs data was a mixed bag with robust employment growth, but this is only keeping up with new entrants to the labour market thanks to strong population growth and gains in participation keeping unemployment at 5.4%. Strong jobs growth helps household income but it’s being offset by softness in wages which with still high unemployment and underemployment is unlikely to change any time soon.

While the return of the line about the next move in rates more likely being up in the minutes from the RBA’s last meeting caused some excitement, I wouldn’t read much into it. Its broader comments remain neutral with “no strong case for any near-term adjustment” in rates. Meanwhile, the RBA is still not too fussed by higher money market funding costs but noted "it was uncertain how persistent these pressures would be". If they do persist then it’s a defacto monetary tightening and would mean a lower than otherwise cash rate outlook. Since the end of the financial year the Australian bank bill spread to the cash rate has fallen but at 50 basis points it remains high relative to its long-term average of around 25 basis points meaning ongoing pressure on the big banks to modestly raise some of their mortgage rates.

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Economic update: Trade skirmish escalating

Monday, July 09, 2018

Investment markets and key developments over the past week

•   Trade war fears continued to impact investment markets over the last week, but it turned out to be a classic case of “sell on the rumour, buy on the fact” as markets bounced just before and after the initial US/China tariffs went into effect on Friday. These tariffs have been talked about since March and so were largely factored into markets and now investors appear to be hoping for a resolution. However, despite a late rally, Chinese shares still fell 4.2% over the week and Japanese shares lost 2.3%. But US shares rose 1.5% and Eurozone shares gained 1.3%, with good US jobs data also helping.  Australian shares also rose 1.3%, helped by a rebound in Telstra. Bond yields generally fell, excepting in Italy. Iron ore and metal prices fell, as did the oil price due to a rise in oil stockpiles and President Trump’s pressure on Saudi Arabia to get prices down (he is clearly focussed on the mid-term elections and sees Saudi Arabia owing him a favour given the return of US sanctions on Iran). The US dollar fell back a bit, and this saw the $A push back above $US0.74. 

•   Trade skirmish escalating, and it will likely get worse before it gets better, but still expect a negotiated solution before it gets too bad.  The 25% tariff on $US34bn of imports from China and Chinese same sized retaliation on US goods have started up. Of course, this along with the tariffs on steel and aluminium still only amounts to tariffs on less than 3% of total US imports that have actually started up – which is a long way from the 20% Smoot Hawley tariff on all imports in the 1930s. That said, it’s not over yet, with much more still threatened - including US tariffs on another $US16bn of imports from China proposed to be implemented soon and two additional $US200bn tranches on Chinese goods, and Trump even threatening to put a tariff of more than all of Chinese imports if China keeps retaliating along with a 20% tariff on auto imports from the EU.

•   However, much of this still looks like a negotiating stance – otherwise all the tariffs would already have started up by now. And Trump knows that the costs to US workers (from soybean farmers to Harley Davidson workers) and consumers will escalate as more and more tariffs are imposed and this could become a problem for him if it’s not resolved by the mid-term elections. There are also some signs that Europe (or at least Merkel) may be open to negotiating by cutting current EU tariffs on auto imports. So our base case remains that some form of negotiated solution will be reached, but things are likely to get worse before they get better. So far, the Australian share market has proved quite resilient in the face of trade war fears – partly because Australia is not directly affected, but it will become vulnerable should trade wars pose a threat to global growth as that would reduce demand for our exports.

•   Bitcoin bubble bath. Remember the obsession with bitcoin and the other cryptos late last year? Whatever happened to it? Well as with many such manias, the Bitcoin price peaked last December at $US19,500 just when everyone including my dog was asking about it and lots jumped on board (my dog tried but I cut off her financing!). Since then its seen a 70% plunge almost rivalling the tech wreck and providing another classic reminder to be wary of the crowd. Sure, blockchain technology has a bright future, but how its priced into Bitcoin and other crypto currencies was always a separate issue.


Source: Bloomberg, AMP Capital

•   I have tended to ignore the ongoing Brexit related negotiations because it’s a bit of a soap opera and it doesn’t have much impact on global markets. It’s really just a UK issue. PM May and the UK Government looks to have finally arrived at a plan for a soft Brexit - proposing a free market with the EU in goods, but not in services (which means for example that UK financial services will lose access to the EU) and people. However, so far the UK has just been arguing with itself and it’s not clear the EU will support breaking up its “four freedoms” – in terms of the free movement of goods, capital, services and people. So there is a long way to go yet and the Irish border issue also remains a big one. It’s too early to say the British pound is out of the woods.

   For a really cool mix of Elvis doing Burning Love with the Royal Philharmonic Orchestra check here. 1970's Elvis was the best.

Major global economic events and implications

•   US economic data remains strong with the June ISM manufacturing and non-manufacturing indexes surprisingly rising to very strong levels, construction spending continuing to rise and another “Goldilocks” jobs report. June jobs data saw payroll employment rise a stronger than expected 213,000 and upwards revisions to previous months, but a rise in unemployment to 4% as participation rose and wages growth remaining stuck at 2.7% year on year supports the notion that there is still spare capacity in the labour market and that the so-called NAIRU (or sustainable unemployment rate) is below the Fed’s estimate of 4.5%. All of which keeps the Fed on track to hike rates every three months but there is no pressure to get more aggressive. Meanwhile, the minutes from the Fed’s last meeting indicate it is clearly keeping a close eye on the threat to global growth from a trade war but at this stage it still sees it as a risk rather than its base case and unlike in 2016 when it delayed rate hikes in the face of global uncertainties, the strength of the US economy today means that the hurdle to slow monetary tightening is much higher now.

•   German factory orders rose solidly in May after four months of falls providing some confidence that the slowdown in Eurozone growth may be bottoming out.

   The Japanese June quarter Tankan survey showed continuing strong business conditions and solid capital spending plans but expectations for inflation remain well below the Bank of Japan’s 2% inflation target. Meanwhile household spending remains weak but wages growth spiked higher (although its done this a few times without being sustained).

   Like China’s official PMIs for June, the Caixin manufacturing PMI fell slightly but the services PMI rose very strongly resulting in a solid gain overall. It’s hard to see much of the feared slowdown here, although manufacturing export orders have fallen possibly on trade concerns.

   Meanwhile India’s manufacturing and services PMIs rose strongly in June pointing to a possible acceleration in growth.

Australian economic events and implications

•   Australian data was the usual mixed bag with stronger than expected May retail sales and continuing robust business conditions PMI readings, but home prices continuing to slide in June, building approvals falling again in May, a weak reading for ANZ job ads and the trade surplus coming in smaller than expected with the April surplus getting revised down. There are a few points to note here. First, both the fall in building approvals and the rise in retail sales look to have been exaggerated by volatile components. Second, trade looks to be on track for a flat growth contribution this quarter after the March quarter boost but fortunately the consumer looks likely to have perked up in the current quarter which will help keep the economy growing albeit not as strongly as the RBA is expecting. Finally, we continue to see more downside in home prices, particularly in Sydney and Melbourne where we expect 15% or so top to bottom falls spread out to 2020 with a nationwide decline of around 5%.

   Meanwhile, the RBA provided no surprises in leaving interest rates on hold for the 23rd month in a row which given the various cross currents affecting the economy - stronger investment, infrastructure and export volumes but weakness in housing, the consumer, inflation and wages and banks tightening lending standards - is where they are likely to remain for a long while yet. We see no RBA rate hike before 2020 and still can’t rule out the next move being a cut.



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