Switzer Sites & Services ▲
Why we started Switzer Daily

The Experts

Shaneoliver_normal
Shane Oliver
Financial markets
+ About Shane Oliver

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

Why a Brexit is a bad idea

Monday, May 30, 2016

By Shane Oliver

Share markets had a good week helped by a combination of improved confidence regarding US growth, increasing signs that the global oil market is rebalancing (helping the oil price and energy shares) and Greece and its creditors agreeing on a new debt deal. Combined, this saw most share markets rally for the week and gains in oil and metal prices. However, bond yields fell and the Aussie dollar was little changed as was the $US generally.

The message from the US Fed remains that a rate hike is getting closer, but July still looks more likely than June. Fed regional presidents continue to wax lyrical on rate hikes (which makes me wonder whether Fed transparency is really a cacophony) but it’s worth reiterating that many of them don’t vote and they tend to be more hawkish that key Fed decision makers. In terms of the latter comments by Fed Governor Jerome Powell (who always gets to vote) - they suggest a lack of urgency given the Brexit vote and the low risk of waiting, suggesting that July is more likely for a hike than June.

Why are markets so far more relaxed about a Fed rate hike? Several reasons;

  1. More confidence in US/Chinese and global growth;
  2. Fed caution and delays have provided confidence it is not going to be reckless;
  3. The global oil market is rebalancing, helping stabilise the oil price and reducing the risks for oil producers, and;
  4. Less concern about a collapse in the Renminbi. Of course, this could all change if the $US takes off big time again, but so far so good.

While the oil market may be rebalancing (with supply cutbacks in the US and outages in Canada, Nigeria and Libya) this is not the case for iron ore, where the price is on its way back down as the global steel glut remains. After spiking to $US70/tonne early this year, it’s now back below $US50.  

Is the Brexit risk receding?

Polls appear to be edging in favour of a Remain outcome from the June 23 referendum as opposed to Leave.

In my view, the case to Leave is dubious because it would be a big negative for the UK financial sector and would either harm UK free trade with the EU (if no trade deal is agreed after a Leave vote) or lead to reduced national sovereignty if a trade deal is cut (because the UK would have to agree to EU rules, but have no say in setting them).

Perhaps this logic is starting to set in.

The end of the migration crisis in Europe (sea arrivals have collapsed to 12,000 in April from 220,000 last October) may also help the Remain case.

No Grexit scare this summer. I know it didn't get much coverage (why bother to report good news, it doesn't sell), but Greece, the EU and the IMF agreed a new debt which will see €10bn disbursed. This is good news because it means there won't be another Grexit scare this summer. Bond yields in Spain and Italy also fell in response.

Major global economic events and implications

US data again provided mixed messages over the last week. On the one hand, business conditions PMIs slipped in May and core durable goods orders were weak in April. But against this home prices continue to rise, new and pending home sales surged, the advance goods trade balance for April was better than expected and jobless claims fell again. The overall impression remains that US growth has bounced back in the current quarter with the Atlanta Fed’s GDPNow GDP tracker now running at 2.9%, but growth is averaging out around 2% or slightly less so the trend is still not overly strong. But a long way from the recession obsession of earlier this year.

The news out of Europe was okay. Sure manufacturing and services PMIs fell in May but only fractionally and they continue to point to moderate economic growth. Meanwhile, consumer confidence and the German IFO index picked up.

Japanese data was soft with a further fall in the May manufacturing conditions PMI to a weak 47.6 and a higher trade surplus due to weaker imports. GDP may be falling again. Meanwhile, national core inflation remained low at just 0.7% year-on-year in April, with Tokyo data pointing to a further fall in May. Expect more fiscal and monetary stimulus in the next month or so.

Australian economic events and implications

In Australia, the business investment slump continues with March quarter construction and capital expenditure data (or capex) falling more than expected. Mining investment remains the main driver. What's more business plans point to ongoing mainly mining driven weakness over the year ahead. The ABS' capex intentions surveys are continuing to fall compared to estimates made a year ago (see the next chart) and point to a roughly 20% decline in capex in the next financial year driven by a further 35% slump in mining investment. So capex remains an ongoing detractor from growth. 

Source: ABS, AMP Capital

However, there are some positives: dwelling construction rose again in the March quarter; the slump in mining investment over the year ahead will take it back to around its long-term norm as a share of GDP so it's growth detraction will fade (see the next chart); and the outlook for non-mining investment is starting to look a bit less bleak with non-mining capex plans edging up from year ago levels. That said the economy will still need help from lower interest rates and a lower Aussie dollar to help offset the growth gap over the year ahead from falling mining investment.

Source: ABS, AMP Capital

RBA Governor Stevens didn't really add anything new on the interest rate outlook but provided a solid defence of its inflation targeting approach describing it as "easily the best monetary policy framework we have ever had", and indicating he "does not agree" with proposals to adjust the target. I agree.

What to watch over the next week?

In the US, the May manufacturing conditions ISM (Wednesday) and jobs data (Friday) will be watched as a guide as to how the US economy performed in May, and both will take on greater than normal significance ahead of the Fed’s June 14-15 meeting. The manufacturing ISM index is expected to fall slightly to around 50.5, payroll employment is expected to rise by an okay 170,000, unemployment is expected to fall back to around 4.9% and average wage earnings growth may edge up slightly from 2.5% year-on-year. Meanwhile, expect stronger personal spending for April but core private consumption inflation remaining around 1.6% year-on-year, continued gains in home prices and an improvement in consumer confidence (all due Tuesday) and a solid reading for the non-manufacturing ISM (Friday).

In the Eurozone, the ECB (Thursday) is unlikely to announce any changes to its monetary stimulus program given the big extra stimulus it provided earlier this year. Expect confidence readings for May (Monday) to hold around levels consistent with moderate growth, core inflation for May to have remained low at around 0.7% year-on-year and unemployment (both Tuesday) to have edged down to 10.1%.

In Japan, expect jobs data to remain solid but household spending and industrial production to remain soft (Tuesday). 

Chinese manufacturing conditions PMIs for May (Wednesday) are expected to slip slightly from April levels. So the message out of China is likely to remain one of continued growth around the 6.5 to 7% level. No bust, but not growth acceleration either.  

In Australia, the key focus will be on March quarter GDP (Wednesday) which is expected to show growth of 0.7% quarter-on-quarter and annual growth slowing back to around trend of 2.7% year-on-year helped along by consumer spending, housing investment and net exports but constrained by falling capex. Meanwhile, expect falls in April data for new home sales (Monday) and building approvals (Tuesday) after solid gains in March, continued moderate credit growth (also Tuesday) and a 0.2% gain in April retail sales (Thursday). Data for home prices, the trade deficit and PMIs will also be released.

Outlook for markets

Expect short term share market volatility to remain high, with significant event risk in the next month or so (Fed meeting, Brexit vote, Spanish election, Australian election) and the fear of “sell in May and go away, come back on St Leger’s Day”. However, beyond near term volatility, we still see shares trending higher this year helped by a combination of relatively attractive valuations, ultra easy global monetary conditions 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 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 for yield by investors. 

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 offer poor returns. 

After its recent fall from $US0.78 the Aussie dollar is technically oversold and due for a bounce. However, any bounce is likely to be limited and the longer term downtrend looks to be resuming as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed resumes hiking, commodity prices remain in a secular downswing and the Aussie dollar sees its usual undershoot of fair value.

| More

 

Will Janet Yellen pull the trigger on interest rates?

Monday, May 23, 2016

By Shane Oliver

Financial markets saw a bout of renewed worries about Fed rate hikes in the past week but shares managed to shrug it off and end higher. Over the week, US and European shares rose 0.3%, Japanese shares rose 2% helped by a fall in the Yen, Chinese shares inched up 0.1% and Australian shares rose 0.4% led by health and energy shares. In fact, for the year to date the Australian share market at +1% is outperforming US, European, Japanese and Chinese shares. Bond yields generally rose as investors moved to factor in a higher probability of a Fed hike next month and this also saw the $US push higher again. While the stronger $US weighed on the $A and metal prices, the oil price managed to gain 3%.

After five months of a lot of noise but inaction, the Fed is clearly edging towards another rate hike, with the June meeting “live” for a hike and a move in the summer looking likely. The minutes from the Fed’s last meeting were far more hawkish than the statement released immediately after the meeting, the key comment being that most Fed meeting participants felt that a hike at the Fed’s June 14-15 meeting would likely be appropriate if incoming data was supportive. In recent weeks, it’s arguable that data has been supportive of a hike, with signs that June quarter GDP growth is picking up and continued labour market strength and inflation edging towards the 2% target. So quite clearly, the June meeting will see serious consideration given to a hike and this has seen the US money market’s probability of a June hike move up to 28% from close to zero only a week or so ago.

My view is that while a June Fed hike is now a close call, a July or September move is more likely because: the Brexit vote will take place just one week after the June meeting and several Fed officials have indicated that the Fed will consider that; Fed voting members appear to be more cautious than the full range of Fed meeting participants who include non-voting regional presidents who tend to be more hawkish; and the Fed will likely need more time to assess recent data releases which have only just started to improve again. So at this stage, our base case is for a July move.

More broadly we remain of the view that Fed hikes will be very gradual with constrained global growth and the risk that the $US will start to surge higher again creating renewed weakness in commodity prices, Renminbi deprecation, pressure on emerging countries and a brake on US growth all acting to constrain by how much and how quickly the Fed can hike.

Ho hum PEFO. The Australian Pre-election Economic and Fiscal Outlook was a bit boring in that it was based on the same underlying assumptions that were in the Budget because the economic and fiscal outlook “has not materially changed” since the Budget on May 3. So as a result the budget deficit projections are identical as those in the Budget. Fair enough, but a couple of risks seem to have heightened since the Budget. First, wages growth has slowed to a new record low of 2.1% and is now running well below the assumed 2.5% wages growth for the year ahead. Related to this the Budget/PEFO inflation assumptions are now above those of the RBA. Second, the iron ore price has fallen 13% since the Budget making the Budget/PEFO iron ore price assumption of $US55/tonne look a little less secure. So the risk with the PEFO projections as with the Budget is that the assumed 6% pa plus revenue growth will not be achieved and so the return of the Budget to surplus will be pushed out even further. Unfortunately, the whole PEFO process lost significant credibility around the 2013 Federal election with the new Coalition Government revising up the budget deficit projections over the four year forward estimates compared to the 2013 PEFO by a total of $68bn just four months after PEFO was released.

What’s happened to autumn? In Sydney its been more like summer lately which reminds me we are still in the grip of a serious El Nino weather phenomenon. An El Nino sees trade winds that normally blow across the Pacific to the west (La Nina) weaken or reverse causing more rain in the east Pacific and less rain/drought in the west Pacific. The Southern Oscillation Index, which measures sea surface pressures across the Pacific and is one indicator of it, remains deep in El Nino territory, pointing to lower farm production and higher food prices, but so far there hasn’t been much sign of this. As we have seen in the past the link between El Nino and farm production varies, but it’s still worth keeping an eye on.

Source: ABS, AMP Capital

Major global economic events and implications

US data was a bit messy with softer readings for regional manufacturing conditions surveys, a bounce in industrial production in April but after two months of falls, home builder conditions and housing starts basically trending sideways, but a fall back in jobless claims and stronger leading economic indicators and existing home sales. The overall impression is that GDP growth is bouncing back, albeit modestly, after the March quarter’s slow down to 0.5% annualised growth. The Atlanta Fed’s GDPNow growth tracker is currently estimating 2.5% annualised growth for this quarter. CPI inflation bounced in April due to higher oil prices, but core inflation dipped slightly to 2.1% yoy.

Japanese GDP rose more than expected in the March quarter as did machine orders but growth has been bouncing between positive and negative quarters against a zero growth trend for the last year now and the Kumamoto earthquake may be a bit of a dampener in the current quarter.

China saw the housing market continue to hot up in April, particularly in Tier 1 cities. Meanwhile, the People’s Bank of China moved to try and damp down concern about the sharp slowing in credit seen in April indicating that the drop was temporary and that it will continue to support growth. Clearly it doesn’t want sentiment to swing back to the negative on China again. Our base case remains that Chinese growth will come in around or a bit above 6.5% this year. No boom but no bust either.

Australian economic events and implications

In Australia, while the minutes from the RBA’s last Board meeting were interpreted as suggesting that the RBA would not be rushing to cut rates again as it awaits “further information”, March data showing a new record low in wages growth suggests that another rate cut as early as June or July is possible. While labour market data for April was pretty much as expected, increasing signs of softness after last year’s strength – declining hours worked, falling full time jobs and mixed indicators from forward looking labour market indicators - also support the case for further monetary easing. So we remain of the view that the RBA will cut rates two more times this year taking the cash rate down to 1.25%. Our base case for the next move is August but it could come earlier. 

What to watch over the next week?

In the US, the focus will be a speech by Fed Chair Janet Yellen (Friday) for any guidance regarding the prospects for a rate hike at the Fed’s June 14-15 meeting. While the latest Fed minutes indicated that the June meeting is “live” for a possible hike, Yellen is likely to be a bit more cautious. On the data front expect: the manufacturing conditions PMI (Monday) to remain around an index reading of 51; a bounce in new home sales (Tuesday); continuing gains in home prices (Wednesday); modest growth in durable goods orders and a slight rise in pending home sales (both Thursday); and an upwards revision to March quarter GDP growth to 0.8% annualised from the initially reported 0.5%.

In the Eurozone, May business conditions PMIs (Monday) are likely to remain around levels associated with continued moderate economic growth.

In Japan an improvement in the manufacturing conditions PMI (Tuesday) will be looked for and CPI data (Friday) is likely to show deepening deflation at a headline level and very low inflation on a core basis.

In Australia, March quarter construction data (Wednesday) and capex data (Thursday) are likely to show continued softness in business investment led by mining. Capex intentions for 2016-17 will hopefully show signs of improvement in non-mining investment though, consistent with reasonable business conditions of late. A speech by RBA Governor Steven’s (Tuesday) will also be watched for any clues regarding the interest rate outlook.

Outlook for markets

Expect short term share market volatility to remain high. Fed worries are coming back into focus and this could mean more uncertainty around the $US, Renminbi and commodity prices and the old saying “sell in May and go away, come back on St Leger’s Day” always adds to nervousness around this time of year. 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 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 for yield by investors.

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 – and are getting even poorer!

After its recent fall from $US0.78 the $A is technically oversold and due for a bounce. However, any bounce is likely to be limited and the longer term downtrend looks to be resuming as the interest rate differential in favour of Australia narrows as the RBA continues 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. 

| More

 

Two more rate cuts on the cards

Monday, May 16, 2016

By Shane Oliver

Share markets had a mixed ride over the last week with ongoing global growth fears and messy US earnings news. US shares lost 0.5% and Chinese shares remained under pressure falling another 3%. However, Eurozone shares gained 0.5%, Japanese shares rose 1.9% helped by a lower Yen and Australian shares gained 0.7% with the recent RBA rate cut continuing to help. Bond yields generally fell, commodity prices were mixed with oil up but metals down and the $A fell below $US0.73 as the $US edged up slightly.

Another Greek blow up looks unlikely for this summer. Renewed Grexit fears helped set off share market turbulence around mid-last year (and mid-2010, mid-2011 and mid-2012) but the same looks unlikely this time around. With Greece agreeing various reforms on pensions, taxes and contingent spending cuts it looks likely to pass the first review of its latest aid program. European creditors are now starting to discuss debt relief based around longer maturities and lower interest rates. There is a way to go, but at this stage it looks like another Grexit scare won't be back in the headlines this year. 

Impeachment trial of Brazilian President Rousseff is only the beginning. While Brazil’s Senate vote to commence an impeachment trial of Dilma Rousseff was initially greeted positively by the Brazilian share market, Brazil has a long way to go to get back on track. Vice-president Michel Temer who is now acting president looks to be making market friendly appointments to his cabinet and looks likely to try to rein in Brazil’s 5% of GDP budget deficit with spending cuts and tax hikes. However, the huge 20% plus rally in Brazilian shares that has already occurred this year in anticipation of Rousseff’s impeachment is likely to be tested as the trial will take many months, then the outcome can be challenged, and even if Rousseff is ultimately impeached, President Temer would then remain in office until 2018 (and he is unlikely to undertake the sort of reforms Brazil needs and in the meantime, fiscal cutbacks are likely to worsen Brazil’s already deep recession and in turn heighten political tensions which could see them reversed). A new election would help but that could be some time away and it's not clear that it will result in a government focussed on undertaking the necessary economic and political reforms to get Brazil's economy back in shape. In other words, Brazil’s problems are much bigger than Rousseff - they have just been exposed by the commodity slump.

Lowering Australia's inflation target would be madness. Back around 2007-08 when inflation had pushed above 4% (both headline and underlying) some commentators were seriously arguing that the RBA cannot fight rising global commodity prices and so should just raise its inflation target. Now we're hearing that with inflation below target, the RBA should just lower its target with some using the same argument about falling global commodity prices. This is nonsense. The whole point of having an inflation target is to anchor inflation expectation around the target. If it is just raised or lowered each time it looks like being seriously breached due to commodity price movements or whatever - then those expectations - which workers use to demand wage gains, companies use in setting wage increases and prices and which help drive future inflation - will simply move up or down depending on which way the target is changed. This is why it took so long to get inflation back under control in the 1970s and 1980s and why Japan has struggled to end deflation over the last two decades. The RBA should simply ignore calls to lower the target.

Major global economic events and implications

US data was stronger with a big gain in April retail sales, improved consumer sentiment, a rise in small business optimism and strong readings for job openings and hiring suggesting that the labour market is strong and the slowing in payrolls seen in March may be an aberration. That said, unemployment claims have edged up over the last couple of weeks, although the rise over the last week may be due to special factors as it was driven by just New York. Meanwhile, a rise in producer prices suggest an edging up in underlying price pressures. A June or July Fed rate hike still looks unlikely but there is a reasonable chance of a September hike.

Eurozone industrial production fell but German factory orders rose.

Japan's leading economic indicator rose in March, but various economic confidence indicators fell, not helped by the Kumamoto earthquake and underlying wages growth remained soft.

Following the lead from business conditions PMIs, Chinese industrial production, retail sales, fixed asset investment, exports, imports, lending and money supply growth all slowed to varying degrees in April, leaving them in the growth ranges they have been in over the last year or so. Cutting through the volatility, it’s clear that there is no sustained acceleration in Chinese growth, but then again there is no collapse either. More likely it’s just stabilising somewhere around the 6.5-7% GDP growth range. Chinese CPI inflation was unchanged at 2.3% year-on-year in April, with non-food inflation remaining low at just 1.1% year-on-year. There was good news though with producer price deflation continuing to recede from -4.3% year-on-year to -3.4% year-on-year. This is a good sign. Meanwhile, the decline in underlying foreign exchange reserves continued to slow suggesting that capital outflows are continuing to slow as a degree of stability has returned to the Renminbi (albeit this is partly dependent on what the $US does).

Indian economic data disappointed with weaker than expected industrial production and higher inflation.

Australian economic events and implications

Australian data was a bit light on, but the highlight was a bounce in consumer confidence that took it above average and to its highest since January 2014 – rate cuts work at least in the short term! This doesn’t appear to have been driven by reaction to the Budget (which looks neutral relative to last year), but rather appears to reflect reaction to the RBA’s latest rate cut which is a positive sign. That said, consumer sentiment is volatile month-to-month and remains below levels associated with strong growth.  

Source: NAB, Westpac/MI, AMP Capital

Meanwhile Australian housing finance was a bit stronger than expected in March driven by loans going to investors to buy new properties. The broad trend is still down but there has been a bit of a bounce in investor loans. Strength here is likely to be limited though given ongoing APRA vigilance. Finally, ANZ job ads slowed a bit again in April, consistent with some moderation in employment growth after last year’s surge.

Reflecting the downside risks to inflation, we are now allowing for two more rate cuts from the RBA this year taking the cash rate down to 1.25%.

What to watch over the next week?

In the US, expect to see gains in the NAHB home builders’ conditions index (Monday), housing starts and industrial production (both Tuesday) and existing home sales (Friday). Manufacturing conditions surveys for the New York and Philadelphia regions will give an early guide as to how conditions are tracking in May. While CPI inflation (Tuesday) is likely to show a solid rise reflecting the recent bounce in oil prices core CPI inflation is expected to fall back slightly from 2.2% year-on-year to 2.1%. The minutes from the Fed’s last meeting (Wednesday) are likely to confirm that the majority view at the Fed is cautious and dovish.

In Australia, the minutes from the RBA’s last meeting (Tuesday) will be a bit dated given the recent Statement on Monetary Policy but no doubt they will be watched for any further clues regarding the interest rate outlook. On the data front expect to see March quarter wages growth (Wednesday) remain low around 2.2% year on year and April labour market data (Thursday) to show weak jobs growth after the solid gain seen in March and a slight bounce in unemployment back to 5.8%. 

Outlook for markets

Expect short term share market volatility to remain high. May always seems to be a nervous time as now everyone knows about “sell in May and go away, come back on St Leger’s Day”, global growth remains fragile and uncertainty lingers around the Fed and China. 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 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 for yield by investors. 

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 – getting even poorer! 

The ongoing delay in Fed tightening still poses short term upside risks for the $A. However, any short term rebound is likely to be limited and the longer term downtrend looks to be resuming as the interest rate differential in favour of Australia narrows as the RBA continues 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. 

| More

 

Global growth worries return

Monday, May 09, 2016

By Shane Oliver

Share markets had a messy week as the return of growth worries weighed with Japanese shares down 3.4%, Eurozone shares down 2.6%, Chinese shares down 0.9% and US shares losing 0.4%. Despite falls in commodity prices and some earnings downgrades from the banks including one cutting its dividend, Australian shares rose 0.8% helped by the RBA’s rate cut and an implicit easing bias in its Statement on Monetary Policy (SOMP). Global growth concerns also pushed bond yields down, weighed on commodity prices and were helped along with the RBA’s rate cut pushing the $A down by 3%. While the $US rebounded, its rise just looks like normal volatility in a downtrend.   

Donald Trump wins the Republican primaries. So much for my view that Donald Trump won't get a majority of delegates leading to a contested GOP convention. Cruz and Kasich have now dropped out. So it seems hurling around divisive abuse and advancing play school solutions to complex problems is the way to secure the Republican nomination (Mexicans and Chinese are rapists, implicating Cruz's father in the assassination of JFK, etc). This must be hard for decent Republicans. Fortunately polls - particularly of independents who will decide the outcome at the presidential election - show Hillary Clinton (who only needs 15% of remaining delegates from Democrat primaries to secure a majority) well ahead of Trump. Trouble is that Trump will now try and swing back to the centre (ie, tone down his rhetoric - if that is possible!) and an upset (eg, a terrorist attack on US soil leading to support for a "strong man", a US recession or criminal charges against Hillary Clinton in relation to her use of emails as Secretary of State) means that a common sense victory in the US presidential election six months away is not assured.

Apart from big changes to superannuation, the Australian 2016-17 Federal Budget was rather uninspiring, with trivial income tax cuts and nothing really new in terms of contributions to long term economic growth. Sure there's $50bn in infrastructure spend over six years, but only just over $1bn of that is new. The plan to reduce corporate tax rates for small business is welcome, but for large business, it will be a long time coming. The real focus of the Budget seemed to be on presenting the Government as "fair" (hence the super hit to higher income earners) ahead of the July 2 election.

The changes to superannuation are consistent with the move to set its objective as providing income in retirement and they still leave superannuation as highly tax preferred compared to alternatives. The concern though is that yet another big change to super and the retrospective nature of some of those changes will further affect confidence in it - likely pushing the perception of super as the “wisest place for saving” in the Westpac/MI consumer survey to another new low, that it will adversely affect the supply of patient long term saving available to help grow the Australian economy and that it will further dampen incentive in the economy because it’s a defacto tax hike for high income earners at a time when the Australian tax system is already highly progressive (the top 5% already contribute 33% of tax revenue). The moves may also push funds into other strategies such as negative gearing.

 

Source:Westpac/Melb Institute Consumer Survey, AMP Capital

RBA cuts the cash rate to a record low of 1.75%, more to come. In cutting for the twelfth time in this rate cutting cycle - which started in November 2011 - the RBA cited a lower outlook for inflation after the much lower than expected March quarter inflation outcome and backed this up in its quarterly Statement on Monetary Policy (SOMP) by lowering its inflation forecasts for this year to just 1 to 2%, and to 1.5-2.5% for 2017 and into 2018. A desire to see a lower Australian dollar was arguably another consideration. While the RBA’s SOMP made no substantive changes to its growth forecasts which see growth running around 3%, it is rightly concerned about preventing sub-target inflation from becoming entrenched in expectations and the associated risk that this could drift into sustained deflation, a la Japan. And it would prefer to manage any risk of reinvigorating home price strength in Sydney and Melbourne via macro prudential regulation rather than run the risk of leaving interest rates too high. With the RBA’s ultra-low inflation forecasts being based on market expectations for one more rate cut at the time the SOMP was prepared the implication is that the cash rate may have to fall even further (to maybe 1%) to be confident that inflation will return to within the target range. So by implication, the RBA has signalled a strong easing bias. Given the downside risks around inflation, the upside risks for the $A if the Fed continues to delay, and continued weak demand growth, we'll see another rate cut around August, with the high risk of another move in November. 

The announcement that RBA Deputy Governor Philip Lowe will replace Glenn Stevens as Governor in September is no surprise and welcome. Dr Lowe’s expertise and experience at the RBA leaves him well placed for the role. He has a similar approach to Glenn Steven’s so it’s hard to see significant changes to the operation of monetary policy. Meanwhile, Glenn Stevens' huge contribution to macro-economic stability in Australia should be acknowledged. While the RBA has made some mistakes on rates, these are minor, and it has quickly changed tack once it has worked out its mistake – eg, through the GFC and the recent easing cycle. More broadly, Glenn Stevens’ quick rate cuts in 2008-09 played a huge role in Australia avoiding the recession that hit all other OECD countries. At the same time, RBA monetary policy has helped anchor inflation around the target zone of 2-3%. While some may criticise Governor Stevens for overseeing housing bubbles and poor affordability, these problems owe to the poor housing supply response, rather than monetary policy settings. 

Major global economic events and implications

US data was mixed, with weaker manufacturing conditions in April and soft payroll employment but stronger services sector conditions, stronger construction activity and a smaller trade deficit. The April jobs report showing a weaker than expected gain in payrolls of 160,000 will no doubt add to fears about a US slowdown and so a June Fed rate hike is now even less likely and the chance of a July move is low as well. However, monthly payrolls can be volatile, the soft April gain may be payback for mild weather in the March quarter, jobless claims are around their lowest since 1973 and wages and hours worked were stronger. So it would be wrong to read too much into the soft headline April payroll increase. Meanwhile, the US March quarter profit reporting season is now 87% done. Results generally have been better *than expected – with 76% beating on earnings and 54% beating on revenue – but not by much, as earnings growth for the quarter has only improved to -7.4% year-on-year from around -9.5%.

Chinese business conditions PMIs fell back slightly in April. Fortunately, they remain above recent lows and the moves were too minor to read much into. The overall impression remains that China is not going to have a bust but it won't be rebounding either. Meanwhile home prices rose again in April as inventory levels continue to fall. Quite clearly the "ghost city" bust of a few years ago came to nothing and the property market is getting hot again.

Australian economic events and implications

Australia saw mainly solid data over the last week with another bounce in building approvals (albeit the trend remains down), solid home price gains in April, a rebound in new home sales, modest growth in retail sales and a sharp improvement in the trade deficit for March. In fact, net exports look like contributing around 0.75% or so to March quarter GDP growth as resource export volumes along with services exports surge. So the recession some still look for is likely to remain elusive. But there was a slight slippage in business conditions in April.

What to watch over the next week?

In the US, expect to see a rebound in April retail sales after weakness in March with reasonably solid core retail sales growth, a slight improvement in consumer sentiment and continued low producer price inflation (all due Friday). Data on small business optimism and job openings will also be released.

Chinese economic activity indicators due May 14th will be watched closely to see if the improvement in momentum seen in March has continued into April. Slight setbacks in business conditions PMIs suggest that they are likely to be mixed though, with a slight slowing in industrial production (to 6.5% yoy from 6.8%), little change in retail sales growth (at around 10.5%) and a continued pick up in investment growth. Credit and money supply growth is likely to have remained strong. While CPI inflation is likely to remain around 2.3% year-on-year, producer price deflation is likely to continue to abate.

In Australia, expect the latest RBA rate cut and the modest tax cuts in the Budget to have driven a rebound in consumer confidence (Wednesday) after April’s fall and March housing finance to reverse the gain seen in February. A speech by the RBA’s Malcolm Edey (Thursday) will be watched for clues on interest rates.

Outlook for markets

Expect short term share market volatility to remain high. May always seems to be a nervous time, as now everyone knows about “sell in May and go away, come back on St Leger’s Day”, global growth remains fragile and uncertainty lingers around the Fed. 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 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 for yield by investors. 

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 – getting even poorer! 

The ongoing delay in Fed tightening still poses short term upside risks for the $A. However, any short term rebound is likely to be limited and the longer term downtrend looks to be resuming as the interest rate differential in favour of Australia narrows as the RBA is 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. 

| More

 

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.

 

| More

 

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.

| More

 

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.

| More

 

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.

| More

 

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.

| More

 

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.

| More

 

MORE ARTICLES

Rising $A is a concern

The ECB delivers and shares rebound

Australia keeps on keeping on

Will Australian property prices crash?

Shares bounce as companies deliver good results

Volatility feeding itself

Outlook for the markets

Decent investment yield matters in volatile times

Central banks more dovish

Good chance of a short-term bounce

Another volatile week ahead

7 reasons not to be too concerned

A poor start to the year

What to watch over the next two weeks

Shares poised for Santa Claus rally

A constrained year for investors

Fed on track to hike

Market focus on central banks

Share markets bounce back

Santa Claus rally likely

Solid gains for global shares

What to watch over the next week

The ECB signals further monetary easing

Pressure mounts on the RBA

The great rebound

US Congress showdown to grip markets

US rate hike expectations shift to 2016

Rough ride ahead

Falling dollar to provide boost for economy

From goodbye to good buy

Is this 1997-98 all over again?

Reporting season so far

Cost cutting focus of earnings reports

The week in review and what's ahead

Global focus returns to the US

Is the short-term correction over?

Uncertain times

Volatility to continue, but bull market not over yet

The RBA's clear easing bias is back

Greek negotiations drag on

RBA not expected to cut...yet

US GDP and Eurozone confidence

What's happening at the Fed?

The lessons of the last Budget

What to watch over the next week

The Fed is the focus

A full week of US earnings results

What to watch over the next week

What to watch over the next week?

The economic week ahead

All eyes on the Fed

Shares at risk of a correction

What to watch over the next week

What to watch over the next week?

Earnings numbers and the week ahead

What to watch over the next week?

What to watch over the next week

What to watch over the next week?

What to watch

A list of lists for the economy and shares

What to watch this week

What does the oil price plunge mean for you?

Summer reads – the economists’ favourites

Where will markets head this week?

Investment markets and key developments

Weekly economic and market update

Global currency gyrations and the Australian dollar

Australian house prices – a bit too hot in parts

The latest Ebola outbreak – implications for investors

Why I love dividends and you should too

Investment markets and key developments over the past week

Weekly market and economic update: 28 July 2014

Investment markets and key developments over the past week - 25 July 2014

The power of compound interest - an investor's best friend

Investment markets and recent key developments

Abenomics: good for Japan, good for investors and good for Australia

Investment markets and key developments over the past week

The bond rally, secular stagnation and now Iraq

Europe continues to reflate

The structural challenges facing Australia

Australia’s March quarter GDP growth

Investment markets and key developments over the past week

India getting back on track

Investment markets and key developments over the past week

The US economy, the Fed and interest rates

21 great investment quotes

Weekly economic and market update

Crash calls for shares

Australian housing to the rescue – but is it too hot?

Common myths and mistakes of investing

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

Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300