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

Shares rally on central bank moves

Monday, September 26, 2016

By Shane Oliver

With central bank announcements from the Bank of Japan and the Fed out of the way (and benign), share markets rallied over the last week, bond yields fell sharply (particularly in Europe with German bond yields back below zero), commodity prices rallied and the US dollar fell. With the $US down and “risk on”, the $A rose above $US 0.76.

The past week has been all about central banks and the news was clearly far better than feared – certainly nothing to support the “out of bullets” fears of a couple of weeks back.

First up, while the Bank of Japan’s announcement lacked the “shock and awe” seen in the early days of Abenomics, it dramatically ramped up the effort of getting inflation expectations up by committing to overshooting on its 2% inflation target and expanding its monetary base (mainly via quantitative easing) until this is achieved.

In other words, it’s now locked into quantitative easing indefinitely. And in an effort to help Japanese banks, it committed to preventing a flatter yield curve.

The BoJ also stressed it’s not out of options for additional action. I remain sceptical that without the adoption of “helicopter money”, the BoJ will continue to struggle to meet its inflation target, particularly with the Yen remaining around 100 to the $US. But the BoJ’s announcement was more aggressive than investors expected, and is a long way from the central bank surrender that some had feared. 

While the Fed was on hold as expected, perhaps the big surprise was that its comments were only mildly hawkish.

On the one hand, it judged that the case for a rate hike has “strengthened” and that the risks to the economic outlook are now “roughly balanced” and there were three dissents in favour a rate hike. On the other, it is still waiting for more evidence of progress towards its objectives. Chair Janet Yellen repeated that the Fed can more effectively respond to rising inflation than to falling inflation as a reason for caution, and the Fed continues to refer to only “gradual” increases in interest rates and the Fed’s “dot plot” of Fed meeting participants’ interest rate expectations continues to decline.

The dot plot is now showing just one hike this year, only two hikes next year and expectations for the long-run natural rate have fallen further to 2.9% (from 3% in June).

Source: US Federal Reserve, Bloomberg, AMP Capital

Our base case remains for the Fed to hike at its December meeting, but this will require more consistently positive economic data from the US over the next three months. For share markets, the Fed remains broadly supportive, although volatility will no doubt increase again as we get closer to the December meeting. 

In Australia, new RBA Governor Philip Lowe and the Treasurer have recommitted to a medium-term inflation target of 2-3% by enhancing the flexibility around the target and referencing the importance of guiding expectations.

Inflation targeting has been good for Australia and lowering the target as some have suggested would have just lowered its credibility. Meanwhile, emphasising the flexibility around the target highlights that the RBA does not have to mechanically keep cutting just because inflation is below target, but by the same token, the reference to guiding expectations highlights that inflation needs to come back to target within a reasonable time frame.

These two adjustments probably just council each other out in terms of what it means for monetary policy in the months ahead. On this front, the Minutes from the RBA’s last Board meeting and Governor Lowe’s Parliamentary testimony were pretty neutral on the outlook for rates. The outlook for low inflation, the upside risks to the Australian dollar as a result of ongoing global monetary stimulus and Fed delays and the need to manage inflation expectations supports our expectation for another rate cut, but the solid economic growth outlook and the risk of financial instability related in particular to the housing sector argue against another move.

So, we continue to regard our outlook for another cut as a close call. With Lowe saying that whether another rate occurs is going to depend amongst other things on “what the next inflation data look like”, the September quarter inflation release in late October will clearly be critical ahead of the RBA’s November meeting. When asked if the RBA is running out of policy options, Governor Lowe responded “not at all”. That said, I don’t think he will have to ease policy much more anyway.

Finally, the Reserve Bank of New Zealand left official rates unchanged at 2% but retained a clear easing bias and the Bank of Indonesia cut again and remains dovish.

The bottom line is that it’s basically more of the same from central banks. They want higher growth and more inflation. More help from governments is desirable, but it will take a while. They don’t want to upset things given uneven and fragile global growth. Global monetary policy is set to remain easy for some time yet. Which means the broad environment (ie beyond short term event risks) remains positive for shares and growth assets.

Major global economic events and implications

It was another mixed week for US economic data with falls in housing starts, existing home sales and the Conference Board’s leading economic indicator, but gains in the National Home Builders’ Association housing conditions index, home prices and manufacturing conditions in the Kansas region and another fall in jobless claims. It’s worth noting though that the weakness in housing starts was all due to the South and weather related and the weakness in existing home sales looks supply related. 

Chinese property prices surged again in August. In response, many cities are announcing policies to slow it down again. China’s MNI business conditions indicator rose in September adding to confidence that Chinese growth has stabilised.

Australian economic events and implications

Australia economic releases were largely second-order over the last week. ABS data showed a further moderation in home price growth over the year to the June quarter to 4.1%, but June quarter growth was 2% plus (or 8% plus on annualised basis) in Sydney and Melbourne, which indicates these cities remain too hot. A surge in auction clearance rates suggests they may have become even hotter lately. There is not much the RBA can do, but it is an issue for APRA to keep an eye on.

 

Source: APM/Domain, AMP Capital

Meanwhile, Australia’s population popped 24 million in the March quarter. While population growth has slowed to 1.4% year-on-year from a peak of 2.1% in 2008, it appears to have stabilised, remains strong compared to most other advanced countries, will help drive reasonable potential economic growth and continues to underpin long term housing demand. 

What to watch over the next week?

After all the central bank announcements, the week ahead might seem quiet. In the US, the main indicators to watch are consumer confidence (Tuesday) which is expected to show a slight fall, durable goods orders (Wednesday) which is expected to fall after strong gains in July and the August core personal consumption deflator (Friday) which is expected to rise 1.7% year-on-year. Data for new home sales (Monday), June quarter GDP growth which is expected to show a rise to 1.4% annualised and pending home sales (both Thursday) will also be released.

In the Eurozone, money supply and bank lending data will be released Tuesday, economic confidence data (Thursday) is expected to hang around levels consistent with moderate economic growth and September core CPI inflation (Friday) is expected to have remained around 0.8% year-on-year, maintaining pressure on the ECB to extend its quantitative easing program beyond its current expiry of March 2017.

In Japan, expect August data to be released on Friday to show that labour market indicators remain strong and industrial production bounced, but that household spending has weakened and inflation remains at -0.5% year-on-year.

China’s Caixin manufacturing PMI (Friday) and official PMI (Saturday) are expected to show little change.

In Australia, expect credit data (Friday) to show moderate growth. Data on job vacancies and new home sales are also due.

Outlook for markets

Despite a short-term boost from the Bank of Japan and the Fed, shares remain vulnerable to a further correction or volatility in the next few months. September and October are often rough months seasonally and various event risks loom in the months ahead, including ongoing debate around the Fed, the Austrian presidential election, Italian banks, the Italian Senate referendum, the US election with support for Trump edging up and global growth generally. However, after any short-term weakness, we anticipate shares to trend higher over the next 12 months, helped by okay valuations, continuing easy global monetary conditions and continuing moderate global economic growth. 

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

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

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up.

Cash and bank deposits offer poor returns. 

There is a high risk that the Aussie dollar will re-test its April high of $US0.78 as the Fed continues to delay, presenting challenges for the RBA.

Beyond the short term, though we see the longer term downtrend in the $A ultimately resuming as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, commodity prices remain low and the $A sees its usual undershoot of fair value.

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Are central banks out of bullets?

Monday, September 19, 2016

By Shane Oliver

While the US share market rose 0.5% over the past week to recover some of its loss from the previous week, as fears of an imminent Fed rate declined, other major share markets fell as they caught up to the earlier fall in US shares.

Eurozone shares fell 3.1% (not helped by a US Dept of Justice claim against Deutsche Bank), Japanese shares fell 2.6%, Chinese shares lost 2.4% and Australian shares fell 0.8%. Bond yields were little changed, but rose sharply in Australia. Commodity prices were mixed, with oil down 6% on supply concerns, but metal prices up. The $A fell, closing below $US0.75.

The soap opera regarding the Fed swung back to dovishness over the last week, with Fed Governor Brainard remaining dovish and urging “prudence” in raising rates and soft economic data seeing the US money market’s assessment of the probability of a September rate hike fall to 20%.

Have central banks run out of bullets? Is fiscal policy now about to take over? The back-up in bond yields (just a flick in a big picture context) and volatility in share markets over the last week or so in part has its origins in concerns that some central banks have hit the bottom of the monetary policy barrel and that the focus will now shift to fiscal stimulus. This seems to be now the standard narrative in financial markets, but when everyone starts saying the same thing, I must admit to get a bit concerned. While I think we will see a shift in focus from monetary policy to fiscal policy (click here) I doubt that we are seeing an abrupt turn. First, government's should do more to help boost growth both via structural reforms and fiscal stimulus (where they can) - but a shift in this direction is likely to unfold slowly.

Second, central banks would all like more help from their governments, but they also have inflation mandates and when inflation is well below target, they still have to act.

Third, the situation varies dramatically between the major central banks, so it’s impossible to generalise and say they have all run out of bullets:  

  • The debate (or rather soap opera) in the US is not whether the Fed has run out of bullets, but about the continuing process of removing monetary stimulus because it has been successful;
  • While the ECB did not seem to be in a hurry to do more stimulus at its last meeting, it wasn't expected to anyway, it currently sees no reason to rush into doing more and the debate has only been about whether it will extend its current quantitative easing program, but it still has plenty of time (and scope) to do that because it doesn't expire till March next year;
  • The situation facing the Bank of Japan is more problematic, because of all major countries Japan is the one where deflation expectations are more entrenched. While the BoJ initially had some success in 2013 and 2014, this has now failed for a variety of reasons. To get a more assured result Japan is one country where "helicopter money" (ie the direct financing of fiscal stimulus by the central bank) should be considered;
  • None of this is directly an issue for the RBA - it has lots of bullets (150 points of rate cuts and hasn't even done QE) and with growth remaining good, is unlikely to run out of them anyway.
  • The bottom line is that a shift in reliance away from monetary policy towards fiscal policy and structural reforms is desirable, but it’s likely to be a gradual process and vary from country to country. It’s unlikely to justify a rapid back up in bond yields (more like a choppy bottoming) or sharp fall in share markets.
  • In Australia, there was some good news on the budget, with the Government and Opposition agreeing on $6.3bn in savings over the next four years, highlighting that sensible bi-partisan agreement is possible. A compromise on the “retrospective” aspect of the proposed superannuation savings suggests they are likely to be passed as well. That said, this just helps keep the budget projections on track, as such savings had already been largely factored into projections, and there is still another $40bn or so in savings that have yet to be legislated, so the risk to the AAA rating remains.

Major global economic events and implications

US economic data was soft, with weaker-than-expected retail sales and industrial production, a slight fall in small business confidence and weak details in the New York and Philadelphia manufacturing surveys. Consumer price inflation was slightly stronger than expected, but producer price inflation was weak, and the Fed’s preferred inflation gauge is likely to have remained below target. Although jobless claims remain low and retail sales tend to understate consumer spending, the weak run of data doesn’t support the case for an imminent Fed rate hike.

The Bank of England left monetary policy on hold following last month’s easing and seemed a bit more upbeat on the outlook.

Eurozone industrial production fell in July, but business conditions PMIs point to a reasonable bounce back in August.

Chinese economic data was better-than-expected in August, adding to confidence growth has stabilised around 6.5-7%. Industrial production, power consumption, retail sales, investment and growth in credit all picked up pace.

Australian economic events and implications

Australia saw good news on business and consumer confidence, but mixed jobs data. While the NAB business survey showed a slight fall in business conditions, it is still above average and business confidence actually rose.

Meanwhile, consumer confidence edged up slightly on the Westpac/Melbourne Institute measure, and remains around average, but rose to be well above average according to the ANZ/Roy Morgan measure. The bottom line is that confidence is okay in Australia. August jobs figures were a bit messy, but jobs growth is still solid at 1.5% year-on-year, and unemployment is trending down, but weak growth in full time jobs is going hand in hand with high underemployment, meaning that there remains plenty of spare capacity in the Australian labour market. In other words, the economy can still run faster until it is used up.

On the growth front, RBA Assistant Governor, Christopher Kent, made a point that is very important for Australia - that we are heading towards “the abatement of two substantial headwinds” being the falls in the terms of trade and mining investment. Just as the housing construction cycle starts to turn down in 2018, the big growth drag from these two will likely have come to an end, enabling reasonable growth to continue.

What to watch over the next week?

The week ahead is a big one, with the long awaited Fed rates decision and the outcome of the Bank of Japan’s “comprehensive review” both due on Wednesday.

Our assessment is that the Fed will remain on hold. Recent economic activity data has been mixed – with strong jobs data, but weak ISM business surveys, industrial production and retail sales – pointing to growth averaging below the Fed’s own expectations and a long way from any overheating. So, with wages growth remaining subdued and its preferred inflation measure stuck at just 1.6% year-on-year, the Fed can afford to wait.

This is particularly the case with global growth remaining subdued, and the risk that a Fed rate hike could lead to a renewed surge in the $US, which will weigh on US growth and create problems in currency markets and the emerging world, including China. A September hike can’t be ruled out, but with the US money market only attaching a 20% probability to it, a surprise hike would unleash market ructions that the Fed would probably prefer to avoid. So our base case is that the Fed will be on hold, but it may send a signal that it anticipates economic conditions to justify a hike in December (with the “dot plot” dropping to just one hike for this year from two) but indicate that this remains data dependent (as it should be).

On the data front in the US, expect the home builder conditions index (Monday) to remain strong, housing starts to fall slightly, but permits to rise (Tuesday), existing home sales to rise (Thursday) and the Markit manufacturing conditions PMI (Friday) to remain around the okay 52 level.

In the Eurozone, the composite business conditions PMI (Friday) is expected to remain solid at around 52.9.

Expectations are low for the Bank of Japan’s meeting on Wednesday, and it’s likely that only modest measures will be announced. While its adoption of a 2% inflation target and massive monetary expansion initially had some success, this has flagged in the last 18 months thanks to the GST tax hike which knocked Japan back into recession, the slump in oil prices which knocked inflation back down and global growth worries and share market weakness since mid-last year that have pushed the Yen higher.

It now appears to be positioning the 2% inflation target as a longer term objective. The BoJ appears to be reluctant to add to its purchases of Japanese Government Bonds (it already owns more than 40% of them) and various reports suggest that it is looking to try and encourage a steeper yield curve by buying shorter dated bonds and possibly even lowering its negative interest rate. Logically, the next step for Japan is “helicopter money” ie direct BoJ financing of fiscal stimulus so as to achieve a more guaranteed impact than just bond buying, but without ramping up Japan’s already high public debt. But while the BoJ may stress close cooperation with fiscal policy, it’s doubtful it’s ready to announce helicopter money just yet.

In Australia, it will be a quiet week. RBA minutes (Tuesday) and new RBA Governor Lowe’s Parliamentary testimony (Thursday) will be watched closely for rate clues, but will probably imply a neutral bias. Expect ABS home price data for the June quarter (Tuesday) to show a 3% rise, based on CoreLogic data (which rose 3.3%). Skilled vacancy data and March quarter population figures will also be released.

Outlook for markets

Shares may get a short term boost if, as expected, the Fed leaves rates on hold in the week ahead. But after a period of strong gains from February lows, they remain vulnerable to a further correction in the next few months. September and October are often rough months seasonally, and various event risks loom in the months ahead, including ongoing debate around the Fed, the Austrian presidential election, Italian banks, the Italian Senate referendum, the US election and global growth generally. However, after a short-term correction, we anticipate shares to trend higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions and continuing moderate global economic growth. 

Ultra-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, low inflation and ongoing shocks. That said, the bond rally this year had taken yields to pathetic levels leaving them at risk of a snapback, which we are now seeing.

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

Dwelling price gains are expected to slow to around 3% over the year ahead, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment prices get hit by oversupply.

Cash and bank deposits offer poor returns. 

There is a high risk that the $A will re-test its April high of $US0.78 if the Fed continues to delay, presenting challenges for the RBA. Beyond the short term though, we see the longer term downtrend in the $A ultimately resuming, as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, commodity prices remain low and the $A sees its usual undershoot of fair value. 

Eurozone shares lost 1% on Friday, led by Deutsche Bank after news of a large claim against it from the US Dept of Justice, and the US S&P 500 declined 0.4% as oil prices fell, the $US rose and August consumer price inflation came in slightly stronger-than-expected. ASX 200 futures were flat, although I expect a small decline of around 20 points at the open today after Friday’s strong 1.1% gain in the ASX 200. 

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Could this market correction have further to run?

Monday, September 12, 2016

By Shane Oliver

While Japanese shares (up 0.2%) and Chinese shares (up 0.1%) managed small gains over the last week, a further rise in bond yields on Friday on the back of more hawkish comments from the Fed and following the absence of further easing by the ECB saw Eurozone shares fall 1% and US shares fall 2.4% for the week. A sharp rise in Australian bond yields also helped drag down Australian shares by 0.6%. Despite falls on Friday, commodity prices rose, particularly oil on the back of a sharp Gulf of Mexico storm related fall in US crude inventories. Fed rate hike expectations pushed the Aussie dollar down, but only by 0.4%.

Bond yields have been driven higher by a range of things lately, including perceptions that central banks have become less interested in using negative interest rates, talk of a refocus from monetary to fiscal policy, receding deflationary pressure from commodity prices, perhaps the realisation that bonds are poor value and heightened expectation of Fed rate hikes. And in Australia, a perception that we are at, or close to, the end of the RBA’s easing cycle has added to upwards pressure on local bond yields. The rise in bond yields in the last few days was triggered by the ECB leaving monetary policy unchanged and comments by the normally dovish Fed regional President Rosengren warning of the risks of waiting too long to raise rates.

Shares have been vulnerable to a correction for a while (as has been noted in the Outlook section of this note). We have seen very strong gains from the February and post Brexit lows that left markets overbought with short term measures of volatility suggesting a degree of complacency. We are now in a seasonally weak period of the year and there is significant event risk ahead with the Fed, Italy, the US election and of course, South China Sea tensions and North Korean missile/bomb tests don’t help. So the correction could have further to run in the short term, but we see it as just that.

Bonds have likely seen the best – with central banks becoming less enamoured of negative interest rates (not their best move!), a shift in focus away from monetary stimulus towards fiscal stimulus and a stabilisation in commodity prices leading to lessening deflation risk. But it’s hard to see a sharp back up in bond yields as global growth remains subdued, uneven and fragile and core inflation remains well below inflation targets. While the Fed is likely edging towards another rate hike, mixed data recently makes a December move more likely than a September move and the ECB and Bank of Japan are more likely to continue or add to stimulus as opposed to curtail it.

The European Central Bank left monetary policy unchanged, there was no significant change to the ECB's economic forecasts, and President Draghi commented that an extension of the current quantitative easing program was not discussed. However, with inflation remaining well below target, the ECB's own economic forecasts assuming a continuation of the current QE program and various dovish comments from Draghi around the lack of upward inflation pressures indicate that an extension of the QE program beyond its March 2017 expiry at its December meeting is likely. The ECB also looks likely to announce a technical widening of the assets than can be purchased under the QE program in order to ensure that the ECB does not run into problems in implementing its program.

Having just cut rates last month, it was no surprise to see the Reserve Bank of Australia leave rates on hold at 1.5% at its September meeting. We remain of the view that the RBA will cut rates again at its November meeting when it reviews its economic forecasts after the release of the September quarter inflation data in late October. The risks to inflation are on the downside, thanks to weak inflation globally and record low wages growth domestically and the Aussie dollar is too high and at risk of breaking beyond the April high of $US 0.78 if the Fed continues to delay rate hikes. However, with economic growth holding up very well, another rate cut is a close call and is now critically dependent on seeing a lower-than-expected September quarter inflation result. A cut in the cash rate to 1% or below, and the adoption of quantitative easing, looks very unlikely in Australia.

Major global economic events and implications

US economic data painted a mixed picture – not one supporting an imminent Fed rate hike. Labour market indicators remain very strong, with the rate of job openings, hirings and people quitting for new jobs all at high levels, and jobless claims remain ultra-low, but a slump in the non-manufacturing conditions ISM index on top of the fall in the manufacturing conditions ISM adds to worries that growth may have slowed. The Fed's Beige Book did nothing to clear the picture, talking of modest growth (with a slight downgrade in conditions across states), a tight labour market, but little sign of inflation. While the slump in the ISM indexes could just be noise, the mixed readings on the US economy and continuing low inflation indicate that the Fed would be wise to hold off on raising rates in September. The market's probability of a September rate hike is 30% and that for December is 60%. Our base case remains for a December hike, but this “will they or won't they” soap opera looks like dragging on for a while yet.

Eurozone retail sales rose more than expected in July and are up 2.9% year on year, but German industrial production and factory orders were weaker than expected.

Japanese data continued the more positive tone of the previous week, with an upwards revision to June quarter GDP growth, stronger than expected wages growth, a rise in Japan’s leading index, a rise in overall economic sentiment and Tokyo’s office vacancy rate falling to just 3.9%.

Chinese data for August showed a welcome improvement, with exports and imports suggesting stronger global demand and stronger domestic demand respectively and a small rise in the Caixin services sector conditions PMI adding to confidence that Chinese growth has stabilised. What's more, producer price deflation continued to fade in August, which is invariably a pointer to stronger Chinese nominal growth. Meanwhile, China's State Council (or cabinet) indicated it would step up fiscal stimulus and investment in weak areas of the economy, adding to confidence that Chinese growth is not about to fall out of bed any time soon.

Australian economic events and implications

A good week for the optimists on Australia. June quarter GDP data showed solid growth of 0.5% quarter on quarter or 3.3% year on year. To be sure, the quarterly pace of 0.5% was down on 1% in the March quarter and were it not for a surge in lumpy public spending (notably in defence) growth would have been negative as the slump in mining investment continues to detract from growth. However, some slowing in the quarterly growth rate of 1% quarter on quarter seen in the March quarter was inevitable. Going forward, net exports are likely to remain solid, as new resource projects come on stream, underlying public investment is on the rise thanks to infrastructure projects in NSW and Victoria, mining investment is getting close to more normal levels so the huge growth detraction from its unwind over the last few years will start to abate next year, reasonable growth in consumer spending is likely to be underpinned by a still high household savings rate and the completion of new homes, a stabilisation in commodity prices and our terms of trade suggests that the big hit to national income is over and productivity growth is very strong at 2.9% year on year. What's more, 3.3% growth for the year to the June quarter is way above the US at 1.2%, the Eurozone at 1.6% and Japan at just 0.6% and the diversity of growth drivers of the Australian economy (from mining to housing to public capex, etc) in part highlights why the economy has now gone 25 consecutive years without a recession.

In other data, housing finance fell in July and AIG services and construction conditions PMIs followed the manufacturing PMI lower in August, but these series can be quite volatile. Meanwhile, ANZ job ads were strong in August (pointing to continued solid jobs growth) and the trade deficit improved sharply in July (although this was driven by volatile gold exports so is not quite as good as it looks), but the Melbourne Institute's Inflation Gauge showed that inflation remained weak in August.

What to watch over the next week?

In the US, the main focus is likely to be on August retail sales (Thursday) which are expected to show a rebound in underlying retail sales growth to around 0.3% month on month after a soft July. Note that the retail sales are now only 43% of total consumer spending in the US. Meanwhile, expect a fall in industrial production, but slight improvements in the Philadelphia and New York manufacturing conditions indexes (also Thursday) and core CPI inflation for August have remained around 2.2% year on year (Friday).

The Bank of England (Thursday) is expected to leave monetary policy on hold, being in “wait and see” mode after last month’s easing.

Chinese August activity data (Tuesday) is expected to show a slight improvement for industrial production to 6.1% year on year, no change in retail sales at 10.2% year on year and a slight fall in fixed asset investment.

In Australia, expect the August NAB business conditions and confidence surveys (Tuesday) to hang around the okay levels seen in July, consumer confidence (Wednesday) to be little changed and August jobs data (Thursday) to show a 15,000 gain, with unemployment rising back to 5.8%.

Outlook for markets

After a period of strong gains into July/early, August shares remain vulnerable to a further correction in the next few months. Australian shares have already fallen 4% from their August high, but global shares have only just started to come off. September and October are often rough months seasonally, and various event risks loom in the months ahead including around the Fed, Italian banks, the Italian Senate referendum, the US election and global growth generally. However, after a short term correction, we anticipate shares to trend higher over the next 12 months helped by okay valuations, very easy global monetary conditions and continuing moderate global economic growth.

Ultra-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, low inflation and ongoing shocks. That said the bond rally this year had taken yields to pathetic levels leaving them at risk of a snapback, which we are now seeing.

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

Dwelling price gains are expected to slow to around 3% over the year ahead, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment prices get hit by oversupply.

Cash and bank deposits offer poor returns.

There is a high risk that the $A will re-test its April high of $US0.78 if the Fed continues to delay, presenting challenges for the RBA. Beyond the short term though, we see the longer term downtrend in the $A ultimately resuming as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, the risk of a sovereign ratings downgrade continues to increase, commodity prices remain low and the $A sees its usual undershoot of fair value.

Eurozone shares fell 1.1% on Friday and the US S&P 500 lost 2.5% as bond yields rose further in response to Fed President Rosengren’s warning about waiting too long to raise interest rates coming on the back of the ECB leaving monetary policy unchanged at its Thursday meeting. The weak global lead saw ASX 200 futures fall 79 points or 1.5% pointing to a poor start to trade for the Australian share market on Monday.

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What to watch this week: Aussie growth numbers

Monday, September 05, 2016

By Shane Oliver 

Global shares rose solidly over the last week, with Japanese shares up 3.5% helped by talk of more monetary easing and a fall in the Yen, Eurozone shares gained 1.9%, US shares rose 0.5% helped by a benign jobs report and Chinese shares rose 0.2%. Australian shares lost 2.6%, as the earnings reporting season came to an end. Bond yields fell in the US, were unchanged in Australia, but rose in Europe and Japan. While a rising $US weighed a bit on commodity prices, the Australian dollar rose marginally.

A softer-than-expected US August jobs report leaves a September Fed rate hike looking unlikely. US payrolls rose by 151,000 in August, which after two monthly gains greater than 270,000, tells us the US jobs market is solid. However, it was much weaker than expected and when combined with flat unemployment, weak wage gains (of just 0.1% month-on-month, or 2.4% year-on-year) and a soft August manufacturing conditions ISM, indicates that the Fed will likely remain on hold in September. A December hike by the Fed remains our base case. US money market probabilities for Fed hikes of 32% for September and 59% for December look reasonable.

Global manufacturing conditions PMIs slipped a bit in August, but remain consistent with ongoing moderate global growth. While there were significant falls in the US and Australia, India and the UK saw good gains and nearly 75% of countries have PMIs in so called expansion territory (ie above 50). The bottom line is that the global economy continues to muddle along.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital

Surprise surprise, Brazilian President Dilma Rousseff was impeached! Seven years ago when on holidays in Rio, the day it was announced that Brazil would host the 2016 Olympics, I was interviewed by Brazilian TV at the base of the Sugar Loaf cable car and managed to say "parabens Brasil" (maybe they liked my Hawaiian shirt). Since then, it seems to have been downhill for Brazil! And the impeachment of Rousseff doesn't necessarily improve things. There are some signs that their recession is easing and a stabilisation in commodity prices will help. But former Vice-President and now President until 2018, Michel Temer, has his own problems, which may deepen as austerity designed to control the budget deficit blow out kicks in and Brazil really needs a radical long-term reform agenda to get back on track.

The final days of the Australian June-half profit reporting season offered nothing new. Funny the way most companies with good results report early, but Harvey Norman invariably comes in with good news on the last day. The basic picture remains one of a tough 2015-16, with earnings down 8% led by resources and aggregate dividends down about 10%, led again by resources (only a fruit cake could have believed that the super high resources dividends were sustainable). However, the median company did okay, with earnings up 5% or so, 62% of companies seeing earnings up year-on-year, 86% of companies raising or maintaining dividends and 54% of companies seeing their share price outperform the market on release day. Overall, the results are consistent with a return to earnings growth of about 8% this financial year.

Major global economic events and implications

US economic data was mostly good, with solid consumer spending in July and a surge in consumer confidence in August adding to evidence that the consumer is in good shape, solid (albeit weaker than expected) payroll growth, solid construction activity, a smaller-than-expected trade deficit, a stronger-than-expected rise in pending home sales and continued modest growth in home prices. Against this though, wages growth remains weak and manufacturing conditions softened according to the August ISM index, which fell to 49.4 from 52.6. While the broader Markit PMI index held up better at 52, the fall in the ISM, weaker-than-expected August jobs growth and continuing very low wages growth are likely to see the Fed remain on hold at its September meeting and wait till December before moving on rates again. Meanwhile, the Fed's preferred inflation gauge - the core private consumption deflator - was stable at 1.6% year-on-year, where it's been for months, indicating that upwards pressure on inflation remains weak and that the Fed has plenty of scope to remain on hold.

Eurozone economic confidence fell slightly in August but remains at levels consistent with ongoing moderate economic growth. Meanwhile, unemployment remained at 10.1% in July (at least it's down from 12.1% a few years ago) and core CPI inflation in August fell to 0.8% year-on-year from 0.9% indicating leaving it well below the ECB's 2% target.

Political uncertainty continues in Spain with acting PM Rajoy losing a parliamentary confidence vote, risking another election in December. However, a left wing government remains unlikely.

Japanese economic data was good (believe it or not). Unemployment fell to just 3%, the jobs to applicants ratio remained at its lowest level since the early 1990s, real household spending and retail sales rose more than expected and housing starts are up nearly 9% year-on-year. Against this though, industrial production was soft and small business optimism fell.

While Chinese consumer confidence fell in August, business conditions PMIs were indicative of stable growth. The official manufacturing PMI rose to 50.4 (from 49.9), the non-manufacturing PMI fell but to a solid 53.5 (from 53.9) and the Caixin manufacturing PMI fell to 50 (from 50.6). Lots of noise, but basically consistent with GDP growth stabilising around or slightly above 6.5%.

Indian GDP growth slowed to 7.1% year-on-year in the June quarter (from 7.9%) on slower growth in investment and consumer spending. That said, it's way above virtually any other country, including China, and India’s manufacturing PMI rose to a 13-month high. At least one of the BRICs is actually better than it used to be!

Australian economic events and implications

Australian economic data was all over the place. Retail sales were flat in July, adding to the loss of momentum here (which partly owes to weak price inflation, but weakness in household goods looks odd given strong dwelling completions) and business investment fell again in the June quarter. However, the fall in capex was driven by buildings and structures and was consistent with the mining driven engineering construction slump already reported in June quarter construction data. Against this plant and equipment investment actually rose in the June quarter and investment plans for the current financial year improved more than expected, suggesting that non-mining investment may be stabilising. Although mining investment looks like falling another 27% this financial year, at 3% of GDP now its negative impact on overall economic growth is starting to wane given that it has already fallen from around 7% of GDP. The next chart shows that there has been a loss of downwards momentum when comparing expected capex plans for the year ahead.

Source: ABS, AMP Capital

Meanwhile on the housing front, building approvals surged back to near record highs in July, led by another spike in apartment projects and house price growth, and according to CoreLogic, remains uncomfortably high in Sydney and Melbourne despite slowing rents and record-low rental yields. That said, July new home sales resumed their downtrend according to the HIA in July, housing credit growth continued to lose momentum (led by investor finance) and I suspect that many of the apartment approvals won't proceed to construction given the emerging oversupply and weakening conditions in the apartment market in several cities. Nevertheless, the case for more APRA intervention in the face of still too hot Sydney and Melbourne property markets remains.

What to watch over the next week?

The G20 leaders’ summit in Hangzhou China (Sunday and Monday) is likely to see the usual motherhood commitments to policy co-ordination, structural reforms and avoiding "competitive devaluation" but don't expect much financial market impact. Such meetings usually only come up with anything significant at times of crisis (like through the GFC). While there is a market belief that some sort of "Shanghai Accord" to stabilise exchange rate movements was agreed at the G20 finance and central bankers meeting in February this year, this may be tested in the months ahead as the Fed moves towards another rate hike. What the G20 should be doing is stepping up efforts to meet the 2% growth boost objective from the 2014 G20 summit (which now looks unachievable) and fighting back against protectionism.

In the US, expect the ISM non-manufacturing index and data for job openings and hirings (Tuesday) to remain solid and the Fed's Beige Book of anecdotal evidence on the economy (Wednesday) will also be released.

In Europe, expect the ECB (Thursday) to maintain a dovish message, but to make no changes to monetary policy. Eurozone economic data has been reasonable and more resilient than expected post the Brexit vote which will likely allow the ECB to delay any decision on extending its quantitative easing beyond March 2017 until maybe it's December meeting.

Chinese August trade data (Thursday) is likely to show an improvement in export and import growth.

In Australia, the Reserve Bank is likely to leave interest rates on hold (Tuesday). While the Australian dollar remains a little too high for comfort, economic activity data since the August rate cut has been reasonable and there has been nothing new on inflation. As a result, the RBA is likely to hold the cash rate at 1.5%. We remain of the view that the RBA will cut rates again, but this won't come until November after the release of September quarter inflation data and when it next reviews its economic forecasts. Another rate cut is a close call though, given that the outlook remains for reasonable economic growth.

Meanwhile on the data front in Australia, expect June quarter GDP growth (Wednesday) to slow to around 0.4% quarter-on-quarter after the March quarter’s unexpected 1.1% growth spurt thanks to weaker export volume growth and a -continued drag from the unwinding of the mining investment boom. Annual growth is expected to be around 3.3% year-on-year. Data for job ads and business indicators (Monday), the June quarter current account deficit (Tuesday), the trade deficit (Thursday) and housing finance (Friday) will also be released. July housing finance data will be watched closely to see if finance to property investment has continued to reaccelerate as seen in the previous two months. Finally, a speech by RBA Deputy Governor Philip Lowe (Thursday) will be watched closely for any clues on the interest rate outlook.

Outlook for markets

After a period of strong gains into July/early August shares are likely to see a consolidation or correction given weak seasonals out to October along with various event risks in the months ahead including around the Fed, Italian banks, the Italian Senate referendum and global growth generally. However, after a short term correction or consolidation, we anticipate shares to trend higher over the next 12 months helped by okay valuations, very easy global monetary conditions and continuing moderate global economic growth.

Ultra-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, low inflation and ongoing shocks. That said, the recent bond rally has taken yields to pathetic levels leaving them at risk of a snapback.

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

Dwelling price gains are expected to slow to around 3% over the year ahead, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment prices get hit by oversupply.

Cash and bank deposits offer poor returns.

Recent, more hawkish Fed commentary has dampened the $A, but with a September Fed rate hike looking unlikely after the softer-than-expected August jobs report in the US there is a high risk that the $A will resume its push back up to April’s high of $US0.78, presenting challenges for the RBA. Beyond the short term, we see the longer term downtrend in the $A ultimately resuming as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, the risk of a sovereign ratings downgrade continues to increase, commodity prices remain in a secular downswing and the $A sees its usual undershoot of fair value.

Eurozone shares gained 1.8% on Friday and the US S&P 500 rose 0.4% after the softer-than-expected August jobs report reduced the likelihood of a Fed rate hike this month. As a result of the positive global lead and higher oil and iron ore prices ASX 200 futures gained 35 points or 0.7% on Friday night, pointing to a positive open for the Australian share market on Monday.

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What to watch this week: reporting season ends

Monday, August 29, 2016

While Eurozone shares rose 1.2% over the last week US shares fell 0.7%, Australian shares lost 0.2%, Japanese shares fell 1.1% and Chinese shares fell 1.7%. A ramping up of expectations for a Fed rate hike, which were reinforced by comments by Fed Chair Janet Yellen and Vice Chair Stanley Fischer, and downwards pressure on defensive shares weighed on the US share market and concerns about regulatory controls of interbank lending and property weighed on the Chinese share market. In a broader sense some sort of share market consolidation/correction seemed likely after the strong gains in seen over the last six months. Meanwhile the Australian dollar and commodity prices were a bit softer as the $US rose. Bond yields rose in the US but were flat to down elsewhere.

Janet Yellen’s Jackson Hole speech reinforced the message that the Fed is getting more confident about resuming rate hikes. In a more upbeat assessment of the US economy she bluntly noted that the case for a rate increase “has strengthened in recent months” but she continued to refer to “gradual” hikes and noted that monetary policy is not on a pre-set course. While her comments are consistent with a possible September hike – as subsequently emphasised by Vice Chair Fischer – there was no clear guidance as to timing and we remain of the view that a hike in December is more likely (unless of course Friday’s August payroll data shows an ultra strong gain of 250,000 or so). Yellen’s comments are consistent with those from the Fed’s Dudley, Williams and Fischer over the last two weeks but coming from her they naturally take on more significance. As a result US money market probabilities for a September and December rate hike have now moved to levels that look reasonable of 42% and 65% respectively, after being ridiculously low just two weeks ago.

However, while the move towards another Fed rate hike will likely cause bouts of consternation in investment markets I don’t see the same degree of uncertainty that we saw around last year’s Fed rate hike because it’s clear from the Fed’s actions this year that it is aware of global risks, the impact of its own actions on those risks and any potential blow back to the US economy and of the impact of a rising $US in doing some of its work for it and so acting as a limitation on how much it can hike. In short, expect the Fed to remain cautious and gradual.

In terms of the Fed’s monetary policy toolkit, the basic message from Janet Yellen was that it was appropriate and adequate. While she noted that the Fed “is not actively considering…additional tools and policy frameworks” she did highlight the need for more effective fiscal policy, an assessment that is becoming increasingly obvious given that there is only so much monetary policy can do.

The next few months will see a bit of a renewed ramp up in political risk in Europe with the main events being the Italian Senate referendum and Austrian presidential election re-run in October both of which have the potential to see a return to worries about a break-up of the Eurozone (which I continue to think ultimately won’t happen). But in the week ahead the focus will be on Spain. In an effort to break a political deadlock Spanish PM Rajoy has called a confidence vote to be held Tuesday or Wednesday, with a potential follow up on Friday, to help resolve the political impasse Spain has been in since the December election. While the June election saw his centre right People's Party attract more support (and the far left Eurosceptic Podemos attract less) and he has the support of the Citizen’s party, he still lacks an outright Parliamentary majority. The vote will put more pressure on the centre left Socialist party to at least abstain or risk having another election later this year. Our base case is that a minority centre right Government will ultimately be formed, but there is still some risk around that and some way to go before it is confirmed.

Ukraine tensions on the rise. After falling out of the headlines following a peace deal, the Ukrainian conflict may be hotting up again with increasing violence in the Donbass region of eastern Ukraine and tensions around Crimea. A further escalation could threaten the peace deal and potentially cause nervousness in investment markets. However, while this may occur we doubt it will become a major problem for the same reasons we couldn't see it escalating two years ago - the US regards Ukraine as part of Russia's "sphere of influence" and Europe has little interest in getting directly involved. And of course both the US and Europe are a bit distracted at present anyway (which may partly explain what Putin is up to). In any case the lifting of sanctions on Russia next year is starting to look less likely.

2015-16 was a bad year for listed company profit growth in Australia, but the worst may be behind us. As is often the case with profit reporting season, the quality of results deteriorates towards the end and we have seen that over the last week. With nearly 95% of results having been released the past week has seen the total number of companies exceeding expectations fall back to 41%, which is below the norm of around 45%. The key themes have been pretty much as expected: with a horrible year for resources stocks (with a 48% profit plunge) but improving conditions ahead on the back of improving commodity prices, cost controls and supply side discipline; constrained revenue growth for industrials; ongoing cost cutting; continuing headwinds for the banks; and an ongoing focus on dividends with 86% of companies raising or maintaining their dividends.

While overall Australian listed company profits have fallen by around 8.5% in 2015-16 thanks largely to the resources slump, it is notable that 62% of companies have actually seen their profits rise on a year ago and the median company has seen profit growth of around 4%. 54% have seen their share price outperform the market the day results were released which adds to the view that results haven’t been worse than expected. Overall profits are on track to return to growth in 2016-17 as the slump in resources profits reverses and non-resource stocks see growth. 2016-17 earnings growth is expected to be around 8%, with mining companies now seeing the fastest rate of upgrades.

Source: AMP Capital

Source: AMP Capital

Major global economic events and implications

US data was a bit mixed. Manufacturing and services conditions PMIs fell slightly in August but against this durable goods orders including for capital spending were stronger than expected in July. Existing home sales fell in July but this followed several months of gains and new home sales surged higher pointing to a sharp rise in housing starts and permits and home prices continue to rise moderately. Meanwhile unemployment claims remain very low and the goods trade deficit fell in July. June quarter GDP growth was revised down but only slightly to 1.1% annualised (from 1.2%) and this was mainly due to lower inventories.

Eurozone business conditions PMIs continue to point to resilience with the composite PMI for August rising slightly to a solid 53.3, a level which is consistent with ongoing moderate growth.

The Japanese manufacturing conditions PMI improved slightly in August but remains weak at 49.6 indicating continued weak growth in Japan. Meanwhile the CPI remained in deflation at -0.4% year on year and core inflation slipped back further to just 0.3%yoy. The benefits from Abenomics – at least in terms of breaking the deflation mentality in Japan – look to be fading. Ultimately I think the BoJ and the Japanese Government will jump in with more aggressive policies – but that may still be a way off.

China's MNI business sentiment indicator for August fell, but retains most of the gains it has seen since its low earlier this year. Meanwhile, after the rebound in property prices seen over the last year it’s no surprise to see Shanghai looking at ways to cool it down again. People’s Bank of China moves to reduce the supply of overnight money to the  interbank lending market also caused some consternation in the last week, although the latter seems to be offset by an addition of longer term funds (in a sort of “operation twist”).

Australian economic events and implications

Australian construction activity fell more than expected in the June quarter, led as usual by another sharp slump in mining related engineering activity which offset gains in residential and non-residential building activity. With this pointing to another weak quarter for business investment and trade unlikely to contribute much to growth after the March quarter surge, June quarter GDP growth could fall back to around 0.3% quarter on quarter after the 1.1%qoq surge in the March quarter. That said, it will still be up 3.1% year on year. Perhaps more significantly, the volume of engineering construction has now fallen back to near its long term trend indicating that the wind down in the mining investment boom is almost complete and that it will be less of a drag on growth next year. Meanwhile, skilled vacancies slowed again in July consistent with a further slowing in jobs growth after the surge of the last year but the ANZ-Roy Morgan weekly consumer confidence index has hit a three-year high which may be good news for consumer spending.

What to watch over the next week?

In the US, the big focus will be on August jobs data (Friday) as the last major data release ahead of the Fed’s September 26-27th meeting. Expect a 180,000 gain in payrolls, a fall in unemployment to 4.8% and wages growth remaining around to 2.6% year on year. This should be enough to keep the September Fed meeting “in play” for a hike, but not enough to make it probable. In other data expect soft July personal spending growth and a fall in the core private consumption expenditure measure of inflation to 1.5% year on year (Monday), continued trend gains in home prices and unchanged consumer confidence (Tuesday), a modest rise in pending home sales (Wednesday), the August manufacturing conditions PMI to fall slightly to 52 (Thursday) and a slight improvement in the trade deficit (Friday).

Eurozone economic confidence readings for August will be released Tuesday but are likely to remain around okay levels. The confidence vote in the Spanish parliament for PM Rajoy will also be watched closely.

Expect Japanese data for July to show ongoing labour market strength but weakness in household spending (both Tuesday) and industrial production (Wednesday).

Chinese manufacturing conditions PMIs for August will be watched closely (Wednesday) but both the official and Caixin PMIs are expected to remain around the 50 level consistent with GDP growth around 6.5% or a bit more. The non-manufacturing PMI will also be released.

In Australia, expect July data to show a 2% bounce in building approvals (Tuesday) after two months of falls, continued moderate growth in credit (Wednesday), a 0.3% gain in retail sales and continued softness in June quarter business investment led by mining investment (both Thursday). Capital spending intensions data will be watched closely for any improvement in the outlook for non-mining investment and Core Logic data on August home prices (also due Thursday) will be watched to see whether recent strength in Sydney and Melbourne property prices has continued.

The Australian June quarter earnings reporting season will wrap up with only 12 major companies left to report in the week ahead including Harvey Norman and Adelaide Brighton.

Outlook for markets

After a period of strong gains shares are due for a breather and weak seasonals for the next couple of months along with risks around Italian banks, the Italian Senate referendum, the Fed and global growth generally could be the drivers. However, after a 1-2 month correction or consolidation, we anticipate shares to trend higher over the next 12 months helped by okay valuations, very easy global monetary conditions and continuing moderate global economic growth.

Ultra-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, low inflation and ongoing shocks. That said, the recent bond rally has taken yields to pathetic levels leaving them at risk of a snapback.

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

Dwelling price gains are expected to slow to around 3% over the year ahead, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment prices get hit by oversupply.

Cash and bank deposits offer poor returns.

Recent more hawkish Fed commentary has dampened the $A, but if it delays again then the $A could resume its push back up to April’s high of $US0.78. Beyond the short term though we see the longer term downtrend in the $A ultimately resuming as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, the risk of a sovereign ratings downgrade continues to increase, commodity prices remain in a secular downswing and the $A sees its usual undershoot of fair value.

Eurozone shares rose 0.7% on Friday but the US S&P 500 reversed initial gains on the back of Janet Yellen’s more upbeat assessment of the US economy to end down 0.2% as rate hike expectations moved higher. Reflecting the soft US lead, ASX 200 futures fell 4 points or 0.1% pointing to a soft start to trade on Monday for the Australian share market.

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What to watch over the week

Monday, August 22, 2016

By Shane Oliver

Shares were mostly flat to down over the last week. While Chinese shares gained 2.2%, US shares were flat, Eurozone shares lost 2% reversing some of the gains of the previous week, Japanese shares fell 2.2% and Australian shares dipped 0.1%. Except in Australia, bond yields rose as some Fed officials indicated a September Fed rate hike was “possible” but the $US fell back to near where it was prior to the Brexit vote, which in turn, saw commodity prices rise, with oil helped by optimism of a supply cutback. The $A fell slightly.

The Olympics, US elections and shares in August

Its well-known that August is a seasonally tough month for US shares, with an average decline of -0.6% in the S&P 500 for all Augusts since 1985. Interestingly though, in US presidential election years/Olympic years (they are the same) since 1985, US shares have seen an average 0.7% gain in August. Maybe the feel-good feeling of the Olympics offsets the uncertainty around the election. For Australian shares, average August gains have been 0.4% over the same period for all Augusts and for Augusts in US election/Olympic years.

A big positive this year has been the fall back in the $US after several years of strong gains. From its high late last year, it has now fallen nearly 6%. This has taken pressure off US manufacturers and multinationals, helped commodity prices to stabilise and pick up (as they are priced in US dollars), reduced the downwards pressure on the Chinese Renminbi and the risk of capital flight out of China, and alleviated fears about a dollar funding crisis in the emerging world – all of which has been positive for global growth prospects and hence, risk assets. Of course, the downside has been for Japan and Australia which would prefer a lower Yen and $A respectively, but this is a minor issue in a global context.

Rethinking monetary policy, or just back to the past?

For the last two decades, central banks have been focussed on price stability (using inflation targets) and have played the first line of defence in stabilising the economic cycle, whereas fiscal policy has played back up, focussing more on fairness and efficiency for much of the time. But we are starting to see increasing discussion about whether a new approach is needed to manage macro-economic stability in a world of slower trend growth. Key aspects of this debate are about inflation targeting – that is, whether inflation targets need to be set higher or turned into price level or nominal GDP targets – and whether fiscal policy should play a greater role.

The debate is arguably not as big an issue for countries like the US and Australia, but it is a big one for countries where deflation is or risks becoming entrenched, such as Japan and maybe Europe. Ideally, Japan needs to combine monetary stimulus and fiscal stimulus – via some form of helicopter money - to have a greater chance of meeting its inflation and growth targets without further blowing out its already huge public debt to GDP ratio. The week ahead is likely to see a heightened focus on some of these issues, as the title of the US Federal Reserve’s annual economic policy symposium in Jackson Hole, Wyoming over Thursday to Saturday is “Designing Resilient Monetary Policy Frameworks for the Future.”

The Australian June-half earnings results improved in tone over the last week. While there was no real surprise from BHP’s profit slump, there have been some excellent results from stocks like JB Hi-Fi and Treasury Wine Estates. Key themes are: improving conditions for resources companies following a stabilisation in commodity prices; constrained revenue growth for industrials; ongoing cost cutting; continuing headwinds for the banks; and an ongoing focus on dividends. So far, 51% of companies have reported, with 46% exceeding expectations which is around the norm of 45%. 68% have seen their earnings rise on a year ago, 56% have seen their share price outperform the market the day results were released and 92% have either maintained or increased their dividends. While overall profits look to have fallen 8% in 2015-16 thanks to the slump in resource profits, they are on track for a return to growth in 2016-17 as the slump in resources profits reverses and non-resource stocks see growth.



Source: AMP Capital

Major global economic events and implications


US economic data was mostly good, with solid home builder conditions and another unexpected rise in housing starts, strong leading indicators and a fall in jobless claims but mixed readings from the New York and Philadelphia regional manufacturing conditions indexes. Meanwhile, there were a few gyrations around expectations for when the Fed will next raise interest rates, with the minutes from the July Fed meeting presenting a relatively dovish picture, but regional Fed President’s Williams and Dudley pushing back against market expectations that look to be too dovish. While I don’t see a Fed hike in September, I think it’s possible if we see another really good jobs report for August, and I remain of the view that the Fed will hike in December. Against this backdrop, the US money market’s probabilities of just a 22% chance of a hike in September and 51% in December, albeit up from a week ago, are still too low.

UK real retail sales surged 1.4% in July or 5.9% year-on-year, far stronger than expected. What happened to post-Brexit gloom? I can understand Brexiteers feeling happy, but they were only 37% of those of voting age!

Chinese home prices rose again in July, but with slower growth for Tier-1 cities, and to confuse the China bears, electricity consumption rose 9.6% year-on-year in July, the fastest in 3 years.

The Japanese economy barely grew in the March quarter, as poor net exports and capex offset consumer spending and housing construction. Poor growth, core inflation sliding back towards deflation and the Yen having risen 20% from last year’s low point are piling pressure on the BoJ and PM Abe to do something. With the US dollar around the 100 Yen “line in the sand” a point of action could be getting near.

Australian economic events and implications

While jobs growth was much better than expected in July, and unemployment fell back to 5.7%, the quality of jobs growth remains poor with another surge in part time jobs at the expense of weak full time jobs. And this, in turn, is keeping the combination of unemployment and underemployment very high at over 14% and driving wages growth (including bonuses) to a record low of just 2% year-on-year in the June quarter. Given this, and the ongoing downside risks it implies for inflation, we remain of the view that the RBA will cut the cash rate again in November to 1.25%. In this regard, the minutes from the RBA’s last Board meeting offered nothing really new.

Speaking of interest rates, the Sydney and Melbourne housing markets are looking to be a bit more of a challenge. The perk up in finance commitments to investors, HIA new home sales and weekly auction clearance rates in Sydney and Melbourne (see chart) despite mixed readings on what home prices are doing suggest that the Sydney and Melbourne property markets may be getting a bit too hot again (at least in parts - I hear that western Sydney isn't so strong). Returning to rapid house price gains at a time when the supply of apartments is starting to surge would not be a good thing. But interest rates need to be set on the basis of what is right for the average of Australia - not just house prices in two cities - so the RBA has been right to cut as the average of Australia needed it. However, pressure is likely shifting back to APRA to further tighten lending standards.



Source: Australian Property Monitors/Domain, AMP Capital

What to watch over the next week?

In the US, the focus is likely to be on Fed Chair Janet Yellen’s address to the Jackson Hole symposium for any clues on the interest rate outlook if she even decides to discuss current monetary policy. The likelihood is that if she does, she will reiterate that the process of raising interest rates to more normal levels is likely to remain cautious and gradual, but leave the impression that the Fed is on track to raise interest rates again this year. On the data front in the US, expect the manufacturing conditions PMI (Tuesday) to remain around 52.9, a fall back in new home sales (Tuesday) and in existing home sales (Wednesday), a further rise in home prices (Wednesday), a rise in core durable goods orders (Thursday) and a slight further downgrade to June quarter GDP growth (Friday) to 1% annualised from 1.2%.

In the Eurozone, business conditions PMIs will be released (Tuesday) but are expected to remain around an okay 53.

Japanese consumer price data (Friday) is expected to show continued deflation of around -0.4% year-on-year at a headline level and core inflation of just 0.4% year-on-year.

In Australia, expect June quarter construction data (Wednesday) to show continued weakness in mining related investment but strength in dwelling construction. Skilled vacancy data for July will also be released.

The Australian June quarter earnings reporting season will see its biggest week, with 87 major companies due to report in the week ahead including Fortescue, Oil Search, Westfield and Woolworths.

Outlook for markets


After a period of strong gains, shares are due to take a breather and weak seasonals for the next couple of months along with risks around Italian banks, the Italian Senate referendum, the Fed and global growth generally could be the drivers. However, after a 1-2 month correction or consolidation, we anticipate shares to trend higher over the next 12 months, helped by okay valuations, very easy global monetary conditions and continuing moderate global economic growth.

Ultra-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, low inflation and ongoing shocks. That said, the recent bond rally has taken yields to pathetic levels, leaving them at risk of a snapback.

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

Dwelling price gains are expected to slow to around 3% over the year ahead, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment prices get hit by oversupply.

Cash and bank deposits offer poor returns.

With the Fed continuing to delay rate hikes, a break of April’s high of $US0.78 and a push up to $US0.80 is likely for the $A. Beyond the short term though, we see the longer term downtrend in the $A ultimately resuming as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, the risk of a sovereign ratings downgrade continues to increase, commodity prices remain in a secular downswing and the $A sees its usual undershoot of fair value.

Eurozone shares fell 0.8% on Friday as worries about Italian banks, the upcoming Italian Senate referendum and the risk of another Spanish election weighed and the US S&P 500 fell 0.1%. Reflecting the soft global lead ASX 200 futures fell 6 points or 0.1% on Friday night pointing to a soft start to trade for the Australian share market on Monday.

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Another rate cut in November?

Monday, August 15, 2016

By Shane Oliver

Shares moved higher again over the last week with US shares hitting new record highs, albeit up just 0.1% for the week, Eurozone shares rising 2.4% to their highest since May, Japanese shares up 4.1%, Chinese shares up 2.8% and Australian shares up 0.6%. Bond yields mostly fell as investors remain unconvinced that the Fed is any closer to raising interest rates again. Commodity prices were mixed with oil up but metals down and a lower $US generally saw the $A briefly make it above $US0.77.

It’s now one year since China devalued its currency (by 3% August 11, 2015) and broke the link to the US - and the sky hasn’t fallen! At the time there, was much fear that this would drive massive capital outflow from China causing the Renminbi to plunge and de-stabilise the emerging world. Here we are one year later and while the Renminbi is now down 7% from its pre-devaluation level, it has not crashed, there has been no avalanche of capital outflows from China, there has been little lasting impact on the emerging world and investors now seem more comfortable with a more flexible and volatile Chinese currency. So another disaster that didn’t happen.

In a wide ranging speech, RBA Governor Glenn Stevens provided a useful reminder of just how well the Australian economy has performed over the last decade – with no recession and relative stability despite the worst global slump since the 1930s and the collapse of the mining boom. While lots of factors have played a role in this good performance, the RBA under Glenn Stevens has played a huge role in this outcome. And I have no reason to believe that the contribution to the Australian economy from the RBA under Governor Steven’s successor Philip Lowe will be any less successful in the years ahead.

Governor Stevens also provided useful insights on a range of other issues: that we are “kidding ourselves” if we think the debate about budgetary adjustment won’t have to become more “hard-nosed”; that there is only so much that monetary policy can do, and that thinking about ways to maximise potential growth is not just about debate amongst “elites”; that Australia cannot but be affected by the whole developed world having ultra-low interest rates (with the obvious implication that we have to follow suit to some degree if we want the $A to continue to help in the rebalancing of the economy); and that the inflation targeting framework is rightly flexible enough to allow for the current undershooting of the inflation target. The big takeout for me is that, while it would be nice to get more help from other areas of economic policy, if inflation looks like remaining below target for an unacceptable period and a strong $A is contributing to this, then the RBA will likely cut rates again. We continue to allow for another rate cut in November.

Speaking of rates and the currency, the Reserve Bank of New Zealand has exactly the same problem as the RBA: it cut rates, but because a cut was factored in and maybe because it didn’t sound bearish enough, the $NZ rose just as the $A did a week earlier. The solution will be more cuts and more dovishness from both the RBA and RBNZ.

What about the big Australian banks? The next chart shows the cash rate, the average one year bank term deposit rate and the standard variable mortgage since 1990.


Source: RBA, AMP Capital

Several things are worth noting. First, the period of one for one moves in the standard variable rate and the cash rate over 1997 to 2007 was a bit of an oddity. Banks do not get the bulk of their funding overnight at the cash rate but from a whole bunch of other sources. Movements in these were sort of consistent with the cash rate over the 1997-2007 period so the cash rate was the key driver. Second, since the GFC banks have been trying to get more of their funding from bank deposits as it’s a more stable source of funding than say, short-term money markets. But it’s also more expensive. And to keep depositors on side, banks have had to pay them more. So for example, the deposit rate line in the chart is now above the cash rate when prior to 2008 it was mostly below. Thirdly, banks have also been under pressure from regulators to raise more equity from their shareholders and this is also more expensive (eg they have to pay a 6% or so dividend).

All of which has pushed up the average cost of money the banks borrow relative to the cash rate, so mortgage rates have not come down fully with the cash rate. At the end of the day it is a highly competitive banking market, so those with a mortgage are free to call up their banks, threaten to refinance with someone else and ask for a better deal (who actually pays the standard variable rate of 5.2-5.3% now anyway?). Returning to the days where bank lending rates are regulated and banks resort to rationing the amount they lend based on useful things like “who the customer knows at the bank” would not be a bright move. The danger is that all the bank bashing leads to a weaker banking system in which we all end up worse off. Finally, the argument that monetary policy is no longer effective because of banks partial and out of cycle rate moves is ridiculous. As can be seen in the chart, the main driver of bank mortgage rates through the cycle remains the RBA via its cash rate.

Major global economic events and implications


US economic data was mixed, with a slight rise in small business optimism and continued strength in job openings and hiring but weak July retail sales, albeit this followed very strong and upwardly revised June retail sales growth. Producer price inflation also fell in July. A big negative though was continued weakness in productivity growth which is an obvious outworking of strong jobs growth and soft GDP growth.

Putting aside issues about whether growth is being understated on the back of cheap or even “free” technologies that are significantly enhancing our lives, low productivity growth adds to concerns that potential growth is lower than currently thought and flowing from this that “normal” interest rate levels are also lower. However, I suspect GDP growth and productivity will move higher in the year ahead as the detraction from US growth flowing from a rundown in inventories and energy investment have likely run their course. In terms of the Fed, the soft July retail sales data make a September rate hike even less likely (market probabilities are currently just 16%) but our base case remains for a December hike.

The US June quarter reporting season is now more than 90% done and indicates a clear rebound in earnings from their March quarter low. 78% of companies have beat on earnings and 56% have beat on sales, both of which are above normal levels. More importantly, while earnings are down 2.5% yoy, they have come in around 3% better than expected and are up about 9.5% on the March quarter low.

Japanese data was a bit better with solid gains in machine orders and economic sentiment.

Chinese economic data for July was weaker than expected with a slight slowing in industrial production (from 6.2% yoy to 6%), retail sales and fixed asset investment, continued weakness in exports and imports and weak credit and money supply growth. It's early days yet and recent floods may be impacting, but so far, the data suggests that Chinese growth in the current quarter may be edging down to around 6.5-6.6% yoy. Expect continued policy easing in China, including more interest rate cuts. Meanwhile, although a fall in food price inflation saw CPI inflation fall slightly, producer price deflation is continuing to fade which is good news for nominal GDP growth in China.

Australian economic events and implications


Australian data was a mixed bag with business conditions and confidence down slightly in July but remaining relatively resilient despite the political uncertainty at the time, consumer confidence up slightly in August to be around its long term average helped by the latest rate cut and housing finance up solidly again in June. The okay level of consumer and business confidence point to okay but not spectacular growth in the economy and the rise in housing finance tells us that overall the housing sector is still solid. In terms of the latter, it looks like investor lending is having a bit of a bounce after growth in the total bank book of lending to investors fell way below the APRA 10% limit, but it’s doubtful that investor lending will be allowed to pick up too far as there is a good chance that APRA will lower the 10% limit to around 7-8%.

The Australian June-half earnings reporting season has kicked off on a relatively ordinary note with so far only 37% of companies exceeding expectations (compared to a norm of 45%). However, 71% have seen their earnings rise on a year ago, 52% have seen their share price outperform the market the day results were released and 93% have either maintained or increased their dividends. It’s also still early days with less than 20% of results out so far.



What to watch over the next week?


In the US, expect the minutes from the July Fed meeting (Wednesday) to confirm that at the time it remained dovish and cautious but bear in mind that since then we have seen another strong US jobs report and a further strengthening in financial markets. Meanwhile, expect the August home builders conditions index (Monday) to strengthen slightly to a solid index reading of 60, housing starts to fall slightly after a very strong rise in June but permits to rise further, headline CPI inflation to fall slightly to  0.9% year on year but core inflation to remain unchanged at 2.3% yoy and industrial production to rise modestly (all due Tuesday).

In Europe the minutes from the ECB's last meeting (Thursday) are likely to confirm it remains dovish but in wait and see mode.

Japanese June quarter GDP growth (Monday) is likely to show growth slowing to just 0.2% quarter on quarter, after 0.5% qoq in the March quarter.

In Australia, expect June quarter wages data (Wednesday) to show wages growth at a new record low of 2% year on year reinforcing the downwards pressure on inflation. Employment data for July (Thursday) is expected to show flat employment after a high employment sample rotates out and given that recent forward looking job indicators have been more mixed lately. Unemployment is likely to rise slightly to 5.9%. Meanwhile, the minutes from the last RBA board meeting (Tuesday) are likely to confirm the dovish tone evident in the August Statement on Monetary Policy.

The June quarter earnings reporting season will ramp up in Australia as we move into the two busiest weeks for reports with 66 major companies due to report in the week ahead including JB HiFi, BHP, Wesfarmers, CSL, QBE, Origin, AMP, IAG, DUET, Lend Lease and Woodside Petroleum. After the downgrades since the last reporting season back in February the hurdle to avoid disappointment is now relatively low. Consensus expectations for 2015-16 earnings are for an 8% decline in profits driven by a 50% fall in resources earnings and a 2% fall in bank profits leaving profits in the rest of the market up just 1%. Key themes are likely to be: improved conditions for resources companies following a stabilisation in commodity prices; constrained revenue growth for industrials; ongoing cost cutting; continuing headwinds for the banks; and an ongoing focus on dividends. Sectors likely to see good profit growth are discretionary retail, industrials, gaming and healthcare. Expect disappointers to be punished severely.

Outlook for markets


After a period of strong gains, shares are due to take a breather and weak seasonals for August and September along with risks around Italian banks, the Fed and global growth generally could be the drivers. However, after a 1-2 month correction or consolidation, we anticipate shares to trend higher over the next 12 months helped by okay valuations, very easy global monetary conditions and continuing moderate global economic growth.

Ultra-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, low inflation and ongoing shocks. That said, the recent bond rally has taken yields to pathetic levels leaving them at risk of a snapback.

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

Dwelling price gains are expected to slow to around 3% over the year ahead, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment prices get hit by oversupply.

Cash and bank deposits offer poor returns.

With the Fed continuing to delay rate hikes and the $A pushing up to around $US0.77, a break of April’s high of $US0.78 and a push up to $US0.80 is now looking likely for the $A. Beyond the short term though, we see the longer term downtrend in the $A ultimately resuming as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, the risk of a sovereign ratings downgrade continues to increase, commodity prices remain in a secular downswing and the $A sees its usual undershoot of fair value.

Eurozone shares and the US S&P 500 both fell 0.1% on Friday not helped by soft US retail sales data. Reflecting the soft global lead, ASX 200 futures fell 11 points or 0.2% on Friday night pointing to a soft open for the Australian share market on Monday.

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Reporting season ramps up

Monday, August 08, 2016

By Shane Oliver

Shares were mixed over the last week. A bit of profit taking after the strong gains seen in July, Japan’s disappointing stimulus plans, and continuing worries about Eurozone banks saw Japanese shares fall 1.9%, Australian shares fall 1.2% and Eurozone shares fall 0.4%. But a strong US payroll report on Friday pushed the US share market up 0.4% for the week to a new record high and UK shares rose 1% helped by aggressive monetary easing from the Bank of England. Chinese shares were flat for the week. Commodity prices were mixed, with oil up slightly after bouncing off technical support after a 23% fall since their June high, but metal prices fell. While the $US rose, mainly after the strong jobs report, the $A was little changed. Bond yields rose sharply in the US and Japan, but were little changed in Australia.

While shares could go through a consolidation through the seasonally tough August-October period with various risks remaining, the broad trend is likely to remain up, helped by indications that global growth is not collapsing (while upside data surprises in the US are starting to roll over they are moving up in Europe, Australia and emerging countries), the worst is likely over for profits and economic policy is likely to remain easy (or easier) for longer. In terms of the latter, there have been another three easing moves over the last week with Japan disappointing, but the UK doing more than expected and the RBA easing and dovish.

After the previous week’s underwhelming monetary easing, Japan has followed up with an underwhelming fiscal stimulus. Actual fiscal stimulus this fiscal year will only amount to ¥4.5 trillion – or 0.9% of GDP – a fraction of what had been alluded to over the last few weeks. It's a little improvement on last year’s 0.7% of GDP stimulus. Having not seen the “helicopter money drop” that some thought was about to be delivered, sentiment on Japan has turned very negative again and the Yen is at risk of resuming its upswing. On the one hand it’s hard to keep making excuses and hanging out for something decisive out of Japan. On the other, it’s hard to believe that PM Abe and BoJ Governor Kuroda have given up and are joining the ranks of past indecisive Japanese policy makers of the last twenty five years. Time will tell, but it does seem clear that the sharp back up in Japanese 10-year bond yields seen over the last two weeks (from -0.3% to -0.1%!) won’t go too far, unless Japanese inflation starts turning back up and that seems unlikely in the short term. 

In contrast to Japan, the Bank of England overwhelmed with a rate cut, more quantitative easing focussed on government and corporate bonds, a 4-year cheap funding scheme for the banks and signalled that more is likely. And more is likely, given the short term confidence hit to the UK economy. But I suspect that this easing, and more significantly, the boost to trade from the 15% or so slump in the British pound from its average 2010-14 level, should help minimise the damage. Fortunately, the UK has a decisive central bank able to help patch it up after it shot itself in the foot in June!

The RBA eased and remains dovish, with another easing likely in November. Economic growth is not the major problem. Rather, the RBA’s move was all about making sure that sub-target inflation does not become entrenched and (while it won’t directly say it) trying to offset upwards pressure on the $A in the face of ongoing Fed rate hike delays. While the RBA’s August Statement on Monetary Policy saw no significant changes to the RBA’s forecasts for roughly 3%, GDP growth and 1.5-2.5% inflation over the next two years, the tone of the Statement is actually quite dovish with the RBA saying that “inflation is likely to remain below 2% over most of the forecast period”, that “there is room for even stronger growth”, that the risks around household debt and “rapid gains in housing prices” have diminished and that “forward looking indicators of the labour market have been mixed”. These comments, and in particular, that the RBA does not see inflation coming decisively back into the centre of its target range of 2-3% suggests to us that it retains an easing bias. If September quarter inflation rate remains very low as we expect and the Fed remains in ultra-gradual mode regarding rate hikes as we also expect, then the RBA will cut again in November.

Major global economic events and implications

US data was good with the ISM manufacturing conditions index adding to evidence that the slump in US manufacturing is over, services sector PMIs remaining consistent with good growth, auto sales rising strongly, personal spending also up solidly and employment reports remaining strong. The July jobs report was particularly good, with payrolls up by a more than expected 255,000 coming on the back of a 292,000 gain in June. While unemployment remained at 4.9%, this was because participation rose. Wages growth remains relatively subdued at 2.6% year-on-year, but is still tracing out a gradual uptrend. Since the GFC, unemployment has fallen from around 10% to now 4.9% and unemployment plus underemployment has fallen from around 18% to 9.7%, highlighting the massive improvement in the US economy. The strong July jobs report means the September Fed meeting is “live” for a hike, but given the Fed’s risk management approach and low inflation giving them plenty of flexibility, they are more likely to wait to December. 

Evidence continues to build that US profits are turning up. 433 S&P 500 companies have reported June quarter earnings, with 78% beating on earnings and 56% beating on sales, both of which are above normal levels. More importantly, while earnings are down 3% year-on-year, they have come in around 2% better than expected and are up about 8% on the March quarter low. 

Final business conditions PMIs for July confirmed that Europe remains on track for ongoing moderate growth, while those for the UK collapsed post Brexit. Fortunately, the UK is only 2.5% of the global economy.

China saw some good news with manufacturing and services conditions PMIs moving slightly higher on average in July, pointing to an ongoing stabilisation in growth. 

Reform is getting back on track in India. In a very positive move, India’s Upper House passed a Goods and Services Tax (GST) Constitutional amendment bill. There is a long way to go before the GST kicks in, but when it does, it will be a huge leap forward for India replacing a myriad of silly taxes. Productivity gains from a simpler and more efficient tax system are likely to be significant. This is a positive sign for further reforms in India to the extent that the Modi Government has been able to reach a consensus with the opposition parties on reform. Meanwhile, the Government has formally locked into an inflation target of 4% with a 2% range for the Reserve Bank of India locking the once inflation prone country into international best practice regarding inflation targeting.

Australian economic events and implications

Australian data over the last week presented a mixed picture. On the one hand, the trade deficit worsened in June, retail sales continue to lose momentum and building approvals are trending down. But on the other, net exports look like they will be a neutral contributor to GDP growth in the June quarter, which is pretty good after a huge contribution in the March quarter, the level of building approvals is still high, the pipeline of dwellings to be completed is huge, new home sales remain strong, non-residential approvals appear to be improving and business conditions PMIs for both the manufacturing and services sectors are well above those seen in major developed countries. All of which suggests that growth continues. Meanwhile, the Melbourne Institute’s Inflation Gauge indicates that inflation remained weak in July and CoreLogic data indicated a continued softening in national home price growth.

What to watch over the next week?

In the US, the focus is likely to be on July retail sales (Friday) which are likely to show continued reasonable growth. Data will also be released on small business confidence, productivity, job openings and hiring and producer prices.

In China, July data is expected to show a slight improvement in momentum in exports and imports (Monday), a further fading in producer price deflation but a fall in consumer price inflation to 1.7% year-on-year (Tuesday) mainly due to slower food prices, a fall back in money supply and credit growth after a surge in June, steady growth in retail sales (of around 10.6% year-on-year) and industrial production (around 6.2% year-on-year) but a further slowing in fixed asset investment (all due Friday).

In Australia, expect the NAB business survey (Tuesday) to show business conditions and confidence holding up reasonably well and consumer confidence (Wednesday) to bounce back a bit helped by the latest RBA rate cut and a settling of political uncertainty in Canberra. Housing finance data for June (Wednesday) is expected to bounce back as the May rate cut feeds through. A speech by RBA Governor Glen Stevens on Wednesday will be watched for any clues on interest rates.

The Australian June half profit reporting season will also start to ramp up with 23 major companies reporting including News Corp, CBA, Fairfax and Telstra.  

After the downgrades since the last reporting season back in February, the hurdle to avoid disappointment is now relatively low.

Consensus expectations for 2015-16 earnings are for an 8% decline in profits driven by a 50% fall in resources earnings and a 2% fall in bank profits, leaving profits in the rest of the market up just 1%.

Key themes are likely to be: improved conditions for resources companies following a stabilisation in the iron ore and oil price; constrained revenue growth for industrials although improved business conditions according the NAB business survey may help; ongoing cost cutting; continuing headwinds for the banks; and an ongoing focus on dividends.

Sectors likely to see good profit growth are: discretionary retail, industrials, gaming, and healthcare. Expect disappointers to be punished severely, with sharp share price falls.

Outlook for markets

Seasonal September quarter weakness along with risks around Italian banks, the Fed and global growth generally could still see more volatility in shares in the short-term. However, beyond near-term uncertainties, we anticipate shares to trend higher over the next 12 months helped by okay valuations, very easy global monetary conditions and continuing moderate global economic growth. 

Ultra-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, low inflation and ongoing shocks. That said, the recent bond rally has taken yields to pathetic levels leaving them at risk of a snapback.

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

Dwelling price gains are expected to slow to around 3% over the year ahead, as the heat comes out of Sydney and Melbourne thanks to tougher lending standards and as apartment prices get hit by oversupply in some areas.

Cash and bank deposits offer poor returns. 

With the Fed continuing to delay rate hikes and the $A pushing up to around $US0.76, there remains a real risk that it will re-test April’s high of $US0.78 and maybe push on to $US0.80. Beyond the short term, we see the longer term downtrend in the $A continuing as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, the risk of a sovereign ratings downgrade continues to increase, commodity prices remain in a secular downswing and the $A sees its usual undershoot of fair value. The $A is still likely to fall to around $US0.60 in the years ahead. 

Thanks to the strong July jobs report in the US, Eurozone shares gained 1.4% on Friday and the US S&P 500 rose 0.9%. Reflecting the positive global lead ASX 200 futures rose 31 points or 0.6% pointing to a positive start to trade on Monday for the Australian share market. 

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What to watch this week: Reporting season

Monday, August 01, 2016

By Shane Oliver

The past week was mixed for share markets. While Australian shares rose 1.2% and Eurozone shares rose 1%, US shares fell 0.1% as oil prices declined, Japanese shares lost 0.4% not helped by an underwhelming easing by the Bank of Japan and Chinese shares fell 0.7% on the back of the banking regulator increasing measures to reduce financial risks. Bond yields also fell, but commodities were mixed with oil down and iron ore up and the $US declined which saw the $A rise. 

More broadly, July was a good month for shares, with strong gains in global shares (US shares +3.6%, Eurozone shares +5.1%, Japanese shares +6.4% and Chinese shares +1.6%) and the Australian share market up around 6.3%, its best month since October 2011. Key drivers included good global economic data, good profit news out of the US, talk of easier for longer monetary policy and in Australia’s case, a further rise in the iron ore price. As can be seen in the chart below, economic data has been coming in better than expected lately, with economic surprise indices (which measure data releases against market expectations) looking better.

Source: Bloomberg, AMP Capital

As expected, the Fed is more upbeat on the US economy, sees the near term risks as having diminished but still sees only gradual interest rate increases ahead. The basic message is that the Fed is not going to do anything to knowingly put the global and US economies at risk given the fragile nature of growth and the fact that inflation remains low. Weaker-than-expected US June quarter GDP growth of just 1.2% annualised and soft June quarter employment cost growth of 2.3% year-on year-will further delay the Fed, but another hike is still likely by year end.

After much anticipation, Japan has announced more monetary and fiscal stimulus. However, the Bank of Japan has underwhelmed with just a doubling of its of ETF buying program (to ¥6 trillion pa) but no increase in its bond buying program or monetary base target and no further cut in interest rates, suggesting no real further easing of monetary policy. However, it’s not all negative, as the ETF buying is positive for shares, the absence of more negative interest rates is positive for banks and the BoJ will review policy more broadly at its next meeting. The focus now shifts to fiscal stimulus, with PM Shinzo Abe announcing plans for a ¥28 trillion economic stimulus. While this is a big number (6% of GDP) much uncertainty remains around how much is real new stimulus and how many years it will be spread over. It’s doubtful that any of this will be enough to break the stop/start recession pattern and achieve the 2% inflation target, so ultimately, some form of helicopter money will be required, but we are not there yet. In the mean-time, there is a risk of further Yen strength.  

The results of the latest European large bank stress tests were better than expected with only Italy’s Monte Paschi and Allied Irish “failing” the tests in that their capital ratio would fall below 4.5% under stress. Allied Irish only failed marginally, but Monte Paschi would see its capital wiped out. The problems at Monte Paschi are no surprise though. 

What's wrong with Italian banks? Put simply, after years of poor growth and low interest rates Italy's banks have seen their non-performing loans rise to the point that one of them – Monte Paschi - needs to be recapitalised or else it will have to slow lending which will be bad for Italian growth. The trouble is that bank share prices have collapsed, making it hard to raise capital from the equity market and European rules on bank recapitalisation require private bond holders in banks to take losses ahead of the injection of public money. After the political furore that followed when an elderly retail investor committed suicide last November after having to take a €100,000 loss on a bond holding in a small bank, the Italian Government cannot afford to have a wider “bail-in” of ordinary bank investors as it will damage its prospects of winning a referendum on reducing the Italian Senate's power, which in turn could lead to the fall of the Renzi Government. So there is a stand-off between PM Matteo Renzi and the European Commission, but ultimately, a compromise is likely as the rest of Europe realises that failure to do so could see the Eurosceptic Five Star Movement attain power in Italy. The European Banking Authority's bank stress tests could help clear the way for such a compromise.

While June quarter inflation in Australia was in line with expectations including those of the Reserve Bank, it showed that inflation has fallen further below target and that underlying inflationary pressures are very weak. Ongoing signs of very weak pricing power are evident in a range of areas including for supermarket items, clothing, rents, household equipment, car prices, communication and recreation. The basic message is the global deflationary forces, high levels of competition and weak wages growth are keeping inflation ultra-low with the risk inflationary expectations will be pushed down and make it harder to get inflation back to target. As such, pressure on the RBA remains intense.

Major global economic events and implications

US data was a bit mixed over the last week with stronger-than-expected consumer confidence and new home sales and continuing low jobless claims, but soft durable goods orders, pending home sales, GDP growth and employment cost growth. June quarter GDP growth disappointed at just 1.2% annualised after just 0.8% in the March quarter. However, final demand growth was solid at 2.4% and the detraction from inventories (which was -1.2 percentage points) is likely to have largely run its course. 

Evidence is continuing to build that US profits have bottomed. 316 S&P 500 companies have now reported June quarter earnings to date and the results show an 8% plus pick-up in profits on the March quarter with 81% beating on earnings and 58% beating on sales.

While confidence readings in the UK continue to come in very weak post Brexit, they are holding up reasonably well in the Eurozone with economic confidence actually rising slightly in July. Eurozone bank lending growth also picked up a notch in June, pointing to continued moderate growth. June quarter GDP growth slowed to 0.3% quarter-on-quarter or 1.6% year-on-year from 1.7% year-on-year and July core inflation was unchanged at 0.9% year-on-year.

Although Japanese jobs data in June remained solid and industrial production rose, household spending remains very weak, deflation remains evident in a fall in the CPI of -0.4% year-on-year and core inflation fell further to just 0.4% year-on-year. What’s more, the jobs data is being flattered by a falling workforce and while industrial production bounced it followed a weak May and is down -1.9% year-on-year. All of which explains the need for more aggressive stimulus in Japan.

Australian economic events and implications

Apart from continuing low consumer price inflation in the June quarter, producer price and import price inflation was also weak. Private sector credit data showed weak growth with growth in the stock of lending to property investors slowing.

What to watch over the next week?

In the US, jobs data (Friday) is likely to remain consistent with solid US economic growth. Expect a 180,000 gain in payroll employment, unemployment remaining around 4.9% and a slight edging up in wages growth. Meanwhile the manufacturing conditions ISM index (Monday) is likely to remain around 53, the core private consumption deflator (Tuesday) is expected to hang around 2.6% year-on-year and the non-manufacturing conditions ISM (Wednesday) is expected to remain solid. June quarter corporate earnings will also remain a focus.

The true stimulus flowing from Japan’s ¥28 trillion plus stimulus package will be assessed when details are released Tuesday. 

The Bank of England (Thursday) is likely to ease policy, responding to the post Brexit confidence slump.

Chinese manufacturing conditions PMIs (Monday) are expected to show a modest improvement, but nothing to excite.

In Australia, we expect the Reserve Bank (Tuesday) to cut the cash rate again by another 0.25% taking it to a new record low of 1.5%. The June quarter inflation data is not low enough to make an RBA rate cut certain, particularly given that recent economic data has been reasonably good. However, on balance we expect that the RBA will cut again to help ensure that inflation expectations do not become entrenched below 2%, so that there is reasonable confidence that inflation will move back into the target zone in a reasonable time frame and to head off a rebound in the $A. Alternatively, if the RBA does not cut again on Tuesday, then expect an easing in November. The RBA’s Statement on Monetary Policy (Friday) will likely make minimal changes to its growth and inflation forecasts.

On the data front in Australia, expect July CoreLogic data to show a further loss of momentum in Sydney and Melbourne home prices, a 1% bounce in June building approvals and a slight improvement in the June trade deficit (all Tuesday) and a 0.3% gain in retail sales (Thursday).

The Australian June-half profit reporting season will also start to get underway in the week ahead, with a handful of companies due to report (including Rio, Tabcorp and Suncorp). After the downgrades since the last reporting season back in February the hurdle to avoid disappointment is now relatively low. Consensus expectations for 2015-16 earnings are now for an 8% decline in profits driven by a 50% fall in resources earnings and a 2% fall in bank profits leaving profits in the rest of the market up just 1%. Key themes are likely to be: improved conditions for resources companies following a stabilisation in the iron ore and oil price; constrained revenue growth for industrials although improved business conditions according the NAB business survey may help; ongoing cost cutting; continuing headwinds for the banks; and an ongoing focus on dividends. Sectors likely to see good profit growth are discretionary retail, industrials, gaming and healthcare.

Outlook for markets

Brexit related risks, Italian bank risks, renewed $US strength and seasonal September quarter weakness could still see more volatility in shares in the short term. However, beyond near-term uncertainties, we anticipate shares trending higher over the next 12 months helped by okay valuations, very easy global monetary conditions and continuing moderate global economic growth. 

Ultra-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, low inflation and ongoing shocks. That said, the recent bond rally has taken yields to pathetic levels leaving them at risk of a snapback.

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

Dwelling price gains are expected to slow to around 3% over the year ahead, as the heat comes out of Sydney and Melbourne thanks to tougher lending standards and as apartment prices get hit by oversupply in some areas.

Cash and bank deposits offer poor returns. 

With the Fed continuing to delay rate hikes and the Aussie dollar pushing up to around $US0.76, there is a real risk that it will re-test April’s high of $US0.78 and maybe push on to $US0.80 if the RBA does not cut rates on Tuesday. Beyond the short term, we see the longer term downtrend in the Aussie dollar continuing as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, the risk of a sovereign ratings downgrade continues to increase, commodity prices remain in a secular downswing and the dollar sees its usual undershoot of fair value. The dollar is still likely to fall to around $US0.60 in the years ahead. 

Eurozone shares rose 0.8% on Friday and the US S&P 500 gained 0.2% helped by good earnings results and as soft US GDP growth added to expectations that the Fed would delay hiking rates again. Following the positive global lead ASX 200 futures rose 17 points, or 0.3%, pointing to a positive start to trade Monday.

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Signs are pointing to an August rate cut

Monday, July 25, 2016

By Shane Oliver

It’s now four weeks since the Brexit panic on June 24 and since then US shares are up 7%, Eurozone shares are up 6%, British shares are up 10%, Australian shares are up 7% and Japanese shares are up 11%. Fears around Brexit’s global impact look to have been wildly exaggerated. The only really lasting impact (so far) has been on the British pound which is down another 4% leaving it down 11% from June 23rd, which reflects the negative impact of Brexit on the UK economy.

Over the past week, the rally in shares generally continued with US shares up 0.6%, Eurozone and Japanese shares up 0.8% and Australian shares up 1.3% but Chinese shares down 1.6%. A combination of good economic data, good US profit results, the absence of a major negative impact outside the UK from Brexit and talk of more policy stimulus in parts of the world are continuing to help. Bond yields were generally flat to down, commodity prices fell and the $A fell partly in sympathy with NZ moves towards another monetary easing. 

The talk around Japan’s planned fiscal stimulus is continuing to get ramped up with the size of the package supposedly going from ¥10trillion, to ¥20trillion to maybe even ¥30trillion which is around 6% of GDP, albeit it depends how many years it is spread over. If, as we expect, it’s focussed on encouraging consumers to spend more then it should have a reasonable chance of success. 

In maybe a sign of things to come in Australia – NZ looks to be heading for another rate cut. After a low inflation outcome, a further tightening in restrictions on residential mortgage lending and the Reserve Bank of New Zealand stating that “a decline in the [$NZ] is needed”, the RBNZ has set the scene for a rate cut next month. In fact, it said that “it seems likely that further policy easing will be required”.

The IMF downgraded it's global growth forecasts to 3.1% for 2016 (from 3.2%) and to 3.4% for 2017 (from 3.5%) on Brexit risks - but hardly a surprise. It must often strike the ordinary investor as weird that much fanfare is given to the IMF downgrading its growth forecasts, but share markets seem to largely ignore it. There are several reasons for this but in essence it’s because the market (and most economists) have already moved ahead of the IMF and the IMF global growth forecasts have been starting out too optimistic for years now. Since early this decade, they have been starting out forecasting 4% global growth for the year ahead, only to end around 3%. This is not great – but it’s not bad either! Just more of the same. 

One positive from the last week – we learned that Trumps can say thoughtful things. Not to worry that they were Michelle Obama’s. In the week ahead, it’s on to the Democrat convention which may be a lot calmer!

Major global economic events and implications

US data was on a roll. Housing data was strong (with solid readings for home builder conditions, starts, sales and home prices), jobless claims remain very low, leading indicators rose more than expected and the Markit manufacturing PMI rose solidly in July. So much for all the waffle about a US recession! The US housing recovery likely has a long way to go as housing starts at 1.2 million continue to run below underlying demand of 1.5 million with the overbuilding of last decade having been more than worked off. Buying a house in Detroit still looks like a good proposition! 

Evidence is continuing to build that US profits bottomed in the March quarter. 125 S&P 500 companies have now reported June quarter earnings to date, and so far so good, with 82% beating on earnings and 60% beating on sales. While the market expects profits to fall 3% from a year ago, this will translate into a rise in profits of 8% from the March quarter.

As expected, the ECB remained in wait and see mode at its July meeting. However, President Draghi referred to greater uncertainties in reference to Brexit and reiterated the ECB’s “readiness, willingness and ability to act” if necessary. We remain of the view that its QE program will be extended beyond its current expiry of March 2017. Eurozone business conditions PMIs and consumer confidence fell slightly in July, suggesting little impact on confidence and conditions from Brexit. They remain at levels consistent with moderate growth. Interestingly, the ECB’s bank lending survey showed an increase in demand for loans and a further easing in lending standards which is also a good sign as the survey was conducted before and after the Brexit vote.

It’s not so good for the UK where its PMI fell sharply in July as Brexit hit, adding to evidence it may be heading into recession. Just remember though that the UK is only 2.5% of world GDP.

Japan’s manufacturing conditions PMI showed a welcome improvement in July albeit it’s still weak.

The Chinese property market recovery remains a positive for growth – with residential property prices up another 0.8% in June or 7.8% year-on-year. Meanwhile, the MNI Chinese business sentiment index rose in July and significant flooding in parts of China could have a short-term positive impact on GDP from rebuilding and may temporarily boost food prices.

Australian economic events and implications

In Australia, the minutes from the RBA’s last Board meeting confirmed that the door is wide open for another rate cut at its August 2 meeting. While not as direct as the Reserve Bank of New Zealand, the RBA indicated that it was waiting on further information on inflation, the labour market and the housing market and the next update of the RBA’s economic forecasts. Since it has described the labour market and the housing market as “mixed”, and recent data on both suggest no reason to change that assessment, the implication from the RBA is that should we see another low inflation reading when the June quarter CPI numbers are released on Wednesday. And then it’s likely that the RBA will cut the cash rate from 1.75% to 1.5% on August 2. A CPI outcome of 0.4% quarter-on-quarter for headline and underlying – which is what we expect - would likely be enough to see the RBA cut again.

What to watch over the next week?

The focus in the week ahead will be on monetary policy - with June quarter inflation data in Australia providing a guide to whether the RBA will cut rates again next month and both the Fed and Bank of Japan meeting – and European banks with another round of stress tests.

In the US, we expect the Fed (Wednesday) to leave rates on hold as it seeks to gain more confidence that US growth is back on track and that the impact from Brexit will be minimal, but to indicate that it still expects to raise rates in a gradual and cautious fashion. The US money market is only implying a 10% chance of a hike in the week ahead, but the Fed may try and push up the market’s probability of a hike going forward, which is currently at just 24% for September and 45% for December. With US growth averaging around 2%, the labour market continuing to tighten with wages growth edging higher and inflation heading up towards target, we see more like a 65% chance of a hike in December. The main brake on the Fed will be if the $US rises too strongly as it amounts to a de facto monetary tightening. On the data front in the US, expect to see continuing gains in US home prices, a rise in new home sales but a fall in consumer confidence (all Tuesday), softish durable goods orders and a rise in pending home sales (Wednesday), a slight edging up wages growth (according to the June quarter employment cost index) and a bounce back in annualised GDP growth to 2.6% in the June quarter (both Friday) after just 1.1% growth in the March quarter. Earnings will also remain a focus, with over 180 S&P 500 companies to report June quarter earnings.

In the Eurozone, the focus will be on the latest ECB bank stress tests (Friday) which will indicate whether banks are sufficiently capitalised or not. Italian banks of course will be the main focus, and the stress tests should help clear the way for some of them to be recapitalised. On the data front, expect June quarter GDP (Friday) to show moderate economic growth of around 1.5% year-on-year and confidence readings (Thursday) will provide a further guide to the impact of Brexit on business confidence. Data will also be released for bank lending (Wednesday) and core inflation (Friday) is likely to have remained around 0.9% year-on-year on July.

The Bank of Japan (Friday) is likely to announce further monetary easing as the Japanese government prepares to unveil its much talked about fiscal stimulus package. While it’s doubtful this will involve “helicopter money” (ie direct BoJ financing of government spending), it is getting close. Rather, it's likely to involve further monetary easing through some combination of increased ETF and corporate debt purchases and another cut in the negative deposit rate. While Bank of Japan Governor Kuroda rejected the idea of helicopter money in June, he also rejected negative interest rates shortly before announcing them. Japanese data due Friday is expected to show continued labour market strength and a bounce in industrial production but soft household spending and inflation.

In Australia, expect another low inflation reading on Wednesday for the June quarter to clear the way for an August RBA rate cut. While headline inflation is expected to rise 0.4% quarter-on-quarter thanks to higher petrol prices and a seasonal rise in health costs, this is likely to see annual inflation drop to 1.1% year-on-year and low wages growth and competitive pressures are likely to have seen underlying inflation rise just 0.4% qoq or 1.4% yoy, which is down from 1.6% yoy in the March quarter. June credit data (Friday) is likely to show that credit growth remains moderate with the stock of lending to property investors continuing to show slower growth.

Outlook for markets

Brexit related risks, Italian bank risks, renewed $US strength as the Fed heads back towards tightening and seasonal September quarter weakness could still see more volatility in shares in the short term. However, beyond near-term uncertainties, we anticipate shares trending higher over the next 12 months helped by okay valuations, very easy global monetary conditions and continuing moderate global economic growth. 

Ultra-low bond yields (with one third of the global bond index in negative yield territory) 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, low inflation and ongoing shocks. That said, the recent bond rally has taken yields to pathetic levels leaving them at risk of a snapback. Renewed expectations of a Fed hike may be the driver.

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

Dwelling price gains are expected to slow to around 3% over the year ahead, as the heat comes out of Sydney and Melbourne thanks to tougher lending standards and as apartment prices get hit by oversupply in some areas. Prices are likely to continue to fall in Perth and Darwin. 

Cash and bank deposits offer poor returns. 

The Australian dollar is still higher than it should be and the longer term downtrend looks likely to continue, as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, the risk of a sovereign ratings downgrade continues to increase, commodity prices remain in a secular downswing and the $A sees its usual undershoot of fair value. The $A is still likely to fall to around $US0.60 in the years ahead.

Eurozone shares gained 0.1% on Friday and the US S&P 500 rose 0.5%, helped by good earnings results and better-than-expected business conditions PMIs. As a result of the positive global lead, the ASX 200 futures contract rose but only by 4 points or 0.1%, pointing to a mild positive start to trade for the Australian share market on Monday. Gains are likely to be tempered by softer commodity prices, including a fall in the iron ore price, which will weigh on resources stocks.

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