Investment markets and key developments over the past week
- Global share markets were mostly up over the last week but Australian shares fell slightly. Mixed US data, the ongoing soap opera over what the Fed will do and the absence of further ECB easing likely constrained gains. Despite some gyrations global bond yields were little changed globally. However, Australian bond yields rose in response to strong data and perceptions that the RBA may have finished cutting interest rates which in turn helped drag down the Australian share market. Commodity prices rose, particularly oil on the back of a sharp Gulf of Mexico storm related fall in US crude inventories. The combination of stronger than expected Australian economic growth and a lower $US saw the $A rise.
- G20 leaders said all the right things after the latest summit in China about the limits to monetary policy and putting more emphasis on fiscal policy and structural reforms, but there was little if any market impact – perhaps because we have heard it before. For example, what happened to the 2% growth boosting commitment from the 2014 G20 summit?
- In the absence of a greater focus on fiscal policy and structural reforms to boost growth, central banks still have inflation mandates to meet and the pressure falls back on them. And on this front the “easy for longer” story remains. Mixed US economic data – notably slower payrolls and business conditions surveys - and the absence of inflation pressures makes it hard for the Fed to justify a rate hike this month. And in the meantime the Bank of Japan and European Central Bank remain under pressure to do more.
- The European Central Bank left monetary policy unchanged as expected at its meeting in the last week and the lack of any significant change to the ECB's economic forecasts and President Draghi's comment that an extension of the current quantitative easing program was not discussed led to a hawkish market interpretation of the meeting. 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 underlying deflationary pressures globally and record low wages growth domestically and the $A is too high and at risk of breaking beyond the April high of $US0.78 given the Fed’s endless delays in raising rates. 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 of 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 remaining 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 (although there was 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 has dropped further to 28% (from 32% a week ago). Our base case remains for a December hike but this “will they or won't they” soap opera looks like dragging on a 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% qoq 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%mom 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 to have remained around 2.2% year on year (Friday).
- 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 remaining rising back to 5.8%.
Outlook for markets
- After a period of strong gains into July/early August shares are vulnerable to a further consolidation or correction in the next few months. In fact Australian shares have already fallen 4% from their August high. 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 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 a September Fed rate hike looking unlikely there is a high risk that the $A AUD/USD re-tests its April high of $US0.78, 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 in a secular downswing and the $A sees its usual undershoot of fair value.