The past week saw mixed share markets. US shares were flat, with strong data offset by worries about a more hawkish US Federal Reserve (Fed) and tariffs on Chinese imports, Eurozone shares rose 1.4% as the European Central Bank (ECB) remained dovish and Italian risks receded a bit and Japanese shares rose 0.7% as the Bank of Japan remained dovish. Chinese shares were not helped by soft economic data and fell 0.7%. However, the Australian share market rose 0.8%, helped by a mostly positive global lead and as lower bond yields helped support strong gains in yield-sensitive utilities and telcos. Bond yields generally fell as did prices for oil and metals, but iron ore rose. A mildly hawkish Fed and strong US data at the same time as a dovish ECB and Bank of Japan and softer non-US data saw the US dollar rise to its highest since July last year and this saw the A$ fall back below US$0.75.
Good news on North Korea and Italy, but the trade war threat remains. The Trump/Kim summit was a big deal for world peace and while some critics wanted more, no major peace deal has been achieved in a day – that it happened, that there is agreement to work towards the complete denuclearisation of the Korean peninsula, that there will be talks to follow to implement this and that the US will suspend military exercises is the best that could have been hoped for from the summit. It gives investors a bit of peace on this issue for at least a year. Tick for now. On Italy and Itexit worries there was a bit of relief, with new Italian Finance Minister Tria saying that there has been no discussion of an Itexit. Budget conflict with the European Commission still lies ahead, but our view remains that Italy stays in the Euro. So tick for now.
Meanwhile the trade war threat remains, with the US announcing its latest list of $50 billion of Chinese imports to be subject to a 25% tariff of which $34 billion will be implemented on 6th July and the remainder are still subject to further review. And as expected, China immediately announced a proposed list of tariffs on $50 billion of imports from the US. No tick here. Just bear in mind though that this should be no surprise to anyone, as it’s what Trump’s statement on 29th May said the US would do by 15th June, it’s still just another list that has yet to be implemented and if implemented it would cover less than 2% of imports to the US, so we would still be a long way from the Smoot-Hawley 20% tariffs on all imports that helped make the Great Depression “great”. Trump also sees these announcements as a way of pressuring China into action on trade – so more classic Art of the Deal stuff - with US Trade Representative Lighthizer hoping “that this leads to further negotiations” and with the 6th July start date for some of the tariffs still leaving three weeks to do so. Ultimately a negotiated solution is likely – and this is what both the US and China want - but the risks are high and the tariffs could well be implemented before the issue is resolved.
Major central banks slowly taking away the punch bowls, but it’s very gradual and there is still lots of punch around:
- The Fed provided no surprises in hiking rates again for the seventh time this cycle, but yet again it was a bit more hawkish and the “dots” have moved to four hikes this year. Our view remains four hikes this year and three next and we continue to see US money market expectations as too dovish. This should all mean ongoing upwards pressure on US bond yields, but it’s worth noting that US rates at 1.75-2% are still far from tight and so we are still a long way from the point where US growth is threatened.
- The ECB made no changes to monetary policy, but confirmed that it “anticipates” ending its quantitative easing program in December after further phasing it down to €15 billion/month through the December quarter. However, it’s been tapering its QE program since 2016, it’s left the door open to extending QE into 2019 if needed (by making its ending “subject to incoming data”), it’s indicated it will reinvest maturing assets for an “extended period” and that it expects no rate hike until at least mid-2019. Furthermore, ECB President Draghi’s comments were dovish. It took the Fed more than a year after ending QE before it started rate hikes. With inflation way below target, growth indicators softening a bit lately and uncertainties around Italy, a rate hike is unlikely until 2020 at the earliest. So ECB ‘easy money’ may be getting a bit less easy, but it still looks like remaining easy for a long while yet.
- Finally, the Bank of Japan remains full steam ahead with its ultra-easy monetary policies. No surprise here, with weaker data lately and core inflation falling again.
While talk of the ending of ultra-easy monetary policy globally generates periodic excitement in markets and amongst commentators, it’s worth noting that it’s now more than five years since the US “taper tantrum” started it all off – so it’s been a very gradual process – and I suspect global monetary policy will remain easy for years to come. Just less easy than it was.
Major global economic events and implications
US economy accelerating. Small business optimism rose to its second highest level ever (with surging worker compensation and profit readings), retail sales growth was very strong in May, industrial production dipped in May (but this was due to auto) and the New York regional manufacturing conditions index rose further in June. In addition, jobless claims remain ultra-low and consumer, producer and import price data show a continuing edging up in inflationary pressures and point to core private consumption deflator inflation (the Fed’s preferred inflation measure) rising to 1.9-2% year-on-year for May. The Atlanta Fed’s GDPNow growth tracker puts June quarter growth at 4.8%.
Eurozone economy still slowing. Eurozone industrial production fell in April, consistent with some softening in Eurozone growth – which will present a bit of a threat to the ECB’s plans to end its QE program in December.
China slowing too. Chinese data mostly softened, suggesting the long awaited mild slowing in growth may be underway. Unemployment edged down in May to 4.8% and home price gains picked up, but industrial production, retail sales, investment and credit growth all slowed. This may reflect noise in monthly data, but it may also be reflecting the impact of deleveraging measures which have hit “shadow banking.” This is broadly consistent with our view that GDP growth will slow to 6.5% this year. However more moves to ease monetary policy are likely to ensure growth doesn’t slow too much.
Australian economic events and implications
Australian data was back to being a bit on the softish side. Business confidence slipped a bit in May but remains solid, consumer confidence remains stuck around long-term average levels, housing finance continued to slow in April - with tighter bank lending standards pointing to more weakness to come - and jobs data was a bit soft in May. Employment growth was weaker than expected, with full-time jobs falling, and while unemployment fell slightly this was because of a decline in participation. Meanwhile underemployment rose slightly over the last three months to 8.5%, so total labour market underutilisation remains very high at 13.9%.
While RBA Governor Lowe reiterated the mantra that the next move in interest rates is likely to be up, he also said any increase “still looks to be some time away” and indicated that to raise rates the RBA is looking for reduced labour market slack, faster wages growth and increased confidence inflation is picking up. At present there is no sign of reduced labour market slack and this is likely to continue to weigh on wages growth. We remain of the view that with trend growth likely to be remain subdued, bank lending standards tightening, and Sydney and Melbourne house price falls having further go, that the RBA won’t start raising rates to 2020 at the earliest and in the meantime the next move being a cut can’t be ruled out.
What to watch over the next week?
Apart from the ongoing issues around trade, the focus in the week ahead will remain on central banks, with Fed Chair Powell, ECB President Draghi, BoJ Governor Kuroda and RBA Governor Lowe all participating in a panel discussion in Portugal on Wednesday. It’s doubtful that any of them will say anything new, having all just had meetings or made speeches, but no doubt their comments will be watched for any clues on the monetary policy outlook.
In the US, expect home builder conditions (Monday) to remain strong, housing starts (Tuesday), home sales (Wednesday) and home prices to all rise and the June business conditions PMIs (Friday) to remain strong at around 56-57.
Eurozone June business conditions PMIs (Friday) will be watched closely to see if the recent softening trend continues.
The Bank of England (Thursday) is expected to leave monetary policy on hold, particularly given recent softer data and ongoing Brexit uncertainty.
Japanese core inflation data for May (Friday) is expected to show a further dip to 0.3% year-on-year (from 0.4% in April), consistent with Tokyo inflation data already released.
In Australia, ABS March quarter data is expected to confirm a 1% or so decline in home prices (Tuesday) consistent with already released private sector surveys, and population growth data (Thursday) for 2017 is expected to show continued strength of around 1.6% year-on-year, with Victoria the strongest on the back of high immigration levels and interstate migration. The minutes from the RBA’s last board meeting (Tuesday) are likely to confirm that the RBA remains comfortably on hold.
Outlook for markets
Volatility in share markets is expected to stay high, as US inflation and interest rates move up and as issues around President Trump (trade, Mueller inquiry, etc) continue to impact, but the medium-term trend in share markets is likely to remain up as global growth remains solid, helping to drive good earnings growth. We continue to expect the S&P/ASX 200 index to reach 6,300 by end 2018.
Low yields and capital losses from rising bond yields are likely to drive low returns from bonds. Australian bonds are likely to outperform global bonds, helped by the relatively dovish RBA.
Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning, and listed variants are vulnerable to rising bond yields.
National capital city residential property prices are expected to slow further as the air continues to come out of the Sydney and Melbourne property boom and prices fall by another 4% this year, but Perth and Darwin bottom out, Adelaide and Brisbane see moderate gains and Hobart booms.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
The A$ likely has more downside to around US$0.70 as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory, as the US economy booms relative to Australia. Solid commodity prices should provide a floor for the A$ though in the high US$0.60s.
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