Investment markets and key developments over the past week
Global share markets were mixed this week. Dovish comments from US Fed Chair Powell confirmed market expectations for rate cuts starting from July boosting US equities but rate cut expectations were also tempered by stronger US consumer and producer price data. This week, US shares are up by 0.8% (and hit a record high), European shares are 0.9% lower, Japanese shares fell by 0.3%, Chinese equities are 2.2% lower and Australian shares are down by 0.8% (but this follows significant outperformance over recent weeks). US 10-year yields lifted noticeably to just over 2.1% and the US dollar fell.
Oil prices rose on continued tensions in the Middle East and concerns of supply cuts as data showed a decline in oil stocks.
No major updates on US/China trade relations although President Trump did tweet that China needs to be buying more US agricultural products (to reduce the US trade deficit), as previously agreed by the two nations. The US relaxed restrictions this week on US companies selling to Chinese telecommunications company Huawei but this is not a sign that trade dispute risks are diminishing. Negotiations are likely to continue for months.
Trade issues flared up between Japan and South Korea as Japan imposed restrictions on materials exported to South Korea, which Korean firms use for various tech products like smartphone chips. This trade spat reflects historical tensions and is unlikely to go much further but is another negative for the global economy at a time when growth is already under pressure.
Major global economic events and implications
Global central bank easing remains a key theme in markets. US Fed Chair Powell gave his semi-annual testimony to Congress and reinforced expectations for a July interest rate cut with commentary that the Fed has turned more dovish since its June meeting because of “uncertainties around trade tensions and concerns about the strength of the global economy” and concerns that low inflation will persist for longer than expected. Following the testimony, data for US core CPI (excluding food and energy) for June rose a little more than expected, by 0.3%, with annual growth increasing to 2.1%. While this was above expectations, inflation is hardly out of control so another two or three 0.25% interest rate cuts should still be expected this year, with the first in July. US producer price inflation was also stronger than expected with the core reading up 2.3% over the year to June (expected to be at 2.1% year-on-year). Markets are still pricing in another three 0.25% cuts over the next six months but have lowered expectations of a 0.50% rate cut in July. US Fed minutes from June indicated that many members agreed that more policy stimulus was necessary, and that inflation would take longer than expected to get back to the Fed’s target.
Chinese price data this week showed no growth in producer prices over the year to June which was lower than expected and led to concerns about deflation. Consumer prices rose by 2.7% over the year to June (as expected).
The Bank of Canada (BoC) kept interest rates unchanged at 1.75% but the statement around its decision appeared to be a little more dovish, noting the downside risks to the outlook (mainly from trade tensions). With the other major central banks currently easing monetary policy, or getting ready to ease, the BoC might follow the same path as the year progresses.
Australian economic events and implications
The June NAB business survey was disappointing, with business confidence down in June (but still positive) after the post-election bounce in the prior month which shows that fundamentals for businesses are still soft. The employment sub-index increased in June, but the index has been trending lower over the past few months. On employment indicators, ANZ job advertisements bounced by 4.6% in June but this followed a large fall in the prior month and the average trend over recent months has been a downtrend.
Australian housing finance fell further in May, with the value of lending (excluding refinancing) to owner-occupiers down by 2.7% and investor lending down by 1.7% (see chart below). Some further downside to home lending is likely to continue for another few months but is likely to stabilise towards the end of the year as interest rate cuts lift owner-occupier and investor demand. However, we do not expect another boom in home prices or lending despite lower interest rates because of a few factors: supply of new homes is much higher than in recent years, lending standards are still tight (compared to history), foreign demand has fallen and there are still affordability issues, especially on the east coast of Australia.
According to the Housing Industry Association (HIA), housing affordability is at its best since 1999 but this is not a fair reflection of the housing market. The HIA affordability index is largely a measure of home loan serviceability. The two RBA interest rate cuts this year have taken variable mortgage rates to their lowest level since the early 1950’s which is good for mortgage repayments (see chart below).
But affordability is still an issue given high valuations for homes (especially in Sydney and Melbourne) despite the falls in prices over the past two years. Affordability pressures are better observed in indicators like household debt to income ratios (see chart below) which show record high debt levels in Australia (compared to average incomes), especially versus other comparable countries.
What to watch over the next week?
US June quarter earnings season should show okay earnings growth despite concern about weakening economic conditions and some companies revising down guidance on earnings (although this is probably a way of managing expectations!). Earnings should be up 3% over the year to June. US Fed Chair Powell speaks on “Aspects of Monetary Policy in the Post-Crisis Era” at the G7 meeting in France. US data includes the Fed Beige Book, US June retail sales, industrial production and some housing indicators such as the July housing market index and June housing starts and July consumer confidence from the University of Michigan.
Chinese June quarter GDP is expected to show a slowing in annual growth to 6.2%, from 6.4% in the prior quarter. And the usual monthly activity data for June is also out, namely retail sales, industrial production and fixed asset investment which may disappoint given the weakening monthly manufacturing PMI’s and poor activity data which will put pressure on Chinese policy makers to do more easing in the second half of the year.
New Zealand second quarter consumer price data is expected to show an increase in prices of 1.7% over the year to June. A small depreciation in the New Zealand dollar may show a lift tradeable inflation.
In Australia, June employment data is key. Employment growth is holding up in Australia thanks to high population growth and labour force participation, but the unemployment rate has trended upwards over recent months, to 5.2%. The RBA want to see the unemployment rate below 5%. We expect employment growth to slow over the next few months and the June employment data should show the unemployment rate remaining unchanged at 5.2%. RBA Board minutes for the June meeting are likely to show an upbeat view on growth but confirm that the central bank has left the door open to further easing.
Outlook for markets
Share markets remain vulnerable to short term volatility and weakness on the back of uncertainty about trade, Middle East tensions and mixed economic data. But valuations are okay, particularly against low bond yields, global growth indicators are expected to improve into the second half if the trade issue is resolved and monetary and fiscal policy is likely to become more supportive, all of which should support decent gains for share markets over the next 6-12 months.
Low yields are likely to see low returns from bonds, but government bonds remain excellent portfolio diversifiers.
Unlisted commercial property and infrastructure are likely to see reasonable returns. Although retail property is weak, lower bond yields will help underpin unlisted asset valuations.
National average capital city house prices remain under pressure from tight credit, record supply and reduced foreign demand. However, the combination of rate cuts, support for first home buyers via the First Home Loan Deposit Scheme, the removal of the 7% mortgage rate test and the removal of the policy threat to negative gearing and the capital gains tax discount point to house prices bottoming out by year end. Next year is likely to see broadly flat prices as rising unemployment acts as a constraint.
Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 0.5% by early next year.
The A$ is likely to fall further to around US$0.65 this year as the RBA moves to cut rates by more than the Fed does. Excessive A$ short positions, high iron ore prices and Fed easing will help provide some support though with occasional bounces and will likely prevent an A$ crash.
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