Investment markets and key developments over the past week
The news flow was less dominated by politics this week and more by positive economic developments which gave share markets a boost. US shares were up by 0.5% (and have recovered around 4% from post-tariff March lows), Eurozone shares were 1.3% higher, Japanese equities lifted by 1.8%, Australian equities were 0.7% higher while Chinese stocks are 2.9% down over the week.
Commodity prices have been surging recently, particularly for aluminium, nickel and oil. Current US sanctions against Russian producers (and the threat of more sanctions) as well as some supply concerns have caused a surge in aluminium and nickel prices which is likely to continue in the near-term. Oil prices have been rising steadily because of supply concerns following tensions in the Middle East. Broad commodity prices strength is also a sign of continued synchronised global growth. But, if commodity prices move too high too quickly, this will be negative for equity markets because of inflation breakout fears, with commodities a large input into global production. This inflation fear started becoming evident in the back end of this week with US yields moving higher and 10-year yields around 2.96%. Despite the strength in commodity prices, the Australian dollar moved lower this week to 76US cents as the US dollar gained some strength.
Stability in the Chinese economy is also positive for commodity price gains in the near-term. While the medium-term outlook is still for lower Chinese economic growth, the economy has been stronger over the first quarter of 2018 and there may be some more upside over the next few months. Property investment and government spending has been showing stronger signs of growth and is something to watch. This week, the People’s Bank of China (PBoC) cut one of the lending rates in China – the reserve requirement ratio (RRR) by 1% for most banks. This is not a change in monetary policy but a liquidity management tool. The RRR puts a limit on the amount of deposits required in the banking system and the cut was done to assist banks (particularly smaller lenders) in helping to meet balances on medium-term loans.
It was good to see another positive World Economic Outlook report from the International Monetary Fund (IMF). The IMF kept global growth forecasts unchanged at 3.9% in 2018 and 2019, the strongest level since 2011, which are unchanged on the IMF’s last update in January but are above forecasts made in October last year. And after years of revising global growth forecasts down, the IMF has been revising growth estimates up (see chart below) lately.
Major global economic events and implications
US data was generally positive. Retail sales growth was better than expected in March, consumer confidence is positive and leading indicators around the economy are still rising. Manufacturing readings have been mixed across various regions, with a poor reading for New York but stronger for Philadelphia. Industrial production was up in March and housing starts and permits were also stronger in the month. The US Fed’s Beige Book which looks at activity across the 12 Banking Districts indicated that economic activity continued at a “modest to moderate” but there did appear to be some concern from districts about potential tariffs. There were again signs of labour shortages in some industries, another sign that wages growth will continue to rise. Trump made two new Fed nominations - Richard Clarida as vice chairman on of the Fed Board and Michelle Bowman as a governor. There was also numerous “Fed speak” this week with Chicago Fed member Evans saying he was optimistic that inflation would rise towards the Fed’s 2% target, but that he didn’t see a large risk of an “outsized” inflation breakout. San Francisco’s Williams emphasised that the risk of a flattening of the yield curve was nothing to worry about so far and was a normal part of the Fed tightening process.
Eurozone data generally continued to disappoint this week. The ZEW investor confidence survey showed a decline in expectations of economic growth in April, with German expectations in negative territory. This probably reflects the strength in the Euro currency which is a big negative for exporting nations like Germany. Eurozone headline inflation for March was revised down to 1.3% over the year, but the overall trend has been a slight lift in inflation. Core inflation is sitting unchanged at 1%. But, consumer confidence was up in April.
Japanese inflation is trending up with core inflation up by 0.5% over the year to March, a big turnaround compared to a year ago when price growth was still negative. Political risk in Japan remains high with support for Prime Minister Abe continuing to decline on the back of recent scandals.
Chinese data remains solid. Chinese real GDP was up by 6.8% in the first quarter of 2018, above policymakers’ target of around 6.5% growth. But, slower growth is still expected over 2018/19 as policymakers work to reduce debt and pollution. Fixed asset investment was up 7.5% over the year, industrial production was up by 6% and retail sales lifted by 10.1%.
The Bank of Canada (BoC) met this week and kept interest rates unchanged at 1.25% which was expected but the central bank appeared more dovish. While inflation has returned to the 2% target, the BoC appears to be willing to let inflation run above its target rate for now given the risks to the economy from trade policies and a potential slowing in housing.
Australian economic events and implications
The RBA April Board minutes didn’t contain any new major information with the commentary from the central bank still indicating that the next move in the cash rate is likely to be up. But, given the risks in the housing market (slowing dwelling prices at time when lending standards are becoming tighter again) and low inflation, the risk is that interest rates don’t come until the second half of 2019.
Australian employment growth stepped down again in March, with jobs up by a low 4.9K. There were also some big negative revisions to last month’s job gains. Employment growth over the last three months is now running at 1.2% on an annual pace, which is low and below recent outcomes around 3-3.5%. But, jobs growth has been exceptionally strong over the past year and some slowing was expected. Leading employment indicators suggest that annual jobs growth will continue to slow, we think to around 2.5% or so over the next 6 months. Despite the low growth in employment over the past two months, the unemployment rate is unchanged at 5.5%.
What to watch over the next week?
In the US, manufacturing PMIs are released and are expected to show a slight decline for April and March. Durable goods orders are expected to rise but at a slower pace compared to last month. The March quarter employment cost index is released as well as the first quarter GDP data which is expected to come in around 2% on an annual basis which is lower than last quarter but still respectable.
The European Central Bank and Bank of Japan both meet next week but no change to monetary policy is expected from either. The ECB will consider further tapering its asset purchase program after September this year. But, interest rate hikes in the Eurozone are still a story for the second half of 2019.
In Australia, March quarter consumer price data is released and is expected to show headline inflation rising by 0.5% with annual growth sitting just on the Reserve Bank’s target band of 2-3%, at 2.0%. Underlying inflation, a better reading of trends in the economy, is expected to rise by 0.4% with annual growth at 1.8%. Inflation is subdued broadly because the economy has been operating below potential, and the unemployment rate still has further room to move lower. The inflation data is unlikely to be a game-changer for market pricing of RBA rate hikes. RBA Assistant Governor Kent also speaks about “the limits of interest-only lending” next week which will be important given the recent tightening in lending standards. Import and export price data should show that the terms of trade rose in the first quarter of 2018, thanks to strong commodity prices.
Outlook for markets
Volatility in share markets is likely to remain high as US inflation and interest rates move up and as issues around President Trump, trade, Syria, etc continue to impact ahead of the US mid-term elections in November, but the medium-term trend in share markets is likely to remain up as global recession is unlikely and earnings growth remains strong globally and solid in Australia. We continue to expect the ASX 200 to reach 6300 by end 2018 – though it might take a bit longer to get back on the path there.
Low yields and capital losses from rising bond yields are likely to drive low returns from bonds.
Unlisted commercial property and infrastructure are still likely to benefit from the search for yield by investors, but it is waning, and listed variants remain vulnerable to rising bond yields.
National capital city residential property price gains are expected to slow to further as the air continues to come out of the Sydney and Melbourne property boom and prices fall by another 5% 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$ is likely to fall towards US$0.70 as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory. Solid commodity prices should provide a floor for the A$ though – in contrast to early last decade when the interest rate gap was negative and the A$ fell below US$0.50.
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