Investment markets & key developments
Despite a messy US jobs report on Friday, global shares mostly rose over the last week as the US debt ceiling was pushed out to December and there was some easing in concerns regarding the European energy crunch. For the week US shares rose 0.8%, Eurozone shares rose 0.7% and Chinese shares rose 1.3%, but Japanese shares fell -2.5%. The positive global lead saw Australian shares rise 1.9% led by energy, utility, financial and material shares. Consistent with a bit of “risk on” along with still rising inflation concerns bond yields rose as did oil, metal & iron ore prices along with the A$.
Some relief of some worries. As we noted last week there is a long list of worries pushing shares around at present. While they remain there has been some signs of relief in relation to some of them. Looking at the main worries in turn:
- The US debt ceiling has been pushed back into early December – this follows an offer by Senate minority leader McConnell. The move shows McConnell does not want a default, but this just means the issue will come up again in December (along with the need to fund the Government) and Republican’s still don’t plan to vote for it as that will be seen as signing up to the Democrats spending boost. Which means the Democrats will still have to do it on their own (which they don’t really want to do) via the budget reconciliation process for which they now have plenty of time to do so or with regular legislation if they suspend the ability for Republican’s to filibuster which moderate Democrats are against.
- The Biden Administration’s $550 billion infrastructure spending and $3.5 trillion Build Back Better spending packages – following intervention by President Biden progress on these has been delayed a month or so but it still looks likely that to get moderate Democrat support, the Build Back Better package will have to be cut from $3.5 trillion to around $1.5-$2 trillion. While the debt ceiling delay has taken some of the pressure off the Democrats, tensions between moderate and progressive Democrats are escalating which is slowing progress.
- US tax hikes – the share market is not focussed on these but will as they come into view. But again, to get moderate Democrat support they will be scaled back.
- Fed Chair Powell’s renomination – the Fed’s trading controversies have damaged Powell, but it’s either going to be Powell or someone more dovish who runs the Fed.
- The energy crisis in Europe & China – is adding to supply bottlenecks and stagflationary pressures. The good news is that Russian President Putin has offered to increase gas supply to Europe (where prices have risen six-fold since earlier this year) although it may come with some strings attached (eg, speeding up the certification of the Nord Stream 2 gas pipeline). Likewise, there are some signs China is easing restrictions on coal and electricity supply.
- China Evergrande is yet to be resolved and other developers are having problems – but the Chinese Government appears to be stepping up efforts to limit the fall out and protect healthy developers, home buyers and the property market (but maybe not global bondholders).
- Supply constraints and rising bond yields – this is perhaps the biggest issue. As the world goes back to work and consumer spending rotates away from goods back to services then the bottlenecks should start to resolve but this is taking longer than expected risking higher and more entrenched inflation and hence higher bond yields. Too rapid a rise in bond yields can create problems for shares if earnings struggle to keep up.
In short, the good news on some of these issues in the last week is helping shares bounce, but the risk is high that the correction may run a bit further. That said, we ultimately see the issues all being largely resolved in a way that does not severely threaten global growth and so with global monetary policy likely to remain relatively easy for some time we continue to see the broader trend in shares remaining up.
The RBA’s Financial Stability Review highlights rising systemic risks around rapid growth in home lending as APRA kicks off macroprudential tightening to cool it down, with more likely on the way. The RBA’s FSR notes that households and businesses were generally in a sound position heading into the Delta variant lockdowns and sees only a small share as being vulnerable to them and it sees the overall financial system as sound. However, it reiterated concerns about rising growth in household debt, the likelihood that it will accelerate further and the rise in loans with high debt to income ratios. All of which is consistent with APRA’s directive to banks to increase the interest rate buffer used to assess how much borrowers can borrow from 2.5% to 3%, which means that with an interest rate of 2.7% borrowers will need to be able to service the loan even if rates rise to 5.7%, up from 5.2%.
By reducing the amount that can be borrowed this may help slow housing credit growth, but the impact is likely to be modest at around a 5% reduction for a typical borrower and in any case 90% or so of borrowers borrow less than their allowed capacity and some banks had already raised their serviceability buffers. The move adds a headwind to house price growth along with worsening affordability, reduced government incentives, a likely rise in fixed mortgage rates and rising listings but is unlikely to be enough to push prices down. Given we had already allowed for macro prudential tightening we will stick to our expectation for average home price growth to slow to 7% next year from 21% this year. However, APRA has indicated that its prepared to do more and will release a paper covering various options later this year and the RBA has also discussed the merits of various options in its latest FSR. As such, with APRA’s initial move unlikely to close the gap between housing credit growth and household income growth we expect more macro prudential measures from later this year or early next year. Going by the RBA’s analysis this could involve some combination of further action in terms of serviceability buffers along with debt to income and loan to valuation restrictions. This is likely along with higher fixed mortgage rates and maybe higher variable rates to start home pushing prices down in 2023.
Elvis on tour. Elvis roared back in 1972 with Elvis On Tour, another mega hit in Burning Love (that he was initially lukewarm warm on as he wanted to become more middle of the road) and the classic Always On My Mind (where Mark James who wrote Suspicious Minds and Moody Blue was one of the songwriters). Separate Ways written by his friend Red West seemed like it was specifically written for Elvis given his split from Priscilla.
The news on coronavirus is mostly good. New global coronavirus cases are trending down with most regions flat or falling. This includes the US, although Europe is edging up again.
Modern medicine seems to be getting the upper hand against coronavirus – with vaccines helping to keep hospitalisations and deaths down in more heavily vaccinated countries and US states, booster shots being rolled out to help deal with declining vaccine (mainly Pfizer) efficacy after about 5 to 6 months (notably in Israel) and a new Merck drug appearing to reduce the risk of coronavirus hospitalisation and death in clinical trials by 50% and now seeking approval for emergency use. Hospitalisations and deaths in the UK are remaining very subdued given the number of new cases compared to the previous wave.
Finally, vaccination rates are continuing to rise, albeit slowly. 48% of people globally and 72% in developed countries have now had at least one dose of vaccine.
|%1 Dose||%2 Dose||% Booster|
A major test will come in the northern winter – particularly as vaccine efficacy starts to wear off in some countries in the absence of rapid booster programs. And risks remain around the low level of vaccination in poor countries and the possibility of more transmissible/more deadly mutations. But so far good and all this is seeing further reopening in developed countries.
In Australia, new cases are still surging in Victoria, but NSW which led by about a month is seeing a sharp decline.
69% of Australia’s whole population has now had at least one vaccine dose, which is more than the US. For first doses for adults, the ACT is now well above 90%, NSW is nearly at 90% (so much for the reported vaccine hesitancy), Victoria will reach 90% in around two weeks and Australia is now through 80%.
On the basis of projections based on current trends for first doses and the average gap between 1st and 2nd doses the following table shows when key vaccine targets will be met. NSW and the ACT (not shown) have already hit the 70% of adults double vax target and NSW will hit 80% around 20th October, Victoria will hit 70% around 26th October and Australia on average around 24th October.
Having met the 70% of adults double vax target NSW will start reopening on Monday. For Victoria it will be late October/early November (cases permitting) and the ACT (not shown) early October. Other states and territories will hit the 70% target in mid-November.
Singapore’s experience highlights the need for the reopening to be gradual. The experience in Singapore which is now seeing more than 3000 new cases a day after reopening highlights the risks involved in reopening too rapidly – as a sudden surge can quickly overwhelm the hospital system necessitating a reversal in the easing of restrictions. NSW’s decision to speed up its relaxation of social restrictions from Monday poses a bit of a risk on this front as still only 59% of the whole NSW population will have been fully vaccinated compared to 81% in Singapore – so this is something to watch.
Meanwhile, vaccination is continuing to help keep serious illness down. Coronavirus case data for NSW shows that the fully vaccinated make up a low proportion of cases, hospitalisations and deaths.
The level of deaths (the red line in the next chart) is running at around 20% of the level predicted on the basis of the previous wave (dashed line). On this basis the vaccines are helping save roughly 54 lives a day at present.
Economic activity trackers
Our Australian Economic Activity Tracker fell slightly in the last week, but remains up from its August low and is likely to move higher in the weeks ahead as NSW, the ACT and Victoria gradually reopen. However, given the likelihood of high coronavirus numbers through the reopening and only the vaccinated being able to initially participate, this recovery will likely be more gradual at first than was the case after last year’s lockdowns. Our US and European Economic Activity Trackers are stalled, which possibly suggests a loss of momentum in their recovery.
Major global economic events and implications
US economic data was mostly strong. September’s services ISM surprisingly rose to 61.9. US payrolls only rose by 194,000 in September but the details in the jobs report were solid with private payrolls up by 317,000, previous months revised up by 169,000, household employment up by 526,000, unemployment down to 4.8%, permanent unemployment down and private hours worked up by 0.8%. What’s more the ending of enhanced unemployment benefits and falling new COVID-19 cases point to an increased workforce ahead and business and consumer surveys continue to indicate a strong jobs market. So, on balance the Fed is likely to regard this as meeting Fed Chair Powell’s “reasonably good” employment report test and so the Fed is still likely to proceed with tapering next month.
Partly reflecting rising energy (notably gas) prices Eurozone producer price inflation rose to 13.4%yoy in August and German industrial production fell sharply partly reflecting supply constraints. ECB President Lagarde noted the ECB “should not overreact to supply shortages or rising energy prices…[as] monetary policy cannot directly affect these.”
As widely expected, the RBNZ became the third developed country central bank to raise rates (after Norway & South Korea) with hawkish commentary suggesting more ahead.
Australian economic events and implications
Coal and gas to the “rescue”. Despite a 4% fall in iron ore exports, Australia’s trade surplus surprisingly rose to a record $15.1bn in August as coal exports surged 13% & LNG exports surged 16% with rising prices for both. While the plunge in iron ore prices is yet to fully impact the trade surplus its likely to remain in a healthy surplus thanks to the strength in coal & gas.
Payroll jobs down, but vacancies holding up. While payroll jobs fell again into mid-September and are now down by around -5% from their June high reflecting the lockdowns job vacancies have held up far better through this lockdown auguring well for a recovery in jobs as lockdowns are eased.
Apart from hinting at an increase in interest serviceability, the RBA Board meeting provided no surprises. While it remains upbeat on the growth outlook beyond the disruption from lockdowns the RBA remains very dovish on rates, repeating that the conditions for a rate hike are unlikely to be in place before 2024.
What to watch over the next week?
In the US, the minutes from the Fed’s last meeting (Wednesday) will be watched for more detail around the Fed’s tapering plans from November. On the data front core CPI inflation (Wednesday) is expected to rise another 0.2%mom leaving annual inflation at a still high 4%yoy. Producer price inflation (Thursday) is also likely to remain high. Headline retail sales (Friday) are expected to have fallen slightly but underlying measures are expected to show a modest gain. Manufacturing conditions in the New York region (Friday) are expected to have fallen back slightly but remain robust. Small business optimism and labour market openings data will be released Tuesday. The September quarter earnings reporting season will start to get underway with the consensus being for 28% earnings growth on a year ago.
Chinese trade data (Wednesday) is expected to show a moderation in import and export growth after surprising strength in August and inflation data (Thursday) is expected to show a slight rise in CPI inflation to 0.9%yoy but a strong rise in producer price inflation to 10.6% on the back of energy shortages. Credit data will also be released and will be watched for signs of policy easing.
In Australia expect jobs to be down, but confidence to be up. Jobs data (Thursday) is likely to show another 150,000 decline in employment as the full impact of the Victorian lockdown impacts. However, as we saw in August a decline in participation is likely to keep unemployment subdued although we expect a modest rise to 4.8% and the bulk of the impact from the lockdowns will be in terms of hours worked. Of course, with reopening now commencing the jobs data will be a bit dated. Meanwhile, the NAB business conditions and confidence survey for September (Tuesday) is expected to show a modest improvement as is consumer confidence (Wednesday) as a result of rising vaccination rates and reopening roadmaps.
Outlook for investment markets
Shares remain vulnerable to short-term volatility with possible triggers being coronavirus, global supply constraints & the inflation scare, less dovish central banks, US spending and tax plans and the slowing Chinese economy. But looking through the short-term noise, the combination of improving global growth and earnings, vaccines ultimately allowing a more sustained reopening and still low interest rates augurs well for shares over the next 12 months.
Expect the rising trend in bond yields to continue as it becomes clear the global recovery is continuing resulting in capital losses and poor returns from bonds over the next 12 months.
Unlisted commercial property may still see some weakness in retail and office returns but industrial is likely to be strong. Unlisted infrastructure is expected to see solid returns.
Australian home prices look likely to rise by around 21% this year before slowing to around 7% next year, being boosted by ultra-low mortgage rates, economic recovery and FOMO, but expect a progressive slowing in the pace of gains as poor affordability impacts, government home buyer incentives are cut back, listings return to more normal levels, fixed mortgage rates rise, macro prudential tightening slows lending and immigration remains down relative to normal.
Cash and bank deposits are likely to provide poor returns, given the ultra-low cash rate of 0.1%.
Although the A$ could pull back further in response to the latest threats to global and Australian growth and weak iron ore prices, a rising trend is likely over the next 12 months helped by strong commodity prices and a cyclical decline in the US dollar, probably taking the A$ up to around US$0.80.
Subscribe below to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Chief Economist
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