Investment markets & key developments
Sharemarkets were up over the past week, with the US lifting by 3.6%, Eurozone +0.9%, Australia +1.0%, Japan +2.0% and China +1.7%. After global sharemarkets rallied hard from mid June to August on expectations of a “central bank pivot” away from aggressive rate hikes, shares had been on a downtrend since then as central banks have remained hawkish and economic data has been solid (which means that further rate hikes are necessary to reduce demand). The rise in markets this week probably reflects some recent oversold conditions in shares but does make a new “higher low” in equities (after the June low) which could see a setup for a rebound in shares from here (as US shares are still 15% below early 2022 highs and Australia is 9% below its 2022 peak). However, with central banks remaining hawkish (the RBA, ECB and BoC all lifted rates this week) and no definitive signs of a peak in inflation, we remain cautious on the short-term outlook for equities.
Out of interest, 94% of central banks in developed markets have been lifting interest rates (see the chart below).
Bond yields rose in the US and Europe on expectations of further rate hikes. The US 10-year yield rose to 3.3% (from 3.1% last week) and the German 10-year yield lifted to 1.69% from 1.5% a week ago. In Australia, the 10-year yield declined marginally to 3.55% after reaching 3.7% this week after Lowe’s speech hinted at a slowing in the pace of rate hikes ahead.
Reports that the new UK PM Truss was planning a fiscal stimulus program that would add to the UK budget also added to upward pressure on UK yields. Bloomberg reported that the total stimulus (which would be targeted towards households and helping with household energy bills) could be worth up to 9% of GDP. The issue is that while in the short-term it would help cost of living issues and help the economy to avoid a recession, it could also add to household income and risk, entrenching higher inflation for longer so cost of living measures for households should probably be met with fiscal tightening in other areas.
Energy prices were lower over the week, despite news that the gas pipeline between Russia and Europe Nordstream 1 would remain shut (after it was closed due to maintenance) unless sanctions against Russia were reversed. Many European countries are now offering energy price caps, rebates for consumers or cost of living assistance payments. Oil is at $86/barrel (well below its high of over $110/barrel) and most commodities (apart from gas and coal) are down on earlier 2022 highs (see the chart below).
The US dollar reached a cycle high this week before giving up some of these gains. Weakness in the Yen (as the BoJ pursues easy monetary settings) and Euro (because of growth concerns related to the energy crisis) has given upward momentum to the $US. The $A rallied slightly to 0.68 USD.
Economic activity trackers
Our Economic Activity Trackers improved for Australia (from higher hotel and restaurant bookings), weakened in the US (from lower rail freight, job ads and mortgage applications) and were slightly higher in Europe (from higher retail and recreation mobility). Economic activity still appears to be holding up across the three major economies.
Our Inflation tracker which looks at pipeline pressures continues to moderate (see the chart below), which is good news for near-term inflation readings.
Chinese coronavirus cases are trending up again (see chart below) and the lockdown in the city of Chengdu (21 million people) will be extended as mass testing continues. Despite consensus expectations of a move away from zero Covid in China after the National Party Congress later in October, this may not happen quickly as the overall Covid vaccination rate is still low for the older population. More than 35% of Chinese residents over 60 have not received a booster and only 61% above 80 have had their first vaccination. These numbers will need to increase before authorities are more comfortable in allowing a higher Covid case count. So, disruptions to the Chinese economy from coronavirus will continue for now.
Major global economic events and implications
The US services ISM rose in August to 56.9 from 56.7 beating expectations of a decline, in contrast to the services PMI which declined to 43.7 in August which signals a contraction in activity. The reason for the difference between the two series goes down to how they are measured as the ISM is broader, as it includes government, construction and mining. Services activity is expected to weaken as interest rates rise.
US Fed speak this week didn’t confirm the key question of whether the FOMC will hike by 0.50% or 0.75% at its September meeting. The Fed’s Brainard said that “several months of low inflation readings” are needed to be confident that inflation is moving down, that the Fed’s priority is reducing inflation and is “in this for as long as it takes” but also that “the rapidity of the tightening cycle… [could] create risks associated with overtightening” and this comment was enough for markets to potentially see risks of the Fed pivoting away from rate hikes. The Fed’s Mester was not convinced that inflation had peaked and Fed Governor Waller still favours “another significant” increase in interest rates later this month. We think a 0.75% is likely at the September meeting. Fed Chair Powell’s comments this week reflected the same sentiment as in Jackson Hole, with getting inflation down still the goal “we need to act now, forthrightly, strong as we have been doing”. The Fed’s Beige Book showed some slowing in economic activity, noting that activity was “unchanged, on balance since early July” compared to “expanded at a modest pace” in the previous Beige Book.
The ECB lifted interest rates again, taking the deposit rate to 0.75% from 0% and the main refinancing rate to 1.25%. ECB President Lagarde indicated that more rate hikes should be expected as inflation is “far too high”. GDP growth has been downgraded to 0.9% in 2023 (from 2.1%) with the next three quarters expected to show flat growth (so basically a recession). Inflation forecasts were revised up in 2022 to an average rate of 8.1% (from 6.8%) and 5.5% in 2023 (from 3.5%).
The Bank of Canada lifted interest rates by 0.75% taking the overnight rate to 3.25%. The BoC has lifted interest rates by 3% in this rate hike cycle. More hikes are expected although there were some early signs of a pivot from the central bank with the BoC commenting that it would be “assessing how much higher interest rates need to go to return inflation to target”.
Japanese wages growth was up by 2.5% over the year to July (on a constant-sample basis) which is its highest pace in over a decade, which shows that inflation should rise as well in Japan.
China announced a cut in the reserve requirement for foreign exchange deposits, from 8% to 6% which increases the supply of dollars and other currencies onshore and helps keep the RMB from depreciating too far. Chinese consumer price inflation was 2.5% higher over the year to August, less than expected. Producer prices were 2.3% higher over the year to August, well below the 3.2% expected. The Chinese trade data showed some weakness in August, with exports up 7.1% over the year (expectations were of +13%) and imports were 0.3% higher (below expectations of a 1.1% rise) which reflects the weaker economic environment in 2022 as China deals with declining property prices, a zero-COVID policy, power shortages and a drought.
Australian economic events and implications
The RBA lifted the cash rate by 0.50% this week to 2.35% (as expected by economists), this was the fifth consecutive increase in interest rates since May.
RBA Governor Phil Lowe spoke this week at the Australian Business Economists annual Anika foundation lunch on “Inflation and the Monetary Policy Framework”. While most comments were in line with recent statements that getting inflation down is the priority and that more rate hikes should be expected, there was a new comment that “the case for a slower pace of increase in interest rates becomes stronger as the level of the cash rate rises” which is the first signal of a less hawkish approach from the RBA. We expect the cash rate to peak at around 2.85%, with the pace of rate rises to start slowing from next month (we expect a 0.25% rise in October and November). This remains below market and consensus expectations.
Australian June quarter GDP rose by 0.9% (as forecast by economists and the RBA) which is a solid increase, taking annual growth to 3.6%. It was expected that GDP growth would be decent over the first half of 2022 as consumer spending on services normalised as travel and services industries completely opened up, which is reflected in the data. The June GDP is backward looking as it doesn’t really reflect any impacts from RBA rate hikes (which started in May). We expect GDP growth to slow to below 2% per annum by late 2023.
The Australian July trade data was much weaker than expected with the trade balance falling to $8.7bn, with consensus looking for a $14.7bn trade balance. Exports plunged by 9.9% because of a big decline in iron ore and coal exports as prices fell. Non-monetary gold exports also declined. Imports rose by 5.2% with a big lift in consumption goods (which is a sign that consumer demand is holding up but would also reflect higher goods prices).
Other Australian data this week included the Melbourne Institute monthly inflation gauge which showed the trimmed mean inflation measure running at 5.3% year on year in August which indicates further growth in September quarter underlying inflation (see the chart below) and a solid 2% rise in ANZ job advertisements for August.
What to watch over the next week?
In the US, NFIB small business optimism is expected to improve slightly in August (to 90.5 from 89.9 last month) but it is still at very low levels – usually associated with growth downturns. August CPI (on Tuesday) is expected to fall by 0.1% over the month with annual growth slowing to 8.1% (from 8.5% last month). Core CPI is expected to slightly increase in annual terms – to 6.1% from 5.9% last month. The August producer price index is expected to show a fall of 0.1% over the month and other data includes the September Empire manufacturing index, August advance retail sales (on Thursday) which are expected to be flat over the month, the Philadelphia Fed business outlook for September, August import price index, August industrial production and University of Michigan consumer sentiment and inflation expectations.
US politics will start to get back in the news after Congress is back in session after a break over August. Biden’s approval ratings are ticking up recently (see chart below) as the decision to overturn Roe v Wade is energizing Democrats, petrol prices have fallen slightly and the Democrats passed some legislation including the Inflation Reduction Act and student loan forgiveness.
There is now a higher risk that Biden’s better approval rating will see the Democrats keep the House of Representatives in the mid-term (most expected them to lose the House) which would give them another two year timeframe to pass more legislation. This would likely be taken as a negative for sharemarkets because of higher uncertainty but also higher risk of tax hikes being imposed.
In Europe, energy ministers are set to meet on Friday to debate a range of options about the energy crisis. Options appear to be a windfall tax on energy producers (with funds being used to compensate consumers for higher energy costs) or other measures to decrease demand. Support packages from Poland, UK and Germany indicate fiscal packages of 2-3% of GDP are likely. Economic data next week includes the September ZEW investor survey, July industrial production data, July trade balance data and June quarter labour cost data.
Chinese data next week includes August home prices (likely to show a fall), property sales figures, August industrial production, August retail sales (likely to pick up to 3.2% year on year) and fixed asset investment.
In Australia, employment data is released on Thursday and we are looking for a solid rise in employment of 45K, and a lift back in the participation rate to 66.7%, taking the unemployment rate a little higher to 3.5%, but this should not be taken as a negative sign of weakness in the labour force as it indicates that more people are in the labour force. Our leading indicator of employment growth indicates that decent jobs growth will continue for now.
The monthly Westpac/Melbourne Institute consumer confidence index for September is released and may show some improvement from its ultra-low readings, like the recent tick-up in the ANZ/Roy Morgan consumer confidence index (see chart below). Although, while interest rates are rising, inflation is high and consumers are feeling real wage declines, consumer sentiment is likely to remain low which is also indicated in the latest AMP financial stress report, which saw a doubling in the number of Australian employees feeling severely financially stressed since 2020. Next week, the August NAB business survey is also released which is likely to show some weakness.
Outlook for markets
Shares remain at high risk of further falls in the months ahead as central banks continue to tighten to combat high inflation, uncertainty about recession remains high and geopolitical risks continue. However, we see shares providing reasonable returns on a 12-month horizon as valuations have improved, global growth ultimately picks up again and inflationary pressures ease through next year allowing central banks to ease up on the monetary policy brakes.
With bond yields looking like they have peaked for now short-term bond returns should improve a bit further.
Unlisted commercial property may see some weakness in retail and office returns (as online retail activity remains well above pre-covid levels and office occupancy remains well below). Unlisted infrastructure is expected to see solid returns.
Australian home prices are expected to fall 15 to 20% top to bottom into the second half of next year as poor affordability & rising mortgage rates impact.
Cash and bank deposit returns remain low but are improving as RBA cash rate increases flow through.
The $A is likely to remain volatile in the short term as global uncertainties persist. However, a rising trend in the $A is likely over the medium term as commodity prices ultimately remain in a super cycle bull market.
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