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Economics & Markets

Market Update 23 July

By Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist, AMP Capital Sydney, Australia
  Source: Bloomberg, FXStreet, AMP Capital
Source: Bloomberg, FXStreet, AMP Capital

Investment markets and key developments over the past week

Share market indexes mostly managed to look through coronavirus concerns over the last week and rebound helped by good US earnings and dovish guidance from the ECB. US, European and Chinese shares rose but Japanese shares fell. The positive global lead also helped push up the Australian share market to a new record high despite expanding lockdowns with strong gains in lockdown winners like health and IT offsetting weakness in resources stocks. Bond yields continued to decline and commodities were mixed with oil down slightly on an OPEC deal to boost production and iron ore down but metals up slightly. The $A fell as the $US rose further. And Bitcoin had a bounce as celebrity influencers Elon Musk, Jack Dorsey and Cathie Wood reportedly said nice things about it!

We continue to see the fall back in bond yields as part of a correction against a rising trend in yields that will resume as global recovery continues once coronavirus concerns recede again. Despite their bounce of the last week shares remain at high risk of a short-term correction as coronavirus cases rise and the inflation scare continues and as we come into seasonally weaker months for shares, but the rising trend in shares led by cyclical trades is likely to resume into year-end and continue next year as rising vaccination allows economic recovery to continue as interest rates & bond yields remain low.

New coronavirus cases globally are continuing to rise again. There are now over 500,000 new cases a day making Australia at around 160 a day look like a bit of a non-event.

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

Lowly vaccinated countries have little choice but to tighten restrictions and enter lockdowns (unless they want to see their healthcare systems overwhelmed) – and this still works against the latest variants including Delta as evident in new cases rolling back down in South Africa, South Korea and Taiwan (which has seen daily new cases fall back from over 600 a day to single digits such that its now moving to gradual reopening – which is a positive sign for NSW albeit its taken two months in Taiwan but we are at a lower daily case count).

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

But it remains a different situation in the more vaccinated UK, US and Europe. All are now seeing rising new cases. See the next three charts. But its also apparent that hospitalisation and new deaths are tracing out a far more subdued this time. This is consistent with vaccines being 90% plus effective in preventing the need for hospitalisation and deaths even though they’re less effective in preventing infection (61% for AstraZeneca and 82% for Pfizer/Moderna with respect to Delta) and only 47% effective in preventing onwards transmission (based on UK data). It can also be seen in the US with per capita new cases and hospitalisations in the top quartile of vaccinated states running up to 25% below that in the bottom quartile of vaccinated states.

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

Of course, these countries could still run into trouble. They have yet to reach herd immunity - which is likely to be at least 80% fully vaccinated in relation to Delta - with some US states lagging badly. So, they could still have a problem if new cases unrestrained by social restrictions continue to ramp up rapidly amongst the unvaccinated (a rough estimate is that 14 to 26 million people in the UK may have no immunity due to prior exposure or vaccine) and some vaccinated stressing the hospital system and necessitating the return of some restrictions. Eg if daily new cases in the UK surge to say 100,000 a day that would mean around 9100 extra hospitalizations a week (based on the rate of hospitalisation since June). However, with older and more at-risk people close to fully vaccinated in theory this should be manageable with restrictions rather than a return to hard lockdowns. And so, the recovery would then be able to continue. But it does mean a potentially uncertain period of high case numbers until vaccination rates plus natural exposure take these countries to herd immunity. In the meantime, these charts bear monitoring.

On the latest count 28% of people globally and 56% in developed countries have had at least one dose of vaccine.  

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

Australia’s vaccination rate – see the thick line in the next chart – is accelerating again likely reflecting the arrival of 1 million doses of Pfizer a week and as vaccination hesitation has fallen in the face of the latest outbreaks and lockdowns.

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

But while Australia’s vaccination rate is picking up it remains low and will likely take to early next year to reach herd immunity around 80%. So, this leaves us with little choice but to stick to distancing and lockdowns to control the spread of coronavirus to limit pressure on the hospital system and prevent deaths following the latest outbreaks. Which is what our states have been doing. Lockdowns that are hard and start early when new cases are running around 1 to 10 a day are successful earlier in pushing new cases back down and so can usually end within two weeks with minimal economic impact. Whereas lockdowns that start later take longer to work with higher economic and health costs – which is what NSW is now experiencing and this has been made worse by the two to three times more contagious Delta variant.

While new cases in Australia remain very low by global standards they are continuing to rise.  

Source: covid19data.com.au
Source: covid19data.com.au

In NSW, new local daily cases and new cases in the community while infectious (however defined) have risen to new highs despite having had four weeks in lockdown. There has been some stabilisation in the latter in the last few days (see the next chart), but it’s too early to read much into that and as they are a long way from the objective of near zero it’s highly likely the NSW lockdown will be extended for another two weeks into mid-August (which we have been assuming anyway) and possibly to end August. Meanwhile, the Victorian lockdown has been extended (but note that it has been seeing far fewer new cases infectious in the community and so may be able to end soon) and South Australia has entered another lockdown (but it started with far fewer cases and has kept them low so may also be able to end soon). Once again, the divergence between SA and Victoria on the one hand and NSW on the other highlights the benefit of going early and going hard with lockdowns.

Source: NSW Health, AMP Capital
Source: NSW Health, AMP Capital

The economic impact of the expanding lockdowns is now becoming more evident in our Australian Economic Activity Tracker, which had another leg down over the last week. Fortunately, it’s still not seeing the precipitous collapse seen going into April last year because other states are providing an offset to NSW and businesses and households have found more ways to cope through lockdowns. That said we may see further softness in the week ahead.

Source: AMP Capital
Source: AMP Capital

The extension of the Victorian lockdown (costing nearly $1bn a week), the new South Australian lockdown (costing around $280m a week) and the tougher lockdown rules in NSW and its extension to regional areas indicate that the total cost of the lockdowns will now be around $12bn, with most of the impact in September quarter GDP. This will likely now take it negative at around -0.7%. But this assumes the lockdowns outside NSW are short and NSW’s lockdown ends by mid-August after which activity rebounds. Assuming a 1.8% reopening rebound in the December quarter, this will leave growth through the course of 2021 at around 3.3% year on year, which is revised down from our forecast prior to all the latest outbreaks of 4.8%yoy. Assuming only short snap lockdowns from next quarter and then the attainment of herd immunity through increased vaccination early next year allowing an end to lockdowns through 2022, then 2022 growth is likely to be about 1% stronger than previously expected compensating for weaker growth this year. But that’s a long way off!

What’s the risk of recession - in terms of two negative quarters for GDP in a row? With September quarter GDP growth likely to be negative, recession could occur via two ways. First if the lockdowns at the end of the last quarter drag it negative (as occurred in the March quarter last year). This is possible but it seems unlikely as retail sales still rose in the quarter and the lockdowns did not cover all of Australia unlike last year. Second if the current lockdowns spread around Australia and last into the December quarter weighing it down too. This is a higher risk but note that lockdowns in other countries battling Delta have been successful after a few months and they have had higher numbers. Overall, we rate the risk of a renewed recession as being around 25%. That said, it’s semantics in the sense that it’s not a recession in the traditional sense of the word and as we saw last year growth rebounds quickly on reopening. Apart from coming down hard on covid outbreaks in the absence of vaccines, one way to help ensure there is a strong rebound in the December quarter upon reopening is to increase the amount of government assistance to businesses and households. Ideally this should entail the return of JobKeeper at its original level for those who have lost more than 20 hours a week, conditional of course on businesses retaining their staff. The longer the lockdowns go on, the more this will be necessary.

Given the increased uncertainty we now expect the RBA to delay tapering its bond buying from September for a few months, but still see the first rate hike coming in 2023 albeit it may now be later in the year rather than at the start of the year.

While the news around coronavirus and lockdowns is depressing here are six reasons for optimism: mid-winter is behind us; Brisbane won the Olympics; The Bachelor is back; lockdowns have worked in other countries battling the Delta variant; the vaccines are working in reducing hospitalisation and deaths in highly vaccinated countries; and Australia’s vaccination rate is ramping up.

Our US Economic Activity Tracker ticked up in the past week but remains little changed since May. Our European Tracker is pushing further above pre coronavirus levels.

Based on weekly data for eg job ads, restaurant bookings, confidence, mobility, credit & debt card transactions, retail foot traffic, hotel bookings. Source: AMP Capital
Based on weekly data for eg job ads, restaurant bookings, confidence, mobility, credit & debt card transactions, retail foot traffic, hotel bookings. Source: AMP Capital

Elvis getting his mojo back. As the 1960s wore on Elvis Presley’s career seemed to stagnate with 3 films a year often with a similar theme and a few often lightweight singles from them. They were always fun to watch on a Sunday afternoon, but Elvis was languishing. In 1968 things started to change. Live A Little, Love A Little saw a shift to a somewhat more mature romcom. But more importantly the NBC TV special that aired in December that year saw Elvis return to form and set the stage for the return to live performing. Memories is perhaps the best ballad from that special but it was the ending that really made it special. Colonel Tom Parker wanted Elvis to sing a Christmas song, but Elvis refused and so the show’s musical director W. Earl Brown wrote If I Can Dream which catapulted Elvis into the social protest era. His version with Celine Dion is also worth checking out. It’s a bit like John Lennon’s Imagine in terms of being uplifting.

Major global economic events and implications

US business conditions PMIs fell in July, with the covid resurgence weighing on services, but remain strong. Housing data was mixed with home builder conditions and permits down but housing starts and sales up. The fall back in mortgage rates points to ongoing strength though. Meanwhile, initial jobless claims rose but continuing claims fell.

Source: ABS, AMP Capital
Source: ABS, AMP Capital

So far, the US June quarter earnings reporting season is only 24% done but 87% of results have beaten earnings expectations, 81% have beaten on revenue and consensus earnings expectations for the quarter have been revised up from 62%yoy at the start of July to now 69% with upside surprise concentrated in cyclical sectors. Given the rebound in various macro variables this could end up closer to +90%.

The ECB left monetary policy unchanged but introduced more dovish forwards guidance consistent with its new 2% inflation target – saying it won’t raise rates until it sees inflation at target well ahead of the end of its forecast horizon and its seen as staying there and it will accept a transitory period above target. This all pushes out rate hikes and by implication any slowing in QE. Meanwhile the composite business conditions PMI rose to a 21-year high, surpassing the US.

Japanese inflation remained depressed in June with core inflation unchanged at -0.2%yoy.

Australian economic events and implications

Australian business conditions PMIs fell sharply in July reflecting the hit from the lockdowns with the services sector driving the bulk of the fall. Retail sales fell -1.8% in June as lockdowns impacted various states. Despite this retail sales rose 1.3% in the June quarter as a whole, but they are likely to weaken in July as lockdowns continue to hit. Meanwhile, payroll jobs fell over the two weeks to 3 July, particularly in NSW. The trade surplus widened further driven by continuing export strength.

What to watch over the next week?

In the US, the Fed is expected to leave monetary policy on hold but continue the taper talk with Fed Chair Powell noting that it’s still a “ways off”. We don’t expect a formal announcement until later this year with tapering commencing at the start of next year. On the data front expect gains in new home sales (Monday) and pending home sales (Thursday), solid growth in durable goods orders and home prices but a fall in consumer confidence (all Tuesday), an 8.3% annualised rise in June quarter GDP (Thursday) and reopening driven growth in consumer spending for June (Friday). June core private final consumption inflation (also Friday) is likely to be up 0.7%mom or 3.8%yoy driven by pandemic/reopening related items as already seen in the CPI and the June quarter employment cost index is expected to show another strong rise of 0.9%qoq. And US June quarter company profit results will continue to flow.

Eurozone economic confidence readings (Thursday) are likely to be strong, June quarter GDP is likely to show a 1.6%qoq driven rebound after two quarters of lockdown driven contractions, unemployment is expected to fall and core inflation is likely to fall to 0.7%yoy (all due Friday).

Japanese July business conditions PMIs (Monday) are expected to improve, industrial production is likely to rebound and jobs data will also be released (both Friday).

Chinese business conditions PMIs are due Saturday.

In Australia, June quarter CPI inflation is expected to show a sharp rise of 0.8%qoq reflecting a 7.5% surge in petrol prices, higher electricity prices in WA and some pick up in dwelling purchase prices and rents. Combined with the dropping out of the -1.9% decline in the CPI seen in the June quarter last this will see the long-awaited spike in annual inflation to 3.9%yoy. Underlying inflation will likely accelerate reflecting supply constraints and strong demand to +0.5%qoq/+1.6%yoy. Producer price inflation is also likely to rise due to higher commodity prices and credit data will likely show a further pick up in housing credit (both due Friday).

Outlook for investment markets

Shares remain vulnerable to a short-term correction with possible triggers being the upswing in global coronavirus cases, the inflation scare and US taper talk and geopolitical risks. But looking through the inevitable short-term noise, the combination of improving global growth and earnings helped by more fiscal stimulus, vaccines allowing reopening once herd immunity is reached and still low interest rates augurs well for shares over the next 12 months.

Still ultra-low bond yields and a capital loss from rising yields are likely to result in negative 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 15 to 20% this year before slowing to around 5% 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, fixed mortgage rates rise, macro prudential tightening kicks in and immigration remains down relative to normal. The lockdowns have increased short term uncertainty though.

Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%. We remain of the view that the RBA won’t start raising rates until 2023.

Although the A$ could pull back further in response to the latest coronavirus scare and the threat it poses to global and Australian growth, a rising trend is likely to remain 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$0.85 over the next 12 months.

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Shane Oliver, Head of Investment Strategy & Chief Economist
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While every care has been taken in the preparation of this article, AMP Capital Investors (UK) Limited, Registered Office at Companies House, 4th Floor Berkeley Square House, Berkeley Square, London W1J 6BX (no. 05524536) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

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