Investment markets and key developments over the past week
What a difference a day makes. On Thursday most global share markets were underwater for the week partly due to a silly knee jerk reaction to European Central Bank (ECB) President Mario Draghi’s out of context comment that he doesn’t anticipate more interest rate cuts. But Friday saw European and US shares surge higher as investors realised the full extent of the ECB’s stimulus measures. So for the week US shares gained 1.1%, Eurozone shares rose 1% and Australian shares gained 1.5%. However, Japanese shares lost 0.5% and Chinese shares fell 2.2%. The delayed favourable reaction to the ECB also saw bond yields rise, except in peripheral Europe, and the A$ push above US$0.75. Also helping was a fall in the value of the US$ over the week and a rise in the Chinese Renminbi back to around levels it started the year at, which is important given the role that a falling Renminbi played in driving share market turmoil earlier this year.
Whichever way you look at it, the ECB delivered much more than generally expected: its monthly quantitative easing (QE) program was increased from €60bn to €80bn; it will now include buying corporate debt in its QE program; it announced new cheap financing programs for banks (what the ECB calls ‘Targeted longer-term refinancing operation’ (TLTRO)) that will start in June with an interest rate as low as -0.4%; and it cut the rate of interest on bank deposits at the ECB to -0.4% (from -0.3%). While there was an initial negative reaction to President Draghi’s comment that he doesn’t anticipate more rate cuts, it would be wrong to make too much of this. First, Draghi’s comment was likely aimed at limiting expectations for any squeeze on bank margins, following the negative reaction to the Bank of Japan’s move to negative rates in January. Second, given concerns about banks his real message is that “the emphasis will shift from (negative) rates to other non-conventional instruments [like QE and TLTRO]” and it’s likely that ECB officials will stress this in the period ahead. Third, the overall easing announced by the ECB is much bigger than expected and buying corporate debt should help bring the recent blow out in corporate bond yields back down, with a flow on to bank borrowing costs. The focus on corporate debt and cheap bank financing is all about making sure that the recent turmoil around Eurozone bank shares is not allowed to mess with the monetary transmission mechanism in Europe. Finally, the ECB and Draghi signalled even more determination to get inflation back up to its mandate “without undue delay” and Draghi even flagged a willingness to let inflation run above the 2% target for some time if it spends a long time below it. This is all about boosting inflation expectations. But it also alludes to making its quantitative easing program open ended as the US QE3 program was. So overall we give the ECB a big tick.
Closer to home the Reserve Bank of New Zealand also eased over the last week, cutting its official cash rate from 2.5% to 2.25%. While New Zealand is in a different position to Australia, having come from a brief tightening cycle, it does have similar concerns regarding its currency being too strong.
In Australia, consumer sentiment data highlighted a renewed degree of caution when it comes to investing. When asked what is the wisest place for savings, the March survey showed a dip in those nominating shares (from an already low 9.9% in the December survey to 7.6%), a sharp fall in those nominating real estate (from 23.4% to 14.7%) and an increase in those nominating either bank deposits or paying down debt (from 44% to 51.8%). Quite clearly share market volatility has weighed on sentiment towards shares, but it also looks like all the latest talk about a property crash has weighed on sentiment towards property. There could be a contrarian signal in there, given that it’s usually best to do the opposite to the crowd at extremes!
Source: Westpac/MI, AMP Capital
Major global economic events and implications
It was a quiet week on the US data front with a slight fall in small business optimism and a continuing rise in inventories highlighting the more difficult environment for US manufacturers, but a sharp fall in US jobless claims to a five month low, telling us the jobs market remains strong. Meanwhile the message from US Federal Reserve (Fed) officials was mixed, with Vice Chair Fischer pointing to what may be “the first stirrings of an increase in inflation”. Governor Brainard however was sounding much more cautious, and arguing for patience until the outlook becomes clearer.
Japanese data was soft, with falls in economic sentiment, consumer confidence, machine tool orders and slower growth than expected in money supply and bank lending.
German industrial production rose much more than expected in January and factory orders fell by less than expected.
Chinese economic data was disappointing, with February exports and imports falling more than expected, January/February growth in industrial production and retail sales slowing and a sharp fall in February growth in money supply and credit. However, it’s worth noting that: there is a danger in reading too much into January and February data in China due to distortions caused by the floating Lunar New Year holiday; the softness in February money supply and credit data looks like payback after very strong January data and average growth across the two months is still much stronger than seen late last year; and finally a slight pick-up in fixed asset investment suggests stimulus measures may be starting to impact. Nevertheless, the overall impression is that economic growth in China has started the year on a softish note, which probably explains the recently stepped up official focus on stimulating the economy. Our forecast for Chinese economic growth this year remains at 6.5%.
Meanwhile, the Chinese Government looks like it will allow banks to convert bad loans in debtor companies into equity holdings in a move to deal with rising levels of bad debts. A similar approach was used successfully in the 1990s.
Australian economic events and implications
Australia saw softness in housing finance and confidence measures continue to bounce around long term average levels. The message from January housing finance commitments is that investor finance is continuing to slow and owner occupier finance, which was filling the gap, may be too. That said it's premature to read too much into one month's worth of data. Meanwhile, consumer confidence fell slightly in March - perhaps not surprising given all the talk about cuts to tax concessions - and business confidence was unchanged in February. It’s hard to get excited though, with both figures around their long term average levels. Business conditions actually improved in February (consistent with various Purchasing Managers Indices (PMIs)), with employment and capex intentions running around solid levels.
What to watch over the next week?
The focus in the week ahead will remain on central banks, with both the Bank of Japan and the Fed meeting. The Fed (Wednesday) won’t be raising interest rates – with the market attaching just a 4% probability to a hike in the week ahead – but it is likely to indicate that while it intends to raise interest rates further this year, it is aware of the risks of slower global growth and so will proceed cautiously. In particular, the Fed’s median “dot plot” showing Fed decision makers’ expected path for interest rates going forward is likely to show more interest rate hikes this year, but only three 0.25% hikes down from four. This compares to market expectations for no more than one, but the Fed and the market are likely to come closer together.
On the data front in the US, expect to see a further gain in US retail sales (Monday) after allowing for the impact of falling gasoline prices, strength in homebuilding conditions (Tuesday) and housing starts (Wednesday) and a fall in industrial production (also Wednesday). Inflation data to be released Wednesday will likely show a fall at the headline level due to lower gasoline prices, but will be watched for a further pick up at the underlying level. Manufacturing conditions surveys will also be released for the New York and Philadelphia regions along with data on job openings.
Meanwhile, the Bank of Japan is unlikely to cut its deposit rate further into negative territory after the bad reaction to its January cut, but it could undertake an expansion of its quantitative easing program.
In Australia, it’s back to the monthly employment lottery on Thursday. For what it’s worth, we expect a 10,000 gain in jobs and unemployment staying at 6%. The Reserve Bank of Australia (RBA) will also release the minutes from its last meeting on Tuesday, but they are a bit dated given GDP and other data released since then.
Outlook for markets
Shares have had a good bounce, but having become overbought are now vulnerable to a pull back. Worries about the Fed will no doubt dominate in the week ahead and of course uncertainty remains regarding China. So whether we see a retest of February lows remains to be seen. Beyond the near term uncertainties though, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate economic growth.
Very low bond yields – with many sovereign bonds now having negative yields - point to a soft medium term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation. Bonds in higher yielding countries like Australia, the US and maybe even China are relatively attractive.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.
National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but growth is likely to pick up in Brisbane.
Cash and bank deposits are likely to continue to provide poor returns, with the RBA expected to cut the cash rate to 1.75%.
The delay in Fed tightening and stronger data in Australia pose further short-term upside risks for the A$. However, just as we saw with the early 2014 9% bounce in the A$, any short term strength in the currency is unlikely to go too far. The broad trend is likely to remain down as the interest rate differential in favour of Australia narrows (as the RBA eventually resumes cutting the cash rate or at least resorts to jawboning and the Fed eventually resumes hiking), commodity prices remain weaken and the $A undertakes its usual undershoot of fair value.