Investment markets and key developments over the past week
Share markets had a mixed ride over the last week with ongoing global growth fears and messy US earnings news. US shares lost 0.5% and Chinese shares remained under pressure falling another 3%. However, Eurozone shares gained 0.5%, Japanese shares rose 1.9% helped by a lower Japanese yen and Australian shares gained 0.7% with the recent Reserve Bank of Australia (RBA) rate cut continuing to help. Bond yields generally fell, commodity prices were mixed with oil up but metals down and the Australian dollar fell below $US0.73 as the US dollar edged up slightly.
Another Greek blow up looks unlikely for this summer. Renewed Grexit fears helped set off share market turbulence around mid-last year (and mid-2010, mid-2011 and mid-2012) but the same looks unlikely this time around. With Greece agreeing various reforms on pensions, taxes and contingent spending cuts it looks likely to pass the first review of its latest aid program. European creditors are now starting to discuss debt relief based around longer maturities and lower interest rates. There is a way to go, but at this stage it looks like another Grexit scare won't be back in the headlines this year.
Impeachment trial of Brazilian President Rousseff only the beginning. While Brazil’s Senate vote to commence an impeachment trial of Dilma Rousseff was initially greeted positively by the Brazilian share market, Brazil has a long way to go to get back on track. Vice-president Michel Temer who is now acting president looks to be making market friendly appointments to his cabinet and looks likely to try to rein in Brazil’s 5% of gross domestic product (GDP) budget deficit with spending cuts and tax hikes. However, the huge 20% plus rally in Brazilian shares that has already occurred this year in anticipation of Rousseff’s impeachment is likely to be tested as the trial will take many months. Then the outcome can be challenged and even if Rousseff is ultimately impeached, President Temer would then remain in office until 2018 and he is unlikely to undertake the sort of reforms Brazil needs. In the meantime fiscal cutbacks are likely to worsen Brazil’s already deep recession and in turn heighten political tensions which could see them reversed. A new election would help but that could be some time away and it's not clear that it will result in a government focussed on undertaking the necessary economic and political reforms to get Brazil's economy back in shape. In other words Brazil’s problems are much bigger than Rousseff - they have just been exposed by the commodity slump.
Lowering Australia's inflation target would be madness. Back around 2007-08 when inflation had pushed above 4% (both headline and underlying) some commentators were seriously arguing that the RBA cannot fight rising global commodity prices and so should just raise its inflation target. Now we’re hearing that with inflation below target the RBA should just lower its target with some using the same argument about falling global commodity prices. This is nonsense. The whole point of having an inflation target is to anchor inflation expectation around the target. If it is just raised or lowered each time it looks like being seriously breached due to commodity price movements or whatever then those expectations – which workers use to demand wage gains, companies use in setting wage increases and prices and which help drive future inflation – will simply move up or down depending on which way the target is changed. This is why it took so long to get inflation back under control in the 1970s and 1980s and why Japan has struggled to end deflation over the last two decades. The RBA should simply ignore calls to lower the target.
Major global economic events and implications
US data was stronger with a big gain in April retail sales, improved consumer sentiment, a rise in small business optimism and strong readings for job openings and hiring suggesting that the labour market is strong and the slowing in payrolls seen in March may be an aberration. That said unemployment claims have edged up over the last couple of weeks, although the rise over the last week may be due to special factors as it was driven by just New York. Meanwhile, a rise in producer prices suggest an edging up in underlying price pressures. A June or July US Federal Reserve (Fed) rate hike still looks unlikely but there is a reasonable chance of a September hike.
Eurozone industrial production fell but German factory orders rose.
Japan's leading economic indicator rose in March, but various economic confidence indicators fell not helped by the Kumamoto earthquake and underlying wages growth remained soft.
Following the lead from business conditions Purchasing Managers’ Indices, Chinese industrial production, retail sales, fixed asset investment, exports, imports, lending and money supply growth all slowed to varying degrees in April, leaving them in the growth ranges they have been in over the last year or so. Cutting through the volatility it’s clear that there is no sustained acceleration in Chinese growth, but then again there is no collapse either. More likely it’s just stabilising somewhere around the 6.5-7% GDP growth range. Chinese consumer price index (CPI) inflation was unchanged at 2.3% year-on-year (yoy) in April, with non-food inflation remaining low at just 1.1% yoy. There was good news though with producer price deflation continuing to recede from -4.3% yoy to -3.4% yoy. This is a good sign. Meanwhile, the decline in underlying foreign exchange reserves continued to slow suggesting that capital outflows are continuing to slow as a degree of stability has returned to the Chinese renminbi (albeit this partly dependent on what the US dollar does).
Indian economic data disappointed with weaker than expected industrial production and higher inflation.
Australian economic events and implications
Australian data was a bit light on, but the highlight was a bounce in consumer confidence that took it above average and to its highest since January 2014 – rate cuts work at least in the short term! This doesn’t appear to have been driven by reaction to the Federal Budget (which looks neutral relative to last year), but rather appears to reflect reaction to the RBA’s latest rate cut which is a positive sign. That said, consumer sentiment is volatile month-to-month and remains below levels associated with strong growth.
Source: NAB, Westpac/MI, AMP Capital
Meanwhile Australian housing finance was a bit stronger than expected in March driven by loans going to investors to buy new properties. The broad trend is still down but there has been a bit of a bounce in investor loans. Strength here is likely to be limited though given ongoing Australian Prudential Regulation Authority vigilance. Finally, ANZ job ads slowed a bit again in April, consistent with some moderation in employment growth after last year’s surge.
Reflecting the downside risks to inflation we are now allowing for two more rate cuts from the RBA this year taking the cash rate down to 1.25%.
What to watch over the next week?
In the US, expect to see gains in the National Association of Home Builders’ conditions index (Monday), housing starts and industrial production (both Tuesday) and existing home sales (Friday). Manufacturing conditions surveys for the New York and Philadelphia regions will give an early guide as to how conditions are tracking in May. While CPI inflation (Tuesday) is likely to show a solid rise reflecting the recent bounce in oil prices, core CPI inflation is expected to fall back slightly from 2.2% yoy to 2.1%. The minutes from the Fed’s last meeting (Wednesday) are likely to confirm that the majority view at the Fed is cautious and dovish.
In Australia, the minutes from the RBA’s last meeting (Tuesday) will be a bit dated given the recent Statement on Monetary Policy but no doubt they will be watched for any further clues regarding the interest rate outlook. On the data front expect to see March quarter wages growth (Wednesday) remain low around 2.2% yoy and April labour market data (Thursday) to show weak jobs growth after the solid gain seen in March and a slight bounce in unemployment back to 5.8%.
Outlook for markets
Expect short term share market volatility to remain high. May always seems to be a nervous time as now everyone knows about “sell in May and go away, come back on St Leger’s Day”. Global growth remains fragile and uncertainty lingers around the Fed and China. However, beyond near term volatility, we still see shares trending higher this year helped by a combination of relatively attractive valuations, further global monetary easing and continuing moderate global economic growth.
Very low bond yields point to a soft medium term return potential from them, but it’s hard to get bearish in a world of fragile growth, spare capacity and low inflation.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors.
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 price growth is likely to pick up in Brisbane.
Cash and bank deposits are likely to provide poor returns – getting even poorer!
The ongoing delay in Fed tightening still poses short term upside risks for the Australian dollar. However, any short term rebound is likely to be limited and the longer term downtrend looks to be resuming as the interest rate differential in favour of Australia narrows as the RBA continues cutting the cash rate and the Fed eventually resumes hiking, commodity prices remain in a secular downswing and the Australian dollar undertakes its usual undershoot of fair value.