Key events of the past week and implications

  • Share markets continued to move ahead over the past week helped by a combination of reasonable profit results, a further fading of the fiscal austerity fetish in Europe with France being the latest country to receive an extension of time to get its budget down to 3% of gross domestic product (GDP) and more monetary easing with both Australia and Korea cutting interest rates. It’s starting to feel a bit like the Australian share market in 2004, which saw only mild corrections (3% was the worst) and a steadily rising trend as investors bought the dips against the backdrop of improving macroeconomic conditions and a chase for yield.
  • In Australia, the big focus was on the Reserve Bank (RBA) which finally acted on its easing bias by cutting the cash rate to a record low of 2.75%. While the RBA’s quarterly statement saw a lowering in its inflation forecasts, this mainly reflected the lower than expected March outcome and more broadly the statement didn’t really shed much more light on the outlook for rates, not that the RBA gives too much away anyway. Our assessment is that with the slowdown in mining investment now upon us, the response to rate cuts remaining patchy, inflation likely to remain benign and the Australian dollar (A$) remaining relatively strong, further easing is likely with the cash rate expected to fall to 2.5% in the next few months. Ongoing fiscal tightening in Tuesday’s budget will likely add to the case for more rate cuts. One thing to note though is that with rates having fallen a long way over the last 18 months and tentative signs the economy is responding, we are now in a fine tuning phase for the RBA. Improved bank funding costs, allowing the banks to cut by more or independently as seen by the ANZ, will also help take a bit of pressure off the RBA. It remains a good time to lock in attractive fixed rate deals on mortgages.
  • Perhaps the most interesting development over the last week though was a breakdown in the value of the A$. Following the RBA’s rate cut and a generalised fall in the US dollar (US$) in response to strong labour market indicators the A$ has decisively broken down below the US$1.02 to US$1.06 range it has been in since July last year.
  • The RBA’s rate cut and cuts by Korea, Sri Lanka and Vietnam bring the total number of rate cuts by central banks world wide since the global financial crisis to 513 (based on Bank of America and Bloomberg estimates). Don’t forget that there were a few rate hikes around late 2009 and 2010, but there’s no denying the desire of central banks to get global growth moving again. This is a long way from the hopeless policy responses of the early 1930s.

Major global economic events and implications

  • US data was mostly positive. Consumer credit, job openings and wholesale sales were on the soft side, but weekly mortgage applications for purchasing homes rose and have clearly broken out of the low range they have been in since 2010. Jobless claims continued to slide, the US Federal Reserve’s (the Fed) regular bank survey showed an easing in lending conditions and improving demand for loans and the Federal budget deficit continued to improve falling to 5.5% of GDP from a post global financial crisis high of just over 10%. Several Fed officials again indicated a desire to slow the pace of quantitative easing, but it’s noteworthy that they have been saying the same for a while whereas the doves on the board continue to say it’s too early for a change in policy. This debate is likely to wax and wane for some time, but I think any tapering in quantitative easing (QE) is unlikely until around September and when it occurs it will be against the backdrop of more confidence regarding the US economic outlook.
  • The US March quarter earnings story remains broadly positive. It’s now 90% done with 72% of results coming in better than expected and profits up around 4% which is about 5 percentage points better than expected. That said, only 48% have exceeded revenue expectations and guidance has been soft.
  • Eurozone data was, if anything, a bit better than expected with the services and composite business conditions indicator being revised up to show a rise in April, and German factory orders and industrial production both rising more than expected, contradicting concerns about a German slowdown.
  • Chinese data for April was positive, with stronger than expected gains in exports, imports, bank financing and money supply and inflation remaining benign. While consumer price inflation rose to 2.4%, this reflects higher food prices with non-food inflation running at just 1.6% providing plenty of flexibility for monetary policy.

Australian economic events and implications

  • Australian economic data was a mixed bag. As always the labour force report did its best to surprise with an unbelievably strong 50,000 jobs surge in April. However, employment has been bouncing around like a yo-yo lately with a 72,000 surge in February, a 31,000 fall in March and now a 50,000 gain. This pattern would suggest that a large fall is likely this month as would renewed weakness in job advertisements and soft hiring plans in various surveys. It’s also worth noting that the unemployment rate is still trending up and this is a sign that the underlying jobs market is soft. Moreover, retail sales unexpectedly fell in March, the AIG construction conditions index fell, house prices were virtually flat in the March quarter according to the Australian Bureau of Statistics and while the trade balance returned to surplus in March, this was in large part due to weak imports.

Major market moves

  • Share markets rose thanks to solid profit reports, reasonable economic data, fewer worries in Europe and the ongoing chase for yield in the face of low and still falling interest rates. Over the week, US and European shares rose 1.2%, Japanese shares gained 5.9%, Chinese shares rose 1.9% and Australian shares gained 1.5%. The ongoing gains in share markets were matched by a sharp back up in bond yields.
  • Commodity prices mostly rose but US$ strength provided a dampener. The latter saw the yen resume its fall after a month long pause, with the US$ rising above ¥100 for the first time since 2009, and the A$ fall to around parity against the US$.

What to watch over the next week?

  • In Australia, the focus will be on Tuesday’s Budget, where we expect revenue shortfalls running at around A$17 billion a year to have blown the 2012-13 budget out to a deficit of A$15 billion. While the government is likely to announce budget savings to ensure it remains on a trajectory back to surplus, in an election year it’s hard to see it pushing too hard on this front, so we expect the government to project a 2013-14 deficit of still A$10 billion and to delay the return to surplus to 2015-16. Budget savings are likely to focus on reducing company tax deductions, cutting back on family welfare payments, stopping or delaying income tax cuts that would have kicked in from carbon pricing, superannuation changes that have already been announced, and more cutbacks in defence and the public service. Economic assumptions are likely to be relatively cautious with 2.75% growth for 2013-14 and inflation around 2.25%.
  • On the data front, the NAB business survey (Monday) will likely show that business confidence and conditions remain subdued, housing finance (Monday) is likely to show a continued modest uptrend, and wages growth (Wednesday) is likely to have remained subdued with a quarterly increase of 0.8%.
  • Chinese economic activity indicators due out on Monday are expected to show a slight pick up in growth in industrial production to 9.4%, retail sales to 12.8% and fixed asset investment to 21% after the softer than expected readings recorded in March.
  • In the US, expect retail sales (Monday) to have been relatively subdued for April, the New York and Philadelphia regional manufacturing conditions surveys (due Tuesday and Thursday respectively) to have improved slightly in May, home builder conditions (Wednesday) to show a further slight improvement, housing starts (Thursday) to have fallen slightly after a big surge in March and inflation to have remained benign. Data for industrial production, leading indicators and consumer sentiment will also be released.
  • In the Eurozone, March quarter GDP (Wednesday) is expected to show a continued recession but with the pace of contraction slowing to -0.1% after the 0.6% fall in the December quarter. Data for industrial production and inflation will also be released.
  • Japanese March quarter GDP (Thursday) is expected to show a return to growth, with a 0.7% rise.

Outlook for markets

  • After their recent surge, shares are vulnerable to a bit of a correction, particularly as we come into the seasonally weaker period of the year. Maybe more debate about when the Fed will start to ease up on quantitative easing could be a trigger. However, we remain of the view that any setbacks will be mild. Shares are still far from expensive, monetary conditions are very easy, the gradually strengthening growth outlook points to stronger profits ahead and the chase for yield and better returns in the face of low bank deposit rates is seeing the return of ‘buy on the dips’ demand from investors. Increased mergers, buybacks and dividends will also help. So notwithstanding usual volatility, this points to a positive backdrop for shares.
  • Sovereign bonds are being helped by Japanese monetary reflation and low inflation. However, they remain fundamentally vulnerable as an improving global, and Australian, growth outlook will likely see bond yields move higher over the year ahead resulting in capital losses for investors in them.
  • The downtrend in commodity prices along with ongoing rate cuts in Australia are likely acting as an increasing drag on the A$, offsetting the impact of monetary printing in the US and Japan. Having broken down below the US$1.02 to US$1.06 range that has prevailed since July, the A$ looks to be headed lower.

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