Key events of the past week and implications

  • Australia’s political leadership changed with the elevation of Kevin Rudd to Prime Minister.
  • China’s central bank provided assurance on June 24 that the “tight liquidity situation will gradually ease” by guiding “interest rates within reasonable ranges”. This has seen overnight interbank interest rates come down from above 11% last week to 5% at June 28.
  • More soothing words from the US Federal Reserve representatives. Various US Federal Reserve (Fed) officials made speeches trying to clarify the Fed’s intentions on asset purchases (quantitative easing [QE]). After the Fed Chairman Ben Bernanke signalled on June 19 that the Fed expects to be reducing the QE program by the end of this year, there has been considerable turbulence in global financial markets. New York Fed President Bill Dudley commented that QE depends on the “economic outlook” and “not the calendar”. Accordingly there is the possibility that if the US economy’s “growth momentum were to be less favourable”, then the QE “asset purchases would continue at a higher pace for longer”.

Major global economic events and implications

  • US house prices continue their strong recovery. The S&P Case Shiller measure for “Major 10 cities” show a +1.7% monthly price gain in April. Over the past year, US house prices have risen by +11.6% year-on-year which is the strongest annual price gain since 2006. The recent gains in US house prices seem to be having a positive impact on consumer confidence. The Conference Board consumer confidence rose by +7.1 points to 81.4 in June. This is the highest confidence reading since 2008.
  • Europe’s banking system continues to struggle in providing credit to the economy. The European Central Bank’s (ECB) measure of bank lending shows that private sector loans contracted -1.1% over the past year to May. Bank lending to households is flat-lining at +0.2% while lending to “non-financial corporations” fell by -3.1%.
  • ECB President DR Mario Draghi gave a speech on June 25 which defended the central bank “providing liquidity to the banking system”. By doing so, the ECB “avoided an even larger credit crunch and a collapse of parts of the banking system”. Dr Draghi noted that the “overall economic outlook still warrants an accommodative stance” for monetary policy. This suggests the ECB intends to maintain the 0.5% policy interest rate and liquidity support for the banking system for a considerable period. Dr Draghi expects “that monetary stimulus and improvements in financial markets will support a recovery later in the year.”

Australian economic events and implications

  • Job vacancies fell by – 7.3 % in the three months to May. This signals that labour demand continues to deteriorate with the ‘non-mining economy’ struggling (sectors such as manufacturing, retail and tourism).
  • Private sector credit growth still indicates subdued demand for borrowing. Housing credit has increased only 4.5% over the past year to May which is essentially the slowest in the past 36 years.
  • The Federal Government’s Bureau of Resource and Energy Economics (BREE) has released their updated forecasts. BREE is expecting rising export revenues in the next financial year for Australia’s two largest commodity exports. Yet higher revenue will come from increased volumes rather than higher prices. For iron ore which is Australia’s largest commodity export by value, BREE expects that prices will average US$109 per ton in 2013-14. Export volumes should rise by 14.4%. Accordingly the value of iron ore exports is expected to rise by approximately 16% from A$57.3 billion to A$66.7 billion in 2013-14. For coking coal (or metallurgical coal) is also expected to see flat prices but rising production (+6.7%) for 2013. Accordingly, Australian coking coal export values are forecast to rise by +8% from A$21.7 billion in 2012-13 to A$29 billion in 2013-14.

Major market moves

  • Global shares improved this week with some calming actions from China’s central bank and soothing words from the US Federal Reserve. US shares (S&P 500) have risen by +1.3% this week. There were similar gains for Europe with Germany DAX up +0.8 % and UK FTSE rising +1.4%. In Australia the ASX 200 also had a better week with a +1.6%. While Australian share prices have fallen by -2.3 % in June, for the past six months the ASX 200 has recorded modest gains of +3.5%.
  • Government bond yields appear to have stabilised after a turbulent June. Australian Commonwealth government 10-year bond yields have closed June around 3.77% after briefly rising above 4 % this week. US 10-year government bond yields finished the week at 2.45% after peaking at 2.66%.

What to watch over the next week?

  • Australia’s central bank holds its monthly meeting on Tuesday. The Reserve Bank Board (RBA) is more likely to keep interest rates on hold at 2.75% at July’s meeting despite the need for lower interest rates. However the RBA should be cutting interest rates in coming months given the sedate economic activity in the ‘non-mining’ sectors, subdued business and consumer confidence as well as a sluggish labour market. Only a further sharp fall in the Australian Dollar would temper the RBA from employing their ‘scope’ to lower rates.
  • Australia’s economic data releases are likely to portray a soft economy. Nominal retail sales should rise modestly in May but annual sales growth at 3% is a mere shadow on the 6% growth recorded prior to the global financial crisis. Building approvals for May should be flat compared to the same time last year while May’s trade balance is expected to record a small deficit of -A$300 million after a tiny A$55 million surplus for April.
  • China’s central banks actions and comments on mitigating higher money market interest rates. China has seen a spike in interest rates over recent weeks, generating concerns that the banking system is facing a “liquidity crisis” (ie insufficient funds to meet cash requirements and rollover loans). Should this liquidity problem intensify and persist, China’s growth prospects would be damaged. The central banks actions to provide sufficient funds to the banks and lower short term interest rates will be a critical focus for financial markets.
  • The US sees the release of key economic data for June which should provide some guidance on when the Fed’s stimulus measures will be reduced. The Institute of Supply Management (ISM) business surveys and payroll employment reports will indicate how the US corporate sector is responding in terms of confidence and labour hiring. Stronger results could accelerate the Fed’s plans to reduce asset purchases (QE) as early as the next meeting in July. Conversely, weaker results for these business and jobs surveys would see the Fed’s QE program being maintained for a considerable period rather than be reduced.

Outlook for markets

  • Global shares appear to be now entering a consolidation phase after the correction since May. The current turbulence associated with the Fed’s plans to reduce asset purchases (QE), China’s spike in interest rates and Europe’s weak economic activity and fragile financial system should give way to modest optimism that global growth prospects are set to improve over the next year.
  • Hence 2013 should ultimately be a good year for international shares. Global growth should steadily improve over coming months as US employment and housing revivals gather speed while the European economy inches towards recovery. This will create a solid corporate profit environment that should be favourable for global shares. Given global shares are undervalued on historic measures and with investors progressively switching away from government bonds, the remainder of this year should be rewarding for share investors.
  • Global government bond yields will probably move sideways over the next few months as markets contemplate reduced asset purchases and liquidity support from central banks. Global bond markets are oversold and central banks are likely to reduce their support in a measured way rather than a sharp tightening. The Fed has signalled their intentions to taper the QE3 program of US$85 billion per month in purchases of government bonds and mortgage backed securities but this is conditional on an improving US economic outlook. For the medium term however, this moderation in central bank support combined with a global growth pickup should see government bond yields maintain an upward trend.

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