What to watch over the week ahead?

  • Upcoming Chinese economic activity data will provide a critical gauge of the growth slowdown. China is set to release the real gross domestic product (GDP) annual growth data for the June quarter. This is expected to show GDP growth at a circa 7.5% pace. While this is a modest slowing from the March quarter’s 7.7% growth result, global financial markets and Australian commodity producers will be concerned that the Chinese dragon is running out of puff. There are also June’s monthly results for industrial production, fixed investment and retail sales due to be released on Monday. This data will also show how China’s transition from economic growth driven by production and investment towards a more consumer-oriented economy is performing.
  • China money market interest rates should also be monitored. After concerns over a credit crunch-type spike in interest rates in June, China’s money market has calmed down. China’s seven-day repurchase agreement rate has fallen from 5% at the end of June to currently 3.8%. The People’s Bank of China’s assessment that the “tight liquidity situation will gradually ease” on 24 June appears to be justified. Yet these short-term interest rates will need to be monitored.
  • US Federal Reserve (Fed) Chairman Ben Bernanke is scheduled to give a congressional testimony. Hopefully this should finally clarify what the US central bank’s intentions are on asset purchases (also known as quantitative easing, or QE) after last week’s confusing signals. The Fed is currently as decisive as Hamlet…. “To QE or not to QE, that is the tapering question” with their communication strategy. So a clear and consistent message on how much and when the Fed will reduce its asset purchases would be welcome.
  • There is also some important US economic activity data next week with June retail sales and housing starts. The resilience of US consumer spending and the strong housing recovery are key reasons why the Fed is contemplating reducing QE. So further gains in June activity data may accelerate the QE tapering timetable.
  • The Reserve Bank of Australia (RBA) will release the minutes from July’s meeting. While the RBA held the cash interest rate steady at 2.75% in July, the minutes will be dissected by financial markets for signs of the central bank’s intentions. The recent run of soft Australian data justifies another 0.25% interest rate cut in August to 2.50%. Sluggish business confidence, lacklustre consumer sentiment and a rising unemployment rate make a compelling case for lower interest rates.

Outlook for markets

  • Global shares seem to be consolidating this month after June’s turbulence. Concerns over the Fed’s plans to reduce asset purchases, China’s spike in interest rates and Europe’s recession appear to have lessened. Over the coming months, global growth prospects should be improving as America’s employment and housing revival gathers speed while the European economy inches towards recovery.
  • This should create a solid corporate profit environment that should be favourable for global shares. Given that global shares are undervalued on forward price to earnings ratios and with investors inclined to switch away from government bonds, this year should be rewarding for equity investors.
  • Global government bond yields should drift 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 its intention to taper the QE3 program of US$85 billion per month in purchases of government bonds and mortgage-backed securities “later this year”. However in the medium term, less central bank buying support combined with a global growth pick-up should see government bond yields resume a gradual upward trend in 2014.

Headline developments of the past week

  • Australia’s labour force data for June showed that the unemployment rate has continued to grind higher. The unemployment rate rose to 5.7% in June, the highest level since September 2009. This indicates that the labour market is being challenged by business restructuring which is curbing job opportunities as well as strong population growth increasing the supply of labour.
  • The Fed attempted to provide guidance on when the central bank’s bond asset purchases is expected to wind down. The Fed’s meeting minutes show an extended discussion and some disagreement on the timing of when to reduce the QE3 program. There are “some participants” who “thought that a downward adjustment in asset purchases had or would likely soon become appropriate”. Yet there were “other participants” who thought that “this approach appeared likely to limit the Committee’s flexibility in adjusting asset purchases in response to changes in economic conditions”. Further confusing the matter were comments by the Fed Chairman on 10 July. Dr Bernanke emphasised that “highly-accommodative monetary policy” is needed for the “foreseeable future”, thereby indicating no particular strategy or schedule to reduce QE. So the Fed has no clear game plan in terms of the scale and timetable for reducing QE.
  • The International Monetary Fund (IMF) has marginally lowered its global growth forecast for 2013 from 3.3% to 3.1%. The IMF views global growth as “subdued” with Europe being in a “more protracted recession” this year. America should see 1.7% economic growth in 2013 which accelerates to 2.7% next year given “rising household wealth” and “supportive financial conditions”. Europe should recover in 2014 to +1% growth but will be constrained by “tight fiscal and financial conditions”. The IMF has downgraded China’s growth to 7.8% in 2013 and to 7.7% for 2014. The IMF is concerned that emerging economies are generally challenged by “slower external demand growth” as well as “financial stability concerns” and “in some cases weaker policy support”.

Major global economic releases and implications

  • China’s export performance was weak in June with a -3% annual decline and the first negative outcome since 2009. This indicates a significant slowdown in China’s economic activity this year with exports likely to provide a negative contribution to GDP growth.
  • Japan’s industrial production is showing an encouraging response to the central bank’s stimulus efforts and the weaker currency. Industrial production lifted by +2.0% month-on-month in May which represents the fourth consecutive monthly increase.

Australian economic releases and implications

  • The National Australia Bank (NAB) business survey shows that business confidence and conditions are sluggish and suggest that further interest rate cuts are required to lift the corporate sector. Business confidence was flat in June (0) compared to May’s -1 result. Business conditions fell from -4 to -8 in June which is a four-year low. As the NAB survey noted, “the outlook for near-term activity remains worrisome, with forward orders, stocks, employment conditions and capacity utilisation all remaining well below historical average levels”.
  • Consumer sentiment fell marginally from June’s 102.2 result to 102.1 in July. After the surge to 110.5 in March 2013, consumer sentiment has been subdued over recent months.

Major market moves

  • Global shares have had a positive week so far. American shares (S&P 500) and Britain’s FTSE have risen by +2.6% for the week. Germany’s DAX was even more impressive with a +4.5% gain. Australia’s ASX 200 also an encouraging week with price gains of 2.7%.
  • Government bond yields also had a favourable run after the recent turmoil in June. American 10-year government bond yields have rallied from 2.74% to currently 2.56%.

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