Key events of the past week and implications

  • The past week saw global shares continue their upward drift helped by good economic data, good news regarding Iran and favourable developments in Europe. However, Australian shares remained in correction mode.
  • The nuclear deal with Iran is a big positive as it substantially reduces the threat of a disruption to the 17 million oil barrels that flow through the Strait of Hormuz per day, and hopefully will lead to Iran’s 1.5 million barrels of oil per day coming back on line. So potentially less upwards pressure on oil prices and this is good for global growth.
  • There was also good news in Europe with: Merkel and the Social Democrat Party (SDP) agreeing to a coalition which (if ratified by SDP members) will see a minimum wage introduced which will help boost German consumption; the Greek budget on track for a primary surplus this year and Moody’s upgrading its credit rating; and Berlusconi being expelled from the Italian parliament but with little consequence as the Government retained support.
  • Chinese 10-year bond yields fell over the last week, but are still up 100 basis points over the last six months adding to fears China is undergoing another growth-threatening monetary tightening. However, I am not so worried as: the back-up this year in Chinese bond yields just looks like a catch-up to similar increases in global bond yields; it has resulted in a steeper yield curve (long rates rising relative to short rates) which is actually positive for growth; and not much corporate borrowing occurs in the bond market anyway (with corporate bonds only making up 15% of the total bonds outstanding in China) as corporates rely more on bank lending.
  • In Australia, despite comments by Reserve Bank of Australia (RBA) Deputy Governor Lowe indicating that the threshold for intervening to push the Australian dollar down was “fairly high”, the threat that it may occur has continued to weigh on the Australian dollar, which is just what the RBA wants to see. And it is worth noting that the RBA may be selling more Australian dollar / buying more foreign exchange in the months ahead simply to allocate the A$8.8 billion capital boost it received last month. Meanwhile, Lowe re-emphasised the point that with the terms of trade boost to national income largely behind us, Australia will need to focus on boosting productivity in the years ahead if it wants to continue to see decent growth in living standards. This is not a new message but he is right. To this end proposed tax changes that will cost nothing but encourage state governments to privatise assets are a move in the right direction.
  • Meanwhile, the Government’s decision to block the GrainCorp bid and possible plans to buy a stake in Qantas in preference to allowing foreign control will no doubt lead some to fear that Australia is less open to foreign investment and may be returning to a past of greater government involvement in the economy. The initial dip in the Australian share market and the Australian dollar in response to the GrainCorp announcement suggest this is the fear. But while one can debate the merits of such decisions, both should be seen as isolated cases reflecting particular circumstances and do not set a precedent. Just as the Woodside decision a decade ago did not signal a precedent. This is particularly so given the proposed tax agreement with the states to encourage the privatisation of more assets, which points to less government involvement in the economy, not more.

Major global economic events and implications

  • US economic data was mostly ok. On the negative side pending home sales and durable goods orders both fell in October, but may have been affected by the shutdown. Against this though, permits to build new homes rose strongly in September and October, house prices continue to rise, timely consumer confidence measures rose, the leading index rose, initial unemployment claims fell and a new Markit services sector purchasing managers’ index (PMI) rose strongly. Overall, this is consistent with a slight pick-up in the pace of US economic growth this quarter.
  • Eurozone confidence rose for the seventh month in a row and unemployment fell slightly to 12.1%, but lending growth slowed further reminding that growth will remain weak and that further European Central Bank (ECB) help is likely required. With inflation in November at just 0.9% there is plenty of scope for further ECB easing.
  • Japan saw more good economic data with solid gains in industrial production, the manufacturing conditions PMI, the job-toapplicant ratio and household spending and core inflation rising further to 0.3% year-on-year, adding to confidence that Abenomics is working and deflationary pressures are fading.

Australian economic events and implications

  • Australian business investment data for the September quarter provided good news. Construction investment rose solidly in the quarter pointing to a favourable contribution to September quarter gross domestic product (GDP) growth, but more importantly there are signs of life in the outlook for non-mining investment. To be sure the current financial year is likely to be pretty flat for business investment, but the last three months have seen the projected outlook rise from a 1% fall to a 1% gain. And the turn up is coming from non-mining investment, with investment in what the Australian Bureau of Statistics calls “other selected industries” projected to grow 3%, compared to a projected 3% decline just three months ago. This adds to signs already evident from housing indicators and consumer and business confidence that interest rate cuts are gaining traction and that the economic outlook is brightening.
  • In other data, new home sales fell in October, but this followed a strong gain and with the Housing Industry Association reporting another rise in housing affordability and housing finance commitments continuing to rise, the trend in new home sales is likely to remain up. Private credit growth remained weak in October, up just 3.5% year-on-year.

Major market moves

  • Most global share markets pushed higher over the last week helped by good economic data, good news regarding Iran and favourable developments in Europe. US shares and Eurozone shares rose 0.1%, Japanese shares gained 1.8% and Chinese shares rose 1.1%. Australian shares remained in correction mode though falling 0.3%.
  • Commodity prices were little changed to down, with the oil price falling to a six-month low.
  • The threat of intervention continued to hang over the Australian dollar.

What to watch over the next week?

  • In the US, the main focus will be on the payrolls data due Friday as it will likely be important in determining whether the US Federal Reserve (Fed) will start to taper at its December meeting. The consensus is for a 185,000 gain which may not be strong enough to be decisive. However if it is 200,000 or above, expect the probability of a December taper to rise significantly. Unemployment is expected to fall back to 7.2% after the distortion caused by the shutdown in October. Meanwhile, expect the Institute for Supply Management manufacturing (Monday) and services (Wednesday) surveys to remain around levels consistent with reasonable growth, new home sales (Wednesday) to remain solid and September quarter GDP growth (Thursday) to have been revised up to 3.1%.
  • After cutting its official interest rate last month the ECB may well do nothing at its Thursday meeting. But there is some chance it will go further and cut the deposit rate it pays on reserves to -0.1% in order to further encourage banks to lend. Inflation is running well below target in and this is likely to be concerning the ECB.
  • In Australia, the RBA is expected to leave interest rates on hold at 2.5% when it meets Tuesday. Yes it retains an easing bias but it is only a mild one and in any case since the last meeting there has been more evidence the economy is responding to interest rate cuts and the Australian dollar has fallen in value, in part due to jawboning by RBA officials. So with things going in the right direction there is little reason for the RBA to cut rates again in the week ahead. We remain of the view that while the risk is on the downside for interest rates, they have most likely bottomed and will remain on hold ahead of eventual rate hikes late next year.
  • It will be a busy week on the data front in Australia. Expect a 2% fall in building approvals (Monday) after a 14% gain the previous month but retail sales (Tuesday) to continue the modest recovery evident in recent months. September quarter GDP growth (Wednesday) is expected to be around 0.7% quarter-on-quarter or 2.6% year-on-year helped along by modest growth in business investment and consumer spending and a small contribution from net exports. The Australian Industry Group’s PMIs along with data for house prices will also be released Monday.

Outlook for markets

  • Shares are at risk of a consolidation or mild correction phase after very strong gains from early October lows which have left them vulnerable. This appears to have already commenced in Australia with a rash of capital raisings not helping. However, this is likely to be just a pause ahead of the resumption of the rising trend as valuations are reasonable, monetary conditions are set to remain very easy, profits will improve next year as global and Australian growth picks up and there is still a lot of money sitting in cash and bond funds. The Australian share market remains on track to hit 5500 by year-end, with a little help from a Santa rally. Note that the first half of December is often flattish for shares with the Santa rally usually starting around Christmas.
  • Government bond yields are likely in a gradual upwards trend as the global economy continues to pick up momentum and as Fed tapering eventually occurs. Low yields and an unwinding of years of massive inflows point to poor sovereign bond returns ahead. However, dovish forward guidance from central banks is likely to help ensure the rising trend in yields remains gradual.
  • Expect the Australian dollar to be buffeted in the short term between signs Australian rates have bottomed but talk of Fed tapering and RBA jawboning. The medium-term trend in the Australian dollar is likely to remain down to US$0.80.

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