Investment markets and key developments over the past week
It was another volatile week for global shares with strength into the Fed meeting, partly in anticipation of the Fed leaving interest rates on hold, and then European and US shares completely reversing their gains as the Fed provided a reminder about China and emerging market driven global growth worries. This saw US shares fall 0.2% for the week, Eurozone shares down 0.6% and Japanese shares down 1.1%. Chinese shares also fell 3.2% as official support for the market was tested. Australian shares managed a 2% gain though. Bond yields followed a similar pattern to shares initially rising before falling and commodity prices reversed some or all of their gains later in the week as global growth concerns came back into focus and the $US rose. While the $A rose over the week it ended well off its highs.
Fed on hold and dovish. A few months back it was widely expected that the Fed would start to hike rates at its September meeting. In the interim though uncertainty about Chinese and emerging market growth along with continued uncertainty about US inflation has clearly got in the way and the Fed has rightly opted to leave rates on hold. More importantly though, while the Fed is still leaning towards a hike by year end, the commentary from the Fed was relatively dovish with the so called “dot plot” of Fed meeting participants’ interest rate expectations being revised lower and the Fed clearly taking account of the risks posed by recent “global and financial developments” - read China and the emerging world - and the downside risks posed by this to US inflation. The clear message from the Fed is that it is aware of what is going on globally and it is not going to do anything to threaten global growth at a time when US inflation is below target.
While the Fed is likely to be comfortable that it has seen enough improvement regarding the jobs market it still seems to lack “confidence that inflation will move back to its 2% objective over the medium term.” Although Fed Chair Janet Yellen has indicated that the Fed’s October meeting remains “live” for a rate hike, it’s hard to see enough changing by then to justify lift off. In fact, even a move in December looks doubtful with the timing looking to me like it’s shifting into the March quarter of 2016. Given that the risks of deflation still outweigh the risks of higher inflation globally, it makes sense for the Fed to remain cautious.
In terms of market implications, the move by the Fed to leave rates on hold and indications it won’t do anything to upset global growth are positive. However, a Fed rate hike is likely still out there somewhere and uncertainty around it will likely return at some point.
Get ready for some noise out of Washington. The US budget and debt ceiling may hit the headlines again soon with Congress needed to pass budget funding for the new fiscal year that begins on October 1. This and a desire by a group of extreme Republicans to tie budget funding to defunding Planned Parenthood could lead to the usual brinkmanship. The GOP leadership knows that it will end up getting blamed by the American people if it goes down the shutdown route again, and this is something they will likely be keen to avoid given the closeness to next year's elections. So our base case is a last minute deal but no shutdown. Similarly, expect some argy bargy around increasing the debt ceiling later this year (it looks like being reached around mid-November to early December) and again another last minute deal. However, budget funding and the debt ceiling could end up getting rolled in together again and the risk of some market impact is certainly there, so it’s worth keeping an eye on.
The change to Malcolm Turnbull as Australia’s Prime Minister won’t change the current Australian economic reality flowing from the end of the resources boom, but it does have the potential to help. At the very least we should see a short term boost to confidence as he is a more popular political leader. But more importantly, we are likely to see a better articulation of Australia’s economic challenges and what we can do to address them and greater flexibility in working to help guide reforms through Parliament. So while I won’t be rushing to revise up economic growth forecasts and investment market return expectations the change does provide a bit of upside risk.
The latest Greek election has been non-event for global investment markets. The election has seen Syriza win the largest share of votes, and it looks on track to form a coalition with the same party it has governed with since the January election. This is probably a good outcome for Greece as it means that Syriza will have to push through in implementing the third bailout deal to which it has signed up rather than seeking to find populist ways to modify or oppose it outside of government.
Major global economic events and implications
US economic data remains mixed and suggests that growth is continuing to trend along around 2-2.5%. Retail sales data was solid with upwards revisions to previous months and homebuilders’ conditions were strong. But against this, housing starts fell and industrial production and manufacturing conditions were soft. While consumer spending is fine, the strong $US and an inventory correction look to be weighing on manufacturing. Capacity utilisation is also running at sub-par levels which may be constraining business investment and pricing power. In terms of the latter, CPI inflation remained low in August with headline inflation remaining at 0.2% year on year and core inflation at 1.8% yoy. Were it not for housing costs the core inflation rate would be just 0.9% yoy. There is clearly plenty of room for the Fed to continue delaying the interest rate lift off here.
Eurozone industrial production and construction activity was a bit stronger than expected in July, but inflation for August fell to 0.1% yoy and core inflation fell to 0.9% yoy, both of which are well below target.
Average Chinese property prices continued to rise in August with more cities now seeing gains. Chinese property related risks are continuing to recede.
Australian economic events and implications
There was no sign in RBA Governor Stevens’ Parliamentary testimony that the RBA is moving towards another interest rate cut just yet – in fact he was “pretty content”. The Governor seemed reasonably comfortable that the economy is rebalancing and that the $A was around fundamentally justified levels. However, he has left plenty of wiggle room to ease again if needed with “growth not being as fast as we would like”, an acknowledgement of global risks and APRA’s measures to slow lending to property investors doing their job. While the economy is not doing as badly as many seem to have expected (and still expect) my view remains that it is likely to need more help and this will come in the form of more interest rate cuts and a lower $A.
What to watch over the next week?
In the US, expect a slight fall back in existing home sales (Monday), continued modest gains in home prices (Tuesday), a slight rise to around 53.5 for the September Markit manufacturing conditions PMI (Wednesday), a fall back in durable goods orders after a strong month but a reasonable reading for orders excluding the volatile transport component, and a further gain in new home sales (both Thursday). The latest revision to June quarter GDP data (Friday) will likely confirm growth at around 3.7% annualised.
Eurozone business conditions PMIs (Wednesday) are likely to remain solid and bank lending growth (Friday) should show further signs of gradual improvement. The focus will also be on the Catalonian regional election (Sunday Sept 27), but with the polls showing Catalonians preferring to remain in Spain it hopefully won't be an issue for markets.
Japan will see the release of its manufacturing conditions PMI (Wednesday) and inflation data Friday, with the latter likely to weaken thanks to lower energy prices taking inflation further away from the BoJ's 2% target.
In China, the focus will be on whether Caixin/Markit manufacturing conditions PMI for September has continued to deteriorate or more likely shows signs of stabilisation and bottoming as has been evident in some other recent economic data.
In Australia, private surveys point to a 2% quarterly gain in the ABS's June quarter home price index (Tuesday) led by Sydney but with Perth and Darwin in negative territory and population growth in the March quarter to have remained at the already slowed pace of 1.5% year on year.
Outlook for markets
While the base building action seen in most share markets since the late August lows is positive, it’s still too early to say that we won’t see another leg down. At the very least share markets remain vulnerable to more volatility over the next month or so as we are still in a seasonally weak period of the year for shares and uncertainties regarding China and the emerging world remain. A failure to resolve the US budget impasse by October 1 could also add to volatility.
But beyond near term uncertainties we see the cyclical bull market in shares as likely to resume: shares are cheap relative to bonds; monetary conditions are set to remain easy with the latest global growth scare likely to drive further global monetary easing in some countries and the Fed indicating it won’t do anything to threaten global growth; this in turn should help see the global economic recovery continue; and finally investor sentiment is around the levels of pessimism that provides great buying opportunities. As such, despite near term uncertainties, developed country share markets are likely to remain in a broad rising trend. This includes the Australian share market.
Low bond yields point to soft medium term returns from bonds, although the recent share market downswing which saw bonds rally provides a reminder that government bonds remain a great portfolio diversifier.
In the short term there is a chance of a further bounce in the $A to around $US0.75, partly reflecting the Fed’s more dovish stance on interest rates. However, the broad trend in the $A is likely to remain down as the Fed is still likely to raise interest rates sometime in the next six months whereas the RBA is likely to cut rates again and the trend in commodity prices remains down. The $A is expected to fall to $US0.60 in the next year or so, with the risk that it will go even lower.