Please note the views expressed in this bulletin are those of the author and do not necessarily reflect AMP Capital’s house view.

Theme 1: China GDP growth hits target!

Thanks to the financial sector, China GDP growth hit its target for Q2. However, strength is unlikely to be sustained into Q3 – expect more easing.

Surprisingly - or unsurprisingly – China GDP growth for Q2 was in line with its full year 2015 target of 7%. The source of upside surprise was the finance sector - while most other sectors were weaker - notably manufacturing, retail and wholesale trade, construction). The finance sector was boosted by the surge in stock market trading activity, IPOs, margin financing, and stock price gains. So it’s safe to say we may not get the same kind of strength from that sector going into the third quarter following the recent volatility. Within the activity data, and as flagged in the business surveys, there was a tentative improvement – however, the overall picture is still one of distinctly slower growth. The Renminbi has strengthened considerably on a trade weighted basis in recent years. As such, financial conditions remain relatively tight in China, and against the backdrop of slower growth, the case for further easing remains compelling. Our expectation is that the threshold for attempting to weaken the Chinese Yuan Renminbi (CNY) is very high. This is due to a desire to keep the CNY stable as it comes under consideration for inclusion in the IMF’s Special Drawing Rights, and as China pushes on with its One Belt one Road plans. As a result of this, the heavy lifting must occur by dropping the interest rate.

Theme in pictures



 

Source: AMP Capital, Thomson/Reuters Datastream


Theme 2: Reserve Bank of New Zealand to cut interest rates?

The Reserve Bank of New Zealand is firmly into easing mode now, and is likely to completely unwind its recent tightening cycle. Expect some upside for AUD/NZD!

I must admit, I’m surprised that some economists are rushing to the conclusion that the Reserve Bank of New Zealand should cut interest rates from the current 3.25% to 2% by the end of the year. The rationale they provide is the slump in dairy prices, the absence of inflation, and an earlier than expected peaking of the Canterbury rebuild (recall – New Zealand had a small investment boom as it reconstructed the earthquake damaged Canterbury region).

Our colleagues in New Zealand expect the Reserve Bank to fully unwind its recent tightening cycle – some might even argue this is a model for post-GFC central banking (i.e. smaller interest rate cycles) - but that’s a matter for another time. The things that might stop or slow the easing would be a more rapid-than-expected fall in the New Zealand dollar, a rebound in milk prices, or ongoing strength in the housing market.

Back onto the AUD/NZD, if the Reserve Bank of New Zealand goes and the Reserve Bank of Australia stays put this will mean an upward bias for the AUD/NZD. However, the other factor to pay attention to is relative terms of trade or commodity prices. While the milk price can be at the mercy of things like weather, the prevailing winds for iron ore price are decidedly down as China demand continues to slow and supply is still buoyant. So there may be some upside yet for the AUD/NZD with fair value around 1.20. However, with regards to the Reserve Bank of New Zealand cutting to 2% - it’s not a done deal.

For more details on our forecasts for the Reserve Bank of New Zealand, please click here.

Theme in pictures



Source: AMP Capital, RBA, RBNZ, Bloomberg, AMP Capital NZ QSO


Theme 3: Checking in on Japanese equities

Japan looks cheap compared to its expensive history – but the catch-up potential is interesting, ambitious, and worth paying attention to.

I always like to review the cyclically adjusted price to earnings ratio when comparing markets, so that’s the first stop on this brief tour through Japanese equities. It seems Japanese equities look cheap compared to history – a history of high valuations that is. Compared to the US, Japanese equities are a little cheap but nothing to get overly excited about. So, it comes down to the thematics, which are pretty positive for Japan e.g. expected changes among pension companies to increase weightings to equities, as well as improving corporate governance that aim to make Japanese companies more efficient. On that note, it is worth pointing out that Japanese profit margins are pretty high compared to the last 20 years, but still trail well behind that of the US. And it’s a similar story when it comes to return on equity. So there is certainly something to say about catch-up potential.

Theme in pictures



Source: AMP Capital, Bloomberg


Theme 4: Bond break-even

Global bond yields are low, duration is higher. This means yields don’t need to move much for the capital loss/gain to exceed the running yield.

How far would bond yields need to go to wipe out the yield? A simple but interesting exercise below uses bond index ‘duration’ (modified adjusted duration in this case). Recall, duration is the percentage change in the price of the bond based on a 100bp movement in yield. So, if we want to determine how much of an upwards movement in bond yield we would need to see before the running yield is completely eroded by capital loss, we could divide the yield by the duration to get a sort of breakeven indicator. As you might expect, given the trends in bond yield and maturity extension, the number is not very large, so there is not a huge degree of safety margin.

Theme in pictures



 

Source: AMP Capital, Barclays


Theme 5: Eurozone GDP leading indicators

Robust loan demand and rapid money supply growth point to a GDP surge in the Eurozone.

The latest update to the ECB lending survey (which is one historically useful leading indicator - i.e. the ‘expected loan demand by enterprises’ category) shows banks still expect robust loan demand. Italy is one of the key sources of strength, and much of the loan demand is for fixed investment. So, on a headline basis, the bank lending survey shows a reasonable degree of underlying strength, with genuine loan demand coming from investment demand.

As such, we can probably have some faith that the increase in expected loan demand by enterprises is pointing to higher GDP growth outcomes. The below two charts are somewhat controversial as they suggest that Eurozone growth could head to as high as 3-4%. But if the uplift in loan demand is genuine and the surge in real money supply growth flows through to the real economy, then it might be doable.

Theme in pictures




 

Source: AMP Capital, European Central Bank, Thomson/Reuters Datastream

About the Author

Callum Thomas, MMgt (finance), MMgt (banking), BBS (finance), Investment Strategist

Callum is an Investment Strategist in the strategy team of the Multi Asset Group at AMP Capital. Callum has a passion for global macro investment strategy and constantly strives to generate unique and innovative insights that help inform the strategy team's dynamic asset allocation process. Callum is responsible for researching a range of asset classes and global macroeconomic themes to aid in formulating investment strategies across the Multi-Asset Group. He also keenly collaborates with the global equity and fixed income teams. Callum originally joined AMP Capital in June 2009 as an analyst in the investment business of what was then AXA New Zealand. He previously worked in strategy at the New Zealand Stock Exchange.