The Experts

Shane Oliver
Financial markets
+ About Shane Oliver

Shane Oliver is head of investment strategy at chief economist at AMP Capital.

Turkey currency crisis triggers contagion fears

Monday, August 13, 2018

The past week was relatively quiet until Friday when the deepening crisis in Turkey triggered worries about contagion to European banks and emerging markets. This hit share markets resulting in Eurozone shares falling 1.3% for the week, US shares losing 0.3% and Japanese shares losing 1%. However, Chinese shares bounced 2.7% higher over the week and Australian shares gained 0.7%. Safe haven buying saw bond yields fall (except in Italy).

While the iron ore price rose, oil, gold and copper prices fell not helped by another rise in the US Dollar. The surge in the US Dollar saw the Australian Dollar fall to around $US0.73, its lowest since January last year.

The latest worries about contagion from Turkey as its currency plunged as much as 17% on Friday are likely overdone, but emerging market stress will remain for a while yet. Yes, there will be some impact on Eurozone banks that are exposed to Turkish debt (which will keep the ECB cautious), but it’s unlikely to be economically significant.

More fundamentally, Turkey is not indicative of the bulk of emerging countries. Its currency has crashed 42% this year because of current account and budget deficit blowouts, surging inflation, political interference in its central bank, economic mismanagement generally and political tensions with US following the imprisonment of an American pastor followed by US sanctions on Turkey including tariff hikes.

While Brazil, Argentina and South Africa also have particular problems, the rest of the emerging world is in far better shape. That said, emerging markets will remain vulnerable until the $US stops rising (given the impact a rising $US has on foreign debt servicing costs), the global trade threat ends and uncertainty regarding Chinese growth fades. And rising inflation pressures in the US – with core CPI inflation in July at its highest since the GFC - highlight that the upwards pressure on the $US will remain as the Fed is unlikely to stop its process of gradual rate hikes soon.

Friday’s breakdown in the Australian dollar out of its recent narrow trading range around $US0.74, is consistent with our long-held view that the $A is on its way down to around $US0.70. Friday’s fall in the Australian dollar also reminds that being short $A/long $US (or Yen) is a good hedge against threats to the global growth and share market outlook.

The drip feed of increasing tariff pressure on China continued over the last week with the US announcing that it will commence a 25% tariff on another $16bn of imports on August 23rd. This is no surprise though as it’s just the remainder of the initial $50bn they said they would do but only did $US34bn in July. So was China’s announcement of same sized retaliation.

So far there is still no sign of a return to negotiation and the likelihood is that it won’t happen until after the US mid-terms. Domestically there has been some criticism of President Xi Jinping’s handling of the trade issue with the US but his position is not threatened and there is little sign of him changing direction. The big one to watch will be next month when the US has threatened a 10% or 25% tariff on $US200bn of imports.

China’s proposed retaliation of an average 13% tariff on $US60bn of imports from the US is way less than proportional, begging the question of whether its backing down a bit or preparing to move into retaliation via other means as it runs out of imports to retaliate on – this could take the form of tougher taxation or regulation of US companies or maybe allowing the market to push the Renminbi even lower (although the PBOC has said it will not actively devalue the currency), which would then beg the question as to how the US might respond, e.g. more tariffs or maybe even intervention to soften the $US, i.e. “currency wars.” I don’t expect the US to intervene in the $US, but with Trump not interested in basic economics (or showing any awareness that his own policies have pushed the $US up) it’s a risk worth watching. The trade threat clearly has a long way to go yet.

Drought is increasingly becoming a significant threat to Australian growth. Flying to beautiful Townsville and back this past week I was struck by how parched much of the east coast of Australia looks thanks to drought. There has not been a lot of talk about its economic impact so far.

Most Sydneysiders don’t worry about drought until water restrictions are imposed, but because heavy rainfall earlier last year pushed Sydney’s catchment dams to 97% full, so far there has been no need for water restrictions. But total Sydney dams have now fallen to near 66% full and the national reality is that the drought is becoming a bigger threat. In fact, farm production has already fallen for each of the last four quarters.

Of course, agricultural production as a share of GDP aint what it used to be at just 2.5%. But a 25% slump in agricultural production as seen through past major droughts will knock 0.6 percentage points off economic growth. Unfortunately, summer weather forecasts don’t hold out a lot of hope for a quick end to the drought and it would be made a lot worse if another El Niño phenomenon arrived (with the Southern Oscillation index recently falling back from a mild La Nina to neutral). Of course, beyond a short-term boost to meat supply as farmers cut their herds, the drought will also provide a boost to headline inflation via higher food prices, but the RBA, will look through this given the dampening impact on underlying inflation from weak farm sector spending power.

Source: ABS, Bureau of Meteorology, AMP Capital

For fans of The Brady Bunch, the past week or so was an exciting one with NSYNC bass singer Lance Bass announcing he had won the bid for the family home, but then getting gazumped by Discovery Inc’s HGTV who want to use the house for a reality TV show. That said I thought The Brady Bunch was reality – it certainly inspired me to buy at various points a big Chrysler station wagon, and equal sized Pontiac convertible and later on a Brady Bunch style house. It also made it virtually impossible for me to go to sleep on an angry heart. The sale does highlight the magic of compound interest over many years, generating capital growth of at least 8% since the owners purchased it in 1973, and if it had been rented out with a net rental yield of 3.5% a total return of around 11.7% pa.

Major global economic events and implications

US labour market data remains strong with ultra-low jobless claims and ongoing very high readings for job openings, hiring and workers quitting for new jobs. Producer price inflation came in slightly weaker than expected in July but core producer inflation of 2.7% year-on-year implies ongoing upward pressure on consumer inflation and inflation as measured by the core CPI rose to 2.4% yoy in July, its highest since the GFC. All of which is consistent with continued gradual Fed rate hikes. Meanwhile, the June quarter profit reporting season is wrapping up on a strong note with earnings up around 27% on a year ago. With 90% of S&P 500 companies having reported, 83% have beaten on earnings by an average beat of 5.5% and 71% have beaten on sales.

Japan saw some good news on wages, with nominal wages growth lifting to 3.6% year-on-year in June, which is its highest in years. The very tight labour market with sub 3% unemployment may at last be leading to higher wages growth. That said, a sample change early this year may be a contributor, so the Bank of Japan will treat this cautiously. GDP growth also bounced back in the June quarter, albeit low at 1.1% yoy. Not so positive though were household spending, economic confidence and machinery orders. The overall impression is that Japan continues to grow but at a relatively constrained rate – which is not so bad given its falling population.

Despite the trade war threat, Chinese exports and imports came in stronger than expected in July. However, imports may have been boosted by a cut to Chinese tariffs. Meanwhile inflation readings were benign in July, indicating that inflation provides no constraint to further policy stimulus in China.

Australian economic events and implications

In Australia, the RBA provided no surprises in leaving rates on hold for a record two years, and given the cross currents in the economy, there is a good chance they could be on hold for another two years. The RBA’s largely unchanged forecasts in their Statement on Monetary Policy portraying a “favourable outlook” (in the words of Governor Lowe) of growth around 3.25% and a gradual rise in inflation along with strong infrastructure investment, rising business investment and strong export volumes are consistent with the next move in rates being a hike.

However the peak in the housing construction cycle, uncertainty about the outlook for consumer spending, the weakening Sydney and Melbourne property markets, the worsening drought, the risks that low inflation and wages growth will continue for longer and tight bank lending standards all indicate that the next move in rates could well be a cut.

So the stand-off continues, and the RBA will remain on hold for a while to come.

On balance, we agree with the RBA that the next move in rates will probably be a hike, but we are a bit less upbeat on growth, wages and inflation than the RBA, so any rate hike is unlikely to come until 2020 at the earliest and there is a rising risk that the next move will actually be down. Maybe the Reserve Bank of NZ is showing the way in noting that “The direction of our next [interest rate] move could be up or down”!

Meanwhile, housing finance commitments continued to soften in June, mainly driven by a  decline in finance going to investors which looks to reflect both supply as banks continue to tighten lending standards and demand as investors expectations for capital growth slide in response to falling prices, suggesting that a negative feedback loop between falling prices and falling investor demand may be developing.

The flow of June half profit results picked up a notch over the last week with okay but uninspiring results. So far 47% of results have surprised on the upside but 33% have surprised on the downside both of which are higher than average, 67% of results have seen profits up on a year ago which is around average, 71% of companies have increased their dividends from a year ago but a higher than normal 21% have cut them. That said, less than 15% of companies have reported so it’s too early to conclude much.




Economic update: Another Goldilocks US jobs report

Monday, August 06, 2018

Investment markets and key developments over the past week

  • US shares rose 0.8% over the last week helped by strong earnings results, a bounce back in tech stocks and another “Goldilocks” jobs report. However, Eurozone shares fell 1.1%, Japanese shares lost 0.8%, Chinese shares fell 5.9% and Australian shares lost 1% as trade war fears continue to escalate. Despite this bond yields were flat to up. Iron ore prices rose but oil and metal prices fell. The $US continued to push higher but the $A was little changed.
  • The drip feed of escalating tariff threats from Trump and counter threats from China continues, with the US threatening that the proposed tariffs on $US200bn of Chinese imports will be 25%, not 10%, and China announcing a list of $US60bn of US imports to be subject to tariffs should the US proceed. With a 25% tariff on another $US16bn of Chinese imports likely to commence soon Trump is clearly ramping up the pressure on China but China is digging in. A tariff of this magnitude will start to have a significant economic impact on China’s growth (potentially knocking up to 0.5% off growth) and probably also on the US as well. While there has been talk that the US and China may be trying to restart trade talks, China does not appear to be interested given the gun to its head and the May experience. It may prefer to wait till after the US mid-term elections thinking that the longer this goes on the greater the chance of a backlash against Trump and that Trump will be weakened if the Republicans lose control of the House of Representatives. In the mean-time its stepping up measures to support growth. Trump really believes China’s trade practices are unfair, but he’s also tapping a vein of anti-trade/anti-Chinese sentiment amongst his supporters and may also be motivated by a Quixotic desire to slow the ascendancy of China as an economic power. Whatever the motivation its looking likely a solution will not be reached until after the US mid-terms and that trade fears will continue to cause volatility in markets.
  • Meanwhile Trump is offering to meet Iran’s leadership and has asked US Attorney General Sessions to stop the Mueller inquiry. The former may be a good thing (but it’s doubtful as Iran is not North Korea and its leadership would regard a meeting as a media stunt) and the latter would be a Nixon like disaster (but won’t happen because Sessions can’t do it as he recused himself from the inquiry and Trump would have to fire Deputy AG Rod Rosenstein and keep firing Justice Dept officials until he finds someone who is willing to fire Mueller). Meanwhile, Trump’s desire to end the Mueller inquiry does highlight that it may be a real threat to his presidency.
  • Ultra-easy monetary policy locked in for longer by the Bank of Japan, but with more flexibility. Despite all the anticipation the BoJ left monetary policy little changed with the overnight deposit rate remaining -0.1%, the 10-year bond target at zero. While it injected more flexibility into its bond yield target by allowing an effective range of +/-0.2%, up from +/-0.1%, new forward guidance effectively locks the BoJ into ultra-easy monetary policy into 2020. Overall this is positive for Japanese shares, but not so for the Yen. While Japanese 10-year bond yields may drift up to test the 0.2% level, Japan is unlikely to be a source of significant upwards pressure on global bond yields.
  • In Australia, average home prices are continuing to fall led by the once booming cities of Sydney and Melbourne – with more to go. Our assessment remains that with tighter lending standards, poor affordability, rising supply and falling capital gains expectations Sydney and Melbourne property prices will have a top to bottom fall of around 15% spread out to 2020 which given falls already seen implies further downside of 10 to 12%. We are not there yet, but FOMO (fear of missing out) risks becoming FONGO (fear of not getting out) for some investors.  Other cities are in much better shape and most are likely to see moderate growth such that the top to bottom fall in national average home prices will be more like 5%. With falling home prices set to drive a negative wealth effect it’s hard to see the RBA raising rates anytime soon and if anything there is a significant chance that the next move will be a rate cut.

Major global economic events and implications

  • US Economic data remains strong. Personal income and spending remained robust in June and consumer confidence is high. The ISM business conditions indexes fell slightly in July but remain high. Home prices are continuing to rise. And July saw another “Goldilocks” jobs report with strong payroll growth including upwards revisions to prior months, falling unemployment and yet still soft wages growth of 2.7% year on year. Consistent with this the Fed remains upbeat describing growth as “strong” (up from “solid”) and seeing inflation near target and so it remains on track to continue with gradual rate hikes, with the next move next month.

Source: Bloomberg, AMP Capital

  • US June quarter earnings reports remain very strong. Of the 80% of S&P 500 companies to have reported so far, 85% have beaten on earnings by an average beat of 5.3% and 73% have beaten on sales. Earnings are up around 26% year on year.
  • Eurozone growth slowed further in the June quarter to 2.1% year on year, but at least core inflation rose to 1.1% in July. However, with core inflation still way below target and growth slowing we still can’t see the ECB raising rates until 2020.
  • While the Bank of England raised rates another 0.25%, they have still only made it to 0.75% (i.e. half the RBA’s 1.5%) and with Brexit uncertainty this maybe it for a while.
  • Japanese economic data is mixed supporting the continuation of ultra-easy monetary policy. While unemployment rose slightly in June, the jobs to applicants ratio rose to its highest since January 1974 helped by a falling labour force. Industrial production fell more than expected, but the manufacturing PMI for July points to a rebound.
  • Chinese business conditions PMI’s softened in July with manufacturing export orders quite weak suggesting some impact from the trade skirmish. That said the PMIs are still mostly in the range of the last year or so and are consistent with a softening in growth as opposed to a collapse. Our forecast for GDP growth this year remains for a slowdown to 6.5%. Meanwhile, the July Politburo meeting reinforced expectations for more policy stimulus mainly from fiscal policy. The meeting statement included 15 references to “stable”, “stability” or “stabilising” compared to an average of 6 such references in the previous 10 Politburo meetings, highlighting the greater focus on supporting growth in the face of the trade threat.
  • Meanwhile, policy is going the other way in India with the Reserve Bank of India raising its repo rate by 0.25% for the second meeting in a row to 6.5%. It makes sense when inflation is above the 4% target and GDP growth is around 7.4%

Australian economic events and implications

  • Australian economic data was mixed. Retail sales volumes were very strong in the June quarter indicating consumer spending will help June quarter GDP growth, but the quarterly bounce looks distorted by food, retail price inflation is non-existent and with weak wages growth, high underemployment and falling home prices retail sales are likely to soften again this quarter. Meanwhile, building approvals rebounded in June but after several weak months leaving a weak trend, the value of residential alterations & additions and non-residential approvals trending down, private credit growth continuing to slow with investor credit contracting, July manufacturing PMIs falling albeit remaining consistent with growth and home prices falling for the ninth in month in a row in July. While the June trade surplus doubled expectations most of the surprise in relation to exports looks to be price related and so it looks like net exports will contribute to June quarter GDP growth but only modestly.



Economic update: US growth rebounds

Monday, July 30, 2018

Investment markets and key developments over the past week

  • Share markets pushed higher over the last week helped by good US earnings news and a US/European trade “agreement.” Despite disappointing results from Facebook and Twitter hitting tech stocks, US shares rose 0.6%, Eurozone shares rose 1.7%, Japanese shares rose 0.1%, Australian shares rose 0.2% and Chinese shares gained 0.8% helped by stimulus talk. Speculation the Bank of Japan may review its easy monetary policy (which I suspect is overdone) along with the “risk on” tone generally also helped push up bond yields. While oil prices fell, metal and iron ore prices rose but a slight rise in the $US and slightly softer inflation data saw the $A fall. 
  • At last some good news on trade with the US and the European Union agreeing to work towards resolving their differences on trade and hopefully head off a trade war between them. At this stage it’s only a deal to start negotiating, the negotiations will have a long way to go and don’t forget that China and the US had a “trade war on hold” deal back in May that got trashed a week later. So it’s too early to break out the champagne. However, it shows that Trump is not anti-trade per se and does actually want zero trade barriers, it’s a big move in the right direction and it will probably be easier for the US and the EU to work through their differences as they start with similar average effective tariff rates and US gripes with Europe don’t run so deep. Having started down this path there is a reasonably good chance of success leading to the removal of the auto tariff threat and the reversal of the steel, aluminium tariffs. No US/EU trade war would significantly reduce the trade threat to global growth. After “wins” in relation to North Korea and Europe, Trump will no doubt see vindication of his “maximum pressure” negotiating stance – which will embolden him to continue with his tough trade stance on China.
  • Speaking of which, there is still no sign of negotiations with China on trade and China’s non-approval of US chipmaker Qualcomm’s bid for its rival NXP (well at least so far) may signal that China is digging in further. To counter the trade threat, China’s shift to policy stimulus is continuing with a shift to “more proactive” fiscal policy with a focus on tax cuts, and infrastructure investment. Don’t expect a mega stimulus like seen in the past (there is no need) but combined with monetary stimulus the authorities are clearly determined to support growth. This is a positive for Chinese shares after their 24% fall and a forward PE of just 10.7 times.
  • Middle East tensions hotting up again – upside risk to petrol prices. President Trump’s tweet threatening Iran that it “will suffer consequences the likes of which few throughout history have ever seen before” if it threatens the US again highlights that tensions between the US and Iran are hotting up again. Attacks on Saudi tankers by Yemeni militia are arguably reflective of this. Of course, it’s worth recalling that Trump also threatened North Korea with “fire and fury” and that much of this is bluster aimed at applying “maximum pressure” to get what he wants. It may be a bit harder with Iran though, so the risk of tensions in with Iran – eg threats to close the Strait of Hormuz – at a time of constrained global oil supply pose upside risks to oil prices. This will be good for energy stocks, but not so good for Australian motorists given the risk of another up leg in petrol prices beyond their recent high averaging around $1.53.
  • Another round of US tax reform on the way, but don’t get too excited. The US House of Reps looks like having a vote on more tax reform, the main item of which will likely be to make permanent the personal tax cuts beyond their 2025 expiry. It has little chance of passing into law before the mid-terms but is an election sweetener for the Republicans.
  • If you want to see an example of the downside of momentum investing which can get amplified in passive funds, just look at Facebook. While tech stocks are nowhere near the bubble they were in 2000 (their PE is around 27x versus around 100x at the tech boom peak) they have been huge beneficiaries of the easy money environment of recent years meaning a passive investor will have seen a steady increase in exposure to them which is all good when momentum is your friend but when it turns it can turn quickly as Facebook did falling more than 20% in a flash on Thursday.

Major global economic events and implications

  • US economic data remains solid. After the usual soft March quarter GDP growth rebounded to 4.1% annualised in the June quarter driven by consumer spending, investment and trade. Home sales fell in June, but home prices are continuing to rise, the July Markit PMI remains strong, capex orders are rising and jobless claims are ultra-low.
  • Despite disappointing revenue results at Facebook, US June quarter earnings reports remain very strong. Of the 263 S&P 500 results so far 88% have beaten on earnings with an average beat of 5.1% and 73% have beaten on sales. Earnings look to be up around 26% year on year.
  • As expected the ECB made no changes in monetary policy and anticipates keeping rates unchanged at least until September 2019. We don’t see an ECB rate hike until 2020. Meanwhile, Eurozone business conditions gave up some of their June bounce, but they remain strong.
  • In contrast to the US and Europe, Japan’s manufacturing conditions PMI in July fell to its lowest since November 2016. It's still consistent with modest growth but suggests a greater sensitivity to trade fears than in the US and Europe.

Australian economic events and implications

  • Australian inflation remains subdued, no early rate hike in sight. June quarter inflation data confirmed yet again that price growth is only running around the low end of the RBA’s 2-3% target band. Core (ex food and energy) inflation is just 1.6%. And were it not for more rapid price rises for government administered or affected items like tobacco, health, utilities and education along with petrol, inflation would be running closer to 1%. There are no signs of any significant near term rise in underlying inflation pressures, particularly with subdued wages growth, competition and technological innovation remaining intense and producer price inflation running at just 1.5%. The risk is that the longer inflation stays at or below the low end of the target range the harder it will be to get it up as low inflation expectations are becoming entrenched. As such, we remain of the view that the RBA won’t raise interest rates until 2020 at the earliest and the next move being a rate cut cannot be ruled out.
  • Meanwhile falling skilled job vacancies add to signs from other jobs leading indicators that employment growth may slow a bit.




Economic update: Cutting through Trump white noise

Monday, July 23, 2018

Investment markets and key developments over the past week

  • The past week saw a battle between Trump noise (on trade, the Fed, the $US, etc) but good economic & earnings news that saw share markets little changed. US shares ended flat, Eurozone shares rose 0.1%, Japanese shares rose 0.4%, Chinese shares were flat and Australian shares gained 0.3%. Bond yields rose in the US and Europe, commodity prices mostly fell and the $US fell after Trump complained about its strength which left the $A little changed. 
  • Trump’s comments critical of Fed rate hikes naturally raise concerns about political interference at the Fed, which could threaten its ability to control inflation. In the short term, it’s hard to see much impact. Trump is well known to be a high debt/low interest rate guy so it’s no surprise he is not happy. But the Fed answers to Congress, has a mandate to keep inflation down and will do what it sees best – which with strong growth and at target inflation means returning interest rates to more normal levels. Longer term there is a risk though that Trump and populism will weaken the institution of an independent central bank targeting low inflation and this would be a big concern. 
  • Trade war risks are continuing to increase, with Trump repeating his threat to put tariffs on all Chinese imports, a lack of progress towards the resumption of US-China trade talks, Trump considering tariffs on uranium imports (which could impact Australia – but only marginally as uranium is less than 0.2% of our total exports and we would probably get an exemption anyway) and Trump’s treatment of his NATO allies not auguring well for quick progress on the trade dispute with Europe. While Trump’s tweet complaining about Europe, China and others helping drive a rising US dollar lack economic logic - if “making America great again” means stronger US growth relative to other countries then it also means higher US interest rates and a higher $US! - it nevertheless adds to the tension. Our assessment remains that the trade dispute with China will likely get worse before it gets better. However, reports that Germany and various European car makers favour lowering EU auto tariffs are a positive sign and a trade meeting in the week ahead where proposals around doing this may be discussed between Trump and EC President Junker holds the hope of some progress. 
  • Trump’s attitude towards the Mueller inquiry evident in his meeting with Putin continues to remind of Nixon in relation to Watergate. That said we still see Trump’s removal from office as unlikely and economic conditions are far stronger today than in 1974.
  • China continuing to ease and the Renminbi sliding. While Chinese growth slowed only slightly in the June quarter the policy easing of recent months has continued with official calls to increase lending and signs of PBOC support via its medium-term lending facility. This is likely aimed at offsetting weak shadow banking credit growth and the trade threat. Of course, a tightening Fed and an easing PBOC helps drive a rising $US relative to the Renminbi and that is what we are seeing with the $US up around 8% against the Renminbi since early this year just as its up by 7.5% against a range of other currencies. As such the fall in the Renminbi is mostly a strong $US story rather than a weak Renminbi story, but the Chinese authorities are likely happy for now in seeing the Renminbi fall given the tariff threat to Chinese growth, so it likely has more downside. The falling Renminbi in turn risks maintaining downwards pressure on emerging market currencies keeping alive fears of emerging market debt servicing problems and maintaining downwards pressure on emerging market shares.

  • If the stability of the IMF’s global economic forecasts is any guide the process of economists upgrading their expectations and likewise share analysts revising up their profit forecasts that helped propel markets last year looks to have come to an end, with the IMF (and everyone else) now highlighting the obvious downside risks of a trade war and rising US inflation. That said, global growth at 3.9% is still strong and should underpin solid earnings growth even if it’s off its peak.

Source: IMF, AMP Capital

Major global economic events and implications

US economic data remains strong with good gains in retail sales, industrial production and leading indicators, the lowest level of jobless claims since when The Brady Bunch started in 1969 and solid regional business conditions surveys and home builder conditions. Fed Chair Powell’s latest comments remained upbeat consistent with continuing gradual (every three months) rate hikes “for now”.

US June quarter earnings reports are off to a strong start with 94% of results so far beating on earnings and 78% beating on sales and earnings growth expectations being revised up from 21% for the year to the June quarter to now 23%. That said its early days yet with less than 20% of results out.

Japanese inflation ex fresh food and energy surprisingly fell to just 0.2% yoy in June. While media reports suggest that the Bank of Japan may review its zero 10-year bond yield target given concerns about side effects it’s hard to see a change just yet given very weak core inflation and the trade threat.  

Chinese economic growth slowed fractionally in the June quarter to 6.7% year on year from 6.8% and June monthly data was mixed with industrial production and investment slowing but retail sales and house price growth picking up and unemployment unchanged at 4.8%. We anticipate a further slowing in Chinese growth to around 6.5% this year.

Australian economic events and implications

Australian jobs data was a mixed bag with robust employment growth, but this is only keeping up with new entrants to the labour market thanks to strong population growth and gains in participation keeping unemployment at 5.4%. Strong jobs growth helps household income but it’s being offset by softness in wages which with still high unemployment and underemployment is unlikely to change any time soon.

While the return of the line about the next move in rates more likely being up in the minutes from the RBA’s last meeting caused some excitement, I wouldn’t read much into it. Its broader comments remain neutral with “no strong case for any near-term adjustment” in rates. Meanwhile, the RBA is still not too fussed by higher money market funding costs but noted "it was uncertain how persistent these pressures would be". If they do persist then it’s a defacto monetary tightening and would mean a lower than otherwise cash rate outlook. Since the end of the financial year the Australian bank bill spread to the cash rate has fallen but at 50 basis points it remains high relative to its long-term average of around 25 basis points meaning ongoing pressure on the big banks to modestly raise some of their mortgage rates.


Economic update: Trade skirmish escalating

Monday, July 09, 2018

Investment markets and key developments over the past week

•   Trade war fears continued to impact investment markets over the last week, but it turned out to be a classic case of “sell on the rumour, buy on the fact” as markets bounced just before and after the initial US/China tariffs went into effect on Friday. These tariffs have been talked about since March and so were largely factored into markets and now investors appear to be hoping for a resolution. However, despite a late rally, Chinese shares still fell 4.2% over the week and Japanese shares lost 2.3%. But US shares rose 1.5% and Eurozone shares gained 1.3%, with good US jobs data also helping.  Australian shares also rose 1.3%, helped by a rebound in Telstra. Bond yields generally fell, excepting in Italy. Iron ore and metal prices fell, as did the oil price due to a rise in oil stockpiles and President Trump’s pressure on Saudi Arabia to get prices down (he is clearly focussed on the mid-term elections and sees Saudi Arabia owing him a favour given the return of US sanctions on Iran). The US dollar fell back a bit, and this saw the $A push back above $US0.74. 

•   Trade skirmish escalating, and it will likely get worse before it gets better, but still expect a negotiated solution before it gets too bad.  The 25% tariff on $US34bn of imports from China and Chinese same sized retaliation on US goods have started up. Of course, this along with the tariffs on steel and aluminium still only amounts to tariffs on less than 3% of total US imports that have actually started up – which is a long way from the 20% Smoot Hawley tariff on all imports in the 1930s. That said, it’s not over yet, with much more still threatened - including US tariffs on another $US16bn of imports from China proposed to be implemented soon and two additional $US200bn tranches on Chinese goods, and Trump even threatening to put a tariff of more than all of Chinese imports if China keeps retaliating along with a 20% tariff on auto imports from the EU.

•   However, much of this still looks like a negotiating stance – otherwise all the tariffs would already have started up by now. And Trump knows that the costs to US workers (from soybean farmers to Harley Davidson workers) and consumers will escalate as more and more tariffs are imposed and this could become a problem for him if it’s not resolved by the mid-term elections. There are also some signs that Europe (or at least Merkel) may be open to negotiating by cutting current EU tariffs on auto imports. So our base case remains that some form of negotiated solution will be reached, but things are likely to get worse before they get better. So far, the Australian share market has proved quite resilient in the face of trade war fears – partly because Australia is not directly affected, but it will become vulnerable should trade wars pose a threat to global growth as that would reduce demand for our exports.

•   Bitcoin bubble bath. Remember the obsession with bitcoin and the other cryptos late last year? Whatever happened to it? Well as with many such manias, the Bitcoin price peaked last December at $US19,500 just when everyone including my dog was asking about it and lots jumped on board (my dog tried but I cut off her financing!). Since then its seen a 70% plunge almost rivalling the tech wreck and providing another classic reminder to be wary of the crowd. Sure, blockchain technology has a bright future, but how its priced into Bitcoin and other crypto currencies was always a separate issue.


Source: Bloomberg, AMP Capital

•   I have tended to ignore the ongoing Brexit related negotiations because it’s a bit of a soap opera and it doesn’t have much impact on global markets. It’s really just a UK issue. PM May and the UK Government looks to have finally arrived at a plan for a soft Brexit - proposing a free market with the EU in goods, but not in services (which means for example that UK financial services will lose access to the EU) and people. However, so far the UK has just been arguing with itself and it’s not clear the EU will support breaking up its “four freedoms” – in terms of the free movement of goods, capital, services and people. So there is a long way to go yet and the Irish border issue also remains a big one. It’s too early to say the British pound is out of the woods.

   For a really cool mix of Elvis doing Burning Love with the Royal Philharmonic Orchestra check here. 1970's Elvis was the best.

Major global economic events and implications

•   US economic data remains strong with the June ISM manufacturing and non-manufacturing indexes surprisingly rising to very strong levels, construction spending continuing to rise and another “Goldilocks” jobs report. June jobs data saw payroll employment rise a stronger than expected 213,000 and upwards revisions to previous months, but a rise in unemployment to 4% as participation rose and wages growth remaining stuck at 2.7% year on year supports the notion that there is still spare capacity in the labour market and that the so-called NAIRU (or sustainable unemployment rate) is below the Fed’s estimate of 4.5%. All of which keeps the Fed on track to hike rates every three months but there is no pressure to get more aggressive. Meanwhile, the minutes from the Fed’s last meeting indicate it is clearly keeping a close eye on the threat to global growth from a trade war but at this stage it still sees it as a risk rather than its base case and unlike in 2016 when it delayed rate hikes in the face of global uncertainties, the strength of the US economy today means that the hurdle to slow monetary tightening is much higher now.

•   German factory orders rose solidly in May after four months of falls providing some confidence that the slowdown in Eurozone growth may be bottoming out.

   The Japanese June quarter Tankan survey showed continuing strong business conditions and solid capital spending plans but expectations for inflation remain well below the Bank of Japan’s 2% inflation target. Meanwhile household spending remains weak but wages growth spiked higher (although its done this a few times without being sustained).

   Like China’s official PMIs for June, the Caixin manufacturing PMI fell slightly but the services PMI rose very strongly resulting in a solid gain overall. It’s hard to see much of the feared slowdown here, although manufacturing export orders have fallen possibly on trade concerns.

   Meanwhile India’s manufacturing and services PMIs rose strongly in June pointing to a possible acceleration in growth.

Australian economic events and implications

•   Australian data was the usual mixed bag with stronger than expected May retail sales and continuing robust business conditions PMI readings, but home prices continuing to slide in June, building approvals falling again in May, a weak reading for ANZ job ads and the trade surplus coming in smaller than expected with the April surplus getting revised down. There are a few points to note here. First, both the fall in building approvals and the rise in retail sales look to have been exaggerated by volatile components. Second, trade looks to be on track for a flat growth contribution this quarter after the March quarter boost but fortunately the consumer looks likely to have perked up in the current quarter which will help keep the economy growing albeit not as strongly as the RBA is expecting. Finally, we continue to see more downside in home prices, particularly in Sydney and Melbourne where we expect 15% or so top to bottom falls spread out to 2020 with a nationwide decline of around 5%.

   Meanwhile, the RBA provided no surprises in leaving interest rates on hold for the 23rd month in a row which given the various cross currents affecting the economy - stronger investment, infrastructure and export volumes but weakness in housing, the consumer, inflation and wages and banks tightening lending standards - is where they are likely to remain for a long while yet. We see no RBA rate hike before 2020 and still can’t rule out the next move being a cut.




US-China trade tensions remain high

Sunday, July 01, 2018

Investment markets and key developments over the past week

  • The past week saw geopolitical concerns around trade, and particularly the US-China relationship, continue to dominate investment markets. This saw most share markets fall, with US shares down 1.3% for the week, Eurozone shares down 1.5% despite a Friday rally on the back of an EU immigration deal, Japanese shares down 0.9% and Chinese shares down 2.7%. Australian shares remained relatively resilient falling just 0.5% for the week with higher oil prices boosting energy stocks. Bond yields continued to fall on the back of safe haven demand. Commodity prices were mixed with gold, copper and iron ore prices down but oil continuing to move higher after OPEC’s decision to raise production by less than feared – the surge in global oil prices over the last week is likely to add around 5 cents a litre to Australian petrol prices. The $US was virtually flat over the last week but the $A fell slightly.
  • Another strong financial year for investors. While the December half year was strong as global share markets moved to factor in stronger global growth and profits helped by US tax cuts, the last six months have been messy for investors – with US inflation and Fed worries, trade war fears, uncertainty around Italy, renewed China and emerging market worries and falling home prices and the Royal Commission in Australia. Despite this the 2017-18 financial year has seen pretty solid returns for well diversified investors. Global shares look to have returned around 14% in Australian dollar terms, Australian shares returned around 13% (including dividends) and unlisted assets have continued to see double digit returns. While bond and cash returns have been more constrained this still points to balanced growth superannuation returns of around 9% for the financial year which is pretty good given inflation of around 2%. We expect returns to slow a bit over the new financial year but they should still be reasonable as the global and Australian economies are likely to keep growing and this will help profit growth at a time that monetary policy still remains easy. However, global inflation, Fed tightening and trade war fears are the main risks and they will help keep volatility high.
  • US trade related tensions with China remain high. President Trump’s decision to support a strengthening of the Committee on Foreign Investment in the US (CFIUS) process so it can prevent foreign investors from violating US intellectual property rights, rather than declaring an economic emergency in relation to Chinese investments under the International Emergency Economic Powers Act (IEEPA) is less provocative towards China than had been feared. But ultimately the proof will be in the pudding, and in the meantime, there is still no sign of the US and China restarting trade negotiations ahead of the July 6 start date for tariffs on $US34bn of Chinese imports. So, it’s looking very likely that the first round of tariffs will be implemented. Our base case remains that some form of negotiated solution will be reached but things are likely to get worse before they get better. 
  • The European leaders summit looks to be seeing ongoing plodding towards greater Eurozone economic integration and an agreement on an EU wide “Australian” solution to its migration problem focussed on beefed up external border security (stopping the boats) and holding centres (possibly offshore) to process immigrants. The progress on immigration looks to be enough to keep Italy onside and probably to keep Merkel’s coalition government in Germany together for now. All of which is a positive for Eurozone assets, albeit the Italian budget issues remain for the months ahead.
  • What’s up with Chinese shares and the Renminbi? Is it a bad sign for global growth? From its high in January, the Chinese share market has fallen around 22% and the Renminbi has fallen around 6% from its April high. These sort of moves are naturally inviting comparisons to the 2015-16 plunge in Chinese shares and the Renminbi. The weakness has been triggered by signs of slowing growth in China, worries that this will be made worse by a trade war with the US and with the shift to Chinese monetary easing weighing on the Renminbi. However, its very different to 2015 when Chinese shares plunged nearly 50% (after previously more than doubling in value to a forward PE of around 19 times) amidst an unwinding of margin positions, government moves to support the market and a shift to a new way to manage the currency that led to capital outflows. This time around the share fall started from low double-digit PEs and the PE is now only around 10.5 times, there has been no panicky unwinding of margin positions, economic data is arguably more stable, there is more confidence in how the currency is managed. In fact, the fall in the Renminbi is a mirror image of the rise in the value of the $US which against a basket of currencies is up nearly 8% since April. For these reasons the fall in Chinese shares and the Renminbi is less worrying for the global and Australian economies than it was in 2015-16, which is why Australian shares have not been falling at the same time.  
  • In Australia, some small banks have raised mortgage rates in response to a blowout in short term funding costs and others may follow. As noted several times in this Weekly Report, lately the gap between bank bill rates and the expected RBA cash rate has blown out relative to normal levels (by around 0.35%) in recent months and it was only a matter of time before banks started to pass this on given they get about 20% of their funding from this source (more so for the smaller lenders which have been the only ones to move so far). Initially the blow out was driven by the same thing occurring in the US (which was partly driven by US companies returning cash held overseas in US dollars back to the US) but it has continued in Australia possibly reflecting a desire to lock in funding ahead of the financial year end (after the squeeze into the March quarter end), the Westfield takeover and regulatory reforms including the impact of the Royal Commission.

Source: Bloomberg, AMP Capital

  • However, there are a few things to note. First, the increased cost of funding for banks only amounts to less than 0.1% if its fully passed on to all rates so its small. Second, banks so far seem to be focussing the pass through on rates other than traditional owner occupiers on principle and interest loans – given the desire to avoid more adverse publicity - which will reduce the impact on households. Big banks which are yet to move, but likely, will are expected to do the same. Finally, its not a sign that the RBA has suddenly lost control – apart from the small nature of the rise banks have been doing out of cycle moves for a decade now and yet the main driver of the big picture trend in rates remains what the RBA does…and right now they aren’t doing anything. So don’t expect big changes in traditional mortgage rates. What the latest mortgage rate hikes do though is provide a reminder to households (if one is needed) that rates can go up and at the margin along with tightening bank lending standards they make it even less likely that the RBA will hike rates anytime soon.

Major global economic events and implications

  • US economic data was mostly strong. Regional business surveys mostly rose in June, pending home sales fell but new home sales surged and home prices continue to rise, core capital goods orders slipped in May but were revised to be very strong in April pointing to a strong quarterly gain in capex, jobless claims remain very low, personal spending was softer than expected in May but strong income growth and consumer confidence about as high as it ever gets points to strength going forward. Meanwhile core private consumption deflator inflation rose to 2% year on year on May, right on the Fed’s target and consistent with ongoing Fed rate hikes every three months.
  • Eurozone economic sentiment fell only marginally in June with business sentiment actually stabilising and overall sentiment remaining strong, and money supply and credit growth picked up a bit in May. Against this though June core inflation slipped back to 1% year on year, where its been stuck for more than a year now, which is consistent with our view that the ECB rate hikes are a long way away.
  • Japanese data was a bit better than expected with the jobs market remaining very strong (helped by a falling population of course), industrial production falling less than expected and core inflation in Tokyo rising to 0.4% year on year in June…albeit that’s still way below target so the BoJ will remain pedal to the metal.
  • China’s central bank delivered the foreshadowed further cut to bank required reserve ratios – which looks designed to help bolster the economy as credit from shadow banking slows and given the threat of trade wars. Meanwhile profit growth remained strong in May and business conditions PMIs were little changed in June – up slightly for non-manufacturing and down slightly for manufacturing. 

Australian economic events and implications

  • Australian data was a bit light on over the last week, but job vacancies continued to rise very strongly into May according to the ABS suggesting the labour market remains strong. Meanwhile, credit growth is continuing to slow with lending to investors stalling and the downtrend in new home sales continued in May.
  • The ABS should forget about a monthly CPI. It says its apparently close – maybe for mid-2020. This would be great for economists, market commentators and economics journalists as it will mean more to talk about. But as we all know monthly data just means more noise - that the ABS always encourages us to look though using its trend estimates. Which is just what the RBA will do so it won’t make any difference to what happens to monetary policy. But it will mean more volatility in investment markets and more meaningless chatter about what interest rates should do. The ABS should spend the extra resources required to create a monthly CPI on stats with wider economic and social value.

What to watch over the next week?

  • Trade will remain a focus in the week ahead with the proposed 25% US tariffs on $US34bn of Chinese imports scheduled to start up on Thursday absent a last minute re-start of US/China trade negotiations which at this stage looks unlikely.
  • Meanwhile in the US we will get another update on the jobs market with labour market data for June to be released Friday likely to show a 190,000 gain in payrolls, unemployment holding at 3.8% and wages growth ticking up slightly to 2.8% year on year. In other data expect a slight fall in the June manufacturing ISM (Monday) and non-manufacturing ISM (Thursday) but only back to still strong readings of around 58 and the May trade deficit (Friday) is expected to contract slightly. The minutes from the last Fed meeting (Thursday) are likely to just reaffirm that the Fed sees itself as on track for two more rate hikes this year but will be watched to see how concerned the Fed is about the risks to global trade.
  • Eurozone unemployment data (Monday) for May is likely to show a slight fall to 8.4%.
  • The Japanese Tankan business conditions index (Monday) is expected to remain reasonably strong but will be watched for trade war worries and household spending data will be released Friday.
  • Chinese Caixin business conditions surveys will be released Monday and Wednesday,
  • In Australia, the Reserve Bank (Tuesday) is expected to leave interest rates on hold for the 23rd month in a row (or 21 meeting since they don’t meet in Januarys). While a brightening outlook for mining investment, strengthening non-mining investment, booming infrastructure spending and strong growth in export volumes argue against a rate cut, topping dwelling investment, uncertainty around the consumer, continuing weak wages growth and inflation, falling home prices in Sydney and Melbourne, tightening bank lending standards and the threat to global growth from a US driven trade war all argue against a hike. So it makes sense for the RBA to remain on hold. We remain of the view that a rate hike is unlikely before 2020 at the earliest and can’t rule out the next move being a cut.
  • Meanwhile, on the data front in Australia expect CoreLogic data for June (Monday) to show another slight fall home prices, May residential building approvals (Tuesday) to show a small bounce after a fall in April and May retail sales to slow to just 0.2% growth and the trade surplus (both Wednesday) to rise. June business conditions PMIs are likely to have remained solid.

Outlook for markets

  • While we continue to see share markets as being higher by year end as global growth remains solid helping drive good earnings growth and monetary policy remains easy, we are likely to see more volatility and weakness between now and then as the US trade threat could get worse before it gets better and as worries remain around the Fed, President Trump in the run up to the US mid-term elections, China, emerging markets and property prices in Australia.
  • Low yields are likely to drive low returns from bonds. Australian bonds are likely to outperform global bonds helped by the relatively dovish RBA.
  • Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.
  • National capital city residential property prices are expected to slow further as the air continues to come out of the Sydney and Melbourne property boom and prices fall by another 4% this year, but Perth and Darwin bottom out, Adelaide and Brisbane see moderate gains and Hobart booms.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
  • The $A likely has more downside to around $US0.70 as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Solid commodity prices should provide a floor for the $A thoughin the high $US0.60s.
  • Eurozone shares rose 0.9% on Friday helped by an EU immigration deal and the US S&P 500 shares rose 0.1%. Reflecting the positive global lead and a further rise in oil prices ASX 200 futures gained 23 points, or 0.4%, on Friday night pointing to a positive start to trade for the Australian share market on Monday which is likely to be led again by energy stocks.


The week in review: Trade war threat ramps up again

Monday, June 25, 2018

Investment markets and key developments over the past week

          The past week saw geopolitics continue to cause gyrations in markets with political tensions around immigration in Germany and Trump upping the ante on trade with China and Europe. This saw most major share markets fall, with US shares down 0.9%, Eurozone shares down 1.9%, Japanese shares down 1.5% and Chinese shares down 3.8% and emerging market shares remaining under pressure. Australian shares bucked the global lead though. Safe haven demand saw bond yields mostly fall, except in Italy where worries resumed. The oil price rose 5.4% as OPEC agreed to increase output by 1 million barrels per day (which after production constraints probably amounts to about 0.7mbd) but which was less than had been expected. Gold, metals and iron ore prices fell. While the $A had a fall below $US0.74 it ended little changed over the week at $0.7436, with the $US index down slightly.

          Despite the trade war threat Australian shares rose 2.2% over the last week and made it to their highest level since early 2008, but is it sustainable?Australian shares have been boosted by a rebound in financial shares which had become oversold the previous week as bargain hunters snapped them up for their dividends, a boost to consumer stocks from the passage of the Government’s income tax package and strong gains in defensives and yield sensitive REITs. This has left the ASX 200 on track for our year-end target of 6300, assuming our base case of no major trade war is correct. However, the road between now and year end is likely to be rough with a high risk that the trade skirmish gets worse before it gets better, and worries around Trump, Fed rate hikes, China, emerging markets and Australian property prices all likely to cause a rough ride. Given that China takes one third of our exports the local market would be vulnerable should the trade war escalate significantly.

          Emerging markets under pressure but this is not 1997-98 all over again. From their highs early this year EM shares and currencies are down around 10%. The plunge reflects a combination of country specific problems (eg Turkey, Brazil and South Africa), concerns that the rising $US will cause a dollar funding crisis for emerging countries with significant $US debt, worries that they will be adversely affected by any global trade war and repositioning after investors loaded up on EM assets with a 65% rally in EM shares from early 2016 to early this year. The weakness could have further to go as many of these concerns remain, but it’s unlikely to be a rerun of 1997-98 or even 2015 as EM fundamentals around growth and external balances are arguably stronger than then and the rebound in the $US is likely to be limited.

          Trump’s further ramping up of the trade skirmish with China (from tariffs on $US50bn of imports plus another $US200bn should China retaliate and then another $US200bn if China retaliates to that) have significantly increased the risk of a full-blown trade war between the US and China - with a more significant economic impact. So far the bulk of the tariffs are just proposed so there is still room for a negotiated solution which remains our base case as that is what the US is seeking and China would prefer – otherwise the tariffs would have been implemented already. But there is now a high risk that some of the tariffs go into force before a negotiated solution is reached (which would be a short-lived negative for share markets), even though we still see the risk of a full-blown US-China trade war with deeper share market downside as being low at around a 10-20% probability. Key to watch for is the re-start of US-China negotiations ahead of July 6. Trump’s tweet threatening that the US will place tariffs on auto imports from Europe will further up the risk of a trade war with Europe.

          Expect measures to strengthen the Eurozone at its summit on Thursday and Friday, but will it be enough. Progress in this direction has been given a big push by French President Macron and German Chancellor Merkel supports many of his proposals. Expect progress on a banking union, measures to strengthen the European Stability Mechanism, possibly a start to a Eurozone budget, some agreement on an unemployment stabilisation fund and a strengthening of European Union border control enforcement. Solving the immigration issue is critical if Merkel is to head off a potential split with her Interior Minister who leads the Bavarian Christian Social Union and is threatening border controls around Germany and to keep Italy onside. A split with the CSU would unlikely spell the demise of Merkel or the German coalition Government as Merkel could get support from the Greens, but Merkel and her party would prefer to retain support from the CSU. A more integrated Europe would be positive for Eurozone assets including the Euro, but no progress would be bad.

          The Australian Government got a big win with the Senate passing its personal income tax package. However, the impact on consumer spending is likely to be trivial as the tax cuts for low and middle income earners don’t kick in until after taxpayers do next year’s tax return after June 2019 and are only around $10 a week which maybe buys two cups of coffee and the tax cuts for middle to higher income earners won’t be of any significance until next decade and just give back some bracket creep. So a surge in retail stocks on the news may have got a bit ahead of itself.

          Along with slow wages growth and falling house prices in Sydney and Melbourne there are two other drags on Australian households: rising petrol prices and potentially higher mortgage rates. The rise in petrol prices to around $A1.50/litre has pushed the typical Australian household’s petrol bill up by around $12 a week over the last two years.




Week in review: Trade war threat still remains

Monday, June 18, 2018

Investment markets and key developments over the past week

  • The past week saw mixed share marketsUS shares were flat with strong data offset by worries about a more hawkish Fed and tariffs on Chinese imports, Eurozone shares rose 1.4% as the ECB remained dovish and Italian risks receded a bit and Japanese shares rose 0.7% as the Bank of Japan remained dovish. Chinese shares were not helped by soft economic data and fell 0.7%. However, the Australian share market rose 0.8% helped by a mostly positive global lead and as lower bond yields helped support strong gains in yield sensitive utilities and telcos. Bond yields generally fell as did prices for oil and metals, but iron ore rose. A mildly hawkish Fed and strong US data at the same time as a dovish ECB and Bank of Japan and softer non-US data saw the US dollar rise to its highest since July last year and this saw the $A fall back below $US0.75.
  • Good news on North Korea and Italy, but the trade war threat remains. The Trump/Kim summit was a big deal for world peace and while some critics wanted more no major peace deal has been achieved in a day – that it happened, that there is agreement to work towards the complete denuclearisation of the Korean peninsula, that there will be follow on talks to implement this and that the US will suspend military exercises is the best that could have been hoped for from the summit. It gives investors a bit of peace on this issue for at least a year. Tick for now. On Italy and Itexit worries there was a bit of relief with new Italian Finance Minister Tria saying that there has been no discussion of an Itexit. Budget conflict with the European Commission still lies ahead but our view remains that Italy stays in the Euro. So tick for now.
  • Meanwhile the trade war threat remains with the US announcing its latest list of $50bn of Chinese imports to be subject to a 25% tariff of which $34bn will be implemented on July 6 and the remainder are still subject to further review. And as expected, China immediately announced a proposed list of tariffs on $50bn of imports from the US. No tick here. Just bear in mind though that this should be no surprise to anyone, as it’s what Trump’s May 29 statement said the US would do by June 15, it’s still just another list that has yet to be implemented and if implemented it would cover less than 2% of imports to the US so we would still be a long way from the Smoot-Hawley 20% tariffs on all imports that helped make the Great Depression “great”. 
  • Trump also sees these announcements as a way of pressuring China into action on trade – so more classic Art of the Deal stuff - with US Trade Representative Lighthizer hoping “that this leads to further negotiations” and with the July 6 start date for some of the tariffs still leaving three weeks to do so. Ultimately a negotiated solution is likely – and this is what both the US and China want - but the risks are high and the tariffs could well be implemented before the issue is resolved.
  • Major central banks slowly taking away the punch bowls but it’s very gradual and there is still lots of punch around:
  • The Fed provided no surprises in hiking rates again for the seventh time this cycle but yet again it was a bit more hawkish and the “dots” have moved to four hikes this year. Our view remains four hikes this year and three next and we continue to see US money market expectations as too dovish. This should all mean ongoing upwards pressure on US bond yields but its worth nothing that US rates at 1.75-2% are still far from tight and so we are still a long way from the point where US growth is threatened.

Source: Bloomberg, AMP Capital

  • The ECB made no changes to monetary policy but confirmed that it “anticipates” ending its quantitative easing program in December after further phasing it down to €15bn/month through the December quarter. However, its been tapering its QE program since 2016, its left the door open to extending QE into 2019 if needed (by making its ending “subject to incoming data”), its indicated it will reinvest maturing assets for an “extended period” and that it expects no rate hike until at least mid-2019 and ECB President Draghi’s comments were dovish. It took the Fed more than a year after ending QE before it started rate hikes. With inflation way below target, growth indicators softening a bit lately and uncertainties around Italy a rate hike is unlikely until 2020 at the earliest. So ECB easy money may be getting a bit less easy, but it still looks like remaining easy for a long while yet.
  • Finally, the Bank of Japan remains full steam ahead with its ultra-easy monetary policies. No surprise here with weaker data lately and core inflation falling again.
  • While talk of the ending of ultra-easy monetary policy globally generates periodic excitement in markets and amongst commentators it’s worth noting that its now more than five years since the US “taper tantrum” started it all off – so its been a very gradual process – and I suspect global monetary policy will remain easy for years to come. Just less easy than it was.

Major global economic events and implications

  • US economy accelerating. Small business optimism rose to its second highest ever (with surging worker compensation and profit readings), retail sales growth was very strong in May, industrial production dipped in May but this was due to autos and the New York regional manufacturing conditions index rose further in June, jobless claims remain ultra-low and consumer, producer and import price data show a continuing edging up in inflationary pressures and point to core private consumption deflator inflation (the Fed’s preferred inflation measure) rising to 1.9-2% year on year for May. The Atlanta Fed’s GDPNow growth tracker puts June quarter growth at 4.8%.
  • Eurozone economy still slowing. Eurozone industrial production fell in April consistent with some softening in Eurozone growth – which will present a bit of a threat to the ECB’s plans to end is QE program in December.
  • China slowing too. Chinese data mostly softened suggesting the long awaited mild slowing in growth may be underway. Unemployment edged down in May to 4.8% and home price gains picked up, but industrial production, retail sales, investment and credit growth all slowed. This may reflect noise in monthly data, but it may also be reflecting the impact of deleveraging measures which have hit “shadow banking.” This is broadly consistent with our view that GDP growth will slow to 6.5% this year. But more moves to ease monetary policy are likely to ensure growth doesn’t slow too much.

Australian economic events and implications

  • Australian data was back to being a bit on the softish side. Business confidence slipped a bit in May but remains solid, consumer confidence remains stuck around long term average levels, housing finance continued to slow in April with tighter bank lending standards pointing to more weakness to come and jobs data was a bit soft in May. Employment growth was weaker than expected with full time jobs falling and while unemployment fell slightly this was because of a decline in participation. Meanwhile underemployment rose slightly over the last three months to 8.5% so total labour market underutilisation remains very high at 13.9%.
  • While RBA Governor Lowe reiterated the mantra that the next move in interest rates is likely to be up, he also said any increase “still looks to be some time away” and indicated that to raise rates the RBA is looking for reduced labour market slack, faster wages growth and increased confidence inflation is picking up. At present there is no sign of reduced labour market slack and this is likely to continue to weigh on wages growth. We remain of the view that with trend growth likely to be remain subdued, bank lending standards tightening, Sydney and Melbourne house price falls having further go that the RBA won’t start raising rates to 2020 at the earliest and in the meantime the next move being a cut can’t be ruled out.

What to watch over the next week?

  • Apart from the ongoing issues around trade, the focus in the week ahead will remain on central banks with Fed Chair Powell, ECB President Draghi, BoJ Governor Kuroda and RBA Governor Lowe all participating in a panel discussion in Portugal on Wednesday. It’s doubtful that any of them will say anything new having all just had meetings or made speeches, but no doubt their comments will be watched for any clues on the monetary policy outlook
  • In the US, expect home builder conditions (Monday) to remain strong, housing starts (Tuesday), home sales (Wednesday) and home prices to all rise and the June business conditions PMIs (Friday) to remain strong at around 56-57.
  • Eurozone June business conditions PMIs (Friday) will be watched closely to see whether the recent softening trend continues.
  • The Bank of England (Thursday) is expected to leave monetary policy on hold particularly given recent softer data and ongoing Brexit uncertainty.
  • Japanese core inflation data for May (Friday) is expected to show a further dip to 0.3% year on year (from 0.4% in April) consistent with Tokyo inflation data already released.
  • In Australia, ABS March quarter data is expected to confirm a 1% or so decline in home prices (Tuesday) consistent with already released private sector surveys and population growth data (Thursday) for 2017 is expected to show continued strength of around 1.6% year on year with Victoria the strongest on the back of high immigration levels and interstate migration. The minutes from the RBA’s last board meeting (Tuesday) are likely to confirm that the RBA remains comfortably on hold.

Outlook for markets

  • Volatility in share markets is expected to stay high as US inflation and interest rates move up and as issues around President Trump (trade, Mueller inquiry, etc) continue to impact, but the medium-term trend in share markets is likely to remain up as global growth remains solid helping to drive good earnings growth. We continue to expect the ASX 200 to reach 6300 by end 2018.
  • Low yields and capital losses from rising bond yields are likely to drive low returns from bonds. Australian bonds are likely to outperform global bonds helped by the relatively dovish RBA.
  • Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning, and listed variants are vulnerable to rising bond yields.
  • National capital city residential property prices are expected to slow further as the air continues to come out of the Sydney and Melbourne property boom and prices fall by another 4% this year, but Perth and Darwin bottom out, Adelaide and Brisbane see moderate gains and Hobart booms.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
  • The $A likely has more downside to around $US0.70 as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Solid commodity prices should provide a floor for the $A though in the high $US0.60s.
  • Eurozone shares fell 0.7% on Friday and the US S&P 500 declined 0.1% as President Trump’s latest list of $50bn of Chinese imports to be subject to tariffs keeps trade war risks alive. The soft US lead saw ASX 200 futures close flat on Friday night suggesting a flat start to trade for Australian shares on Monday.


Week in review: Turmoil in Italy and US trade

Monday, June 04, 2018

Investment markets and key developments over the past week

  • For the week this left US shares up 0.5%, but Eurozone shares down 1.4%, Japanese and Chinese shares down 1.2% and Australian shares down 0.7%. While bond yields rose late in the week they ended down slightly in most major countries except in Italy. Commodity prices were mixed with copper up slightly but oil and iron ore down. Despite the volatility in markets the $A rose slightly with the $US little changed.
  • Trade war worries back to the fore again with Trump announcing that tariffs and investment restrictions on China will be formalised on June 15 and 30 respectively and start soon thereafter and that US exemptions for the EU, Mexico and Canada to the steel and aluminium tariffs announced earlier this year are ending. These moves are concerning and heighten the risk of a global trade war, but both need to be put in some context. First, the measures regarding China are the same as those flagged on March 22nd which were due to be formalised by May 22nd but were then put on hold after the start of successful negotiations with China two weeks ago. Trump appears to be taking a tough stance again to nullify domestic criticism he has gone too easy on China, but it also looks like a negotiating tactic designed to get more out of China ahead of another round of talks. The risk is that China feels it can no longer trust Trump. But solving this issue was never going to be smooth, it will take time and Trump’s volatile nature along with divisions on the US side will continue to add to noise.
  • Second, the commencement of tariffs on steel and aluminium from the EU, Mexico and Canada is (like all protectionism) dumb economics particularly at a time when the US is already operating at close to full capacity. But it’s worth putting all these tariffs in context: steel & aluminium imports are less than 2% of US imports (and less than that is affected as many countries including Australia are exempted) and $50bn of Chinese imports are also less than 2% of US imports so taken together it’s a non-event compared to the 1929 or 1971 tariff hikes of 20% and 10% respectively that covered most imports. A proportional response is expected on steel and aluminium but it’s only going to have a significant global economic impact if it triggers multiple rounds of tit for tat tariff hikes across a broad range of products.  The bottom line is that while the risks have escalated we are still a long way from a full-blown trade war globally and Trump is likely wary of pushing too hard here for fear of a backlash from US workers who will have to pay more at Walmart and see their jobs go at Harley Davidson, Boeing, etc.
  • Early election averted in Italy with the Five Star Movement and Northern League forming government, but it’s likely to remain messy. The Finance Minister may not be so anti-Euro but the agenda for fiscal expansion and hence the likelihood of conflict with the European Union remains high. As a result, Italian bonds and shares are likely to remain under pressure for a sometime yet as investors fear that the ECB won’t be able to support Italian bonds, the economic outlook deteriorates, and they worry that their investments will fall in value if Italy exits the Euro. Uncertainty about Italy is likely to continue to weigh on the Euro and Eurozone shares and as we saw with the Eurozone debt crisis a few years ago this can also weigh on global and Australian shares at times because it raises concerns about growth in the world’s third largest economic block after the US and China. So Italy at just 1.9% of global GDP can have an outsized impact on markets just like Greece at just 0.3% did during the Grexit crises.
  • However, two things are worth noting. First, ultimately Italy is likely to remain in the Euro because it’s too hard to leave given it would involve a sharp collapse in the value of a “new” Lira, a run on the banks, capital flight and a further sharp rise in Italian bond yields and a majority of Italians support it. But as we saw with Greece and Syriza a few years ago it can take a while (and a sharp rise in Italian bond yields) to get to this point. Second, the risk of contagion to other countries like Spain, Portugal, Ireland and Greece is now low given they are seeing stronger economic conditions, lower unemployment and reduced budget deficits and popular support across for the Euro is high across Eurozone countries at over 70%.
  • Spain is no Italy - the change of government in Spain to one led by the centre left Socialists, does not threaten Spain’s commitment to the Euro. The Socialists are pro-EU and the Euro and given political constraints will honour the Rajoy government’s budget that was recently passed. Even if the new government fails and there are early elections the Citizens Party or Ciudadanos would gain the most and it also supports the Euro. Along with the People’s Party these three pro Euro parties garner two thirds popular support and the eurosceptic Podemos only gets around 17% support. So forget about any “contagion” from Italy to Spain.
  • Trade wars, Itexit fears and the investment cycle. A big debate in the investment world is always about where are we in the investment cycle. This is particularly the case at present in relation to the US economy and share market where the cycle is more mature. A normal cycle would see growth continue at high levels, spare capacity recede and inflation and other signs of excess continue to build driving monetary policy ultimately into tight territory and setting the scene for the next major bear market and economic downswing. However, as we have seen ever since the GFC this has all been a long time coming as various events have slowed the build-up in growth and excesses. Geopolitical shocks such as a trade war or an escalation of worries around an Itexit could have the same impact in cooling growth, pushing bond yields back down and ultimately extending the day of reckoning for the global economic upswing

Major global economic events and implications

  • Another week of strong US data. Consumer confidence remains about as high as it ever gets, personal spending growth was solid in April, home prices are continuing to rise, the ISM manufacturing conditions index rose to an even stronger level in May, construction activity is rising solidly, the goods trade deficit unexpectedly improved in April and labour market data remains strong. May saw another “Goldilocks” jobs report with payrolls up a stronger than expected 223,000 and unemployment falling to 3.8% which is its lowest since 1969 but wages growth only edging up to 2.7% year on year. The April core private final consumption deflator was unchanged at 1.8% year on year but is running at 2% on a 3 and 6-month annualised basis which is right on the Fed’s inflation target. This is all consistent with the Fed continuing to raise interest rates with the next move this month and we still see a total of four hikes this year.
  • Eurozone economic sentiment slipped in May, but it’s still strong. Meanwhile unemployment came in at 8.5% in April which was down from 8.6% in March and May core inflation bounced back to 1.1%yoy. Italian risks may not stop the ECB from starting to taper its quantitative easing program in the December quarter, but it adds to confidence that it will not be raising interest rates until second half next year at the earliest.
  • Japan saw strong labour market data and a rise in consumer confidence but weaker than expected production.
  • Chinese business conditions PMIs for May were flat or rose a bit consistent with continuing solid growth.
  • Indian March quarter GDP growth came in at a strong 7.7%yoy – surpassing China’s growth rate of 6.8%yoy.

Australian economic events and implications

  • Australian economic data was on the soft side with a fall in building approvals, continuing moderate credit growth, a continuing fall in home prices and a softer than expected rise in business investment for the March quarter. Investment plans are showing improvement, but its gradual with investment plans for 2018-19 only up 1.4% on those for 2017-18. At least they are no longer plunging though, so the drag on growth from investment is over.

Source: ABS, AMP Capital

  • Capital city dwelling prices continued to slip in May falling by 0.2% month on month and 1.1% year on year. Prices have now fallen for seven months in a row and Sydney is continuing to lead the way down. Our assessment remains that home prices in Sydney and Melbourne have more downside ahead thanks to tightening bank lending conditions, rising supply, falling capital growth expectations causing buyers to hold back and slowing foreign buying. In the absence of much higher unemployment or higher interest rates, price declines are likely to remain gradual and this is also consistent with auction clearance rates which have slowed but not collapsed. Our expectations are for Sydney and Melbourne prices to fall 6% or so this year, another 5% next year and around 2-3% in 2020. Prices in Perth and Darwin look close to the bottom and moderate growth is expected in other capitals. Overall, Sydney and Melbourne are likely to see a top to bottom fall of around 15% spread out to 2020, but for national average prices the top to bottom fall is likely to be around 5%.
  • The increase in the minimum wage by 3.5% from July will help wages growth, but only a bit. This increase is only fractionally stronger than last years 3.3% rise which helped wages growth tick up from 1.9% to 2.1%. With unemployment and underemployment remaining very high at around 14% its hard to see underlying wages growth picking up much so our guess is that the 3.5% minimum wage increase will just help keep wages growth ticking along at 2.1%. Pumping up minimum wages won’t jump start stronger underlying wages growth because to get that we need to see a much tighter labour market and that needs stronger growth. The risk is that it makes low income workers relatively less attractive further boosting automation and offshoring.

What to watch over the next week?

  • In the US, it will be a relatively quiet week on the data front but expect the May non-manufacturing conditions ISM index (Tuesday) to remain strong at 56-57, job opening and hiring data for April (also Tuesday) to have remained very strong and the trade deficit for April (Wednesday) to improve slightly.
  • Chinese trade data for May (Friday) is expected to show export growth remaining solid at around 10% year on year but import growth slowing back to around 12% yoy. Inflation data will also be released Saturday but should be benign.
  • In Australia, the RBA is expected to leave interest rates on hold for a record 22 months in a row when it meets Tuesday. While the RBA would no doubt like to be raising rates to more normal levels like the Fed is and continues to repeat the mantra that the next move is more likely to be up than down there is currently no case to move rates. Booming infrastructure investment, better non-mining investment, strong export growth and the RBA’s own forecasts for growth and inflation all support the case for an eventual rise in rates but this is counterbalanced by uncertainty around consumer spending, weak wages growth and inflation, tightening bank lending standards and the slowing Sydney and Melbourne property markets. Our view remains that a rate hike is unlikely until 2020 at the earliest and that in the interim a rate cut cannot be ruled out.
  • On the data front in Australia the main focus will be on March quarter GDP growth (Wednesday) which is expected to come in at 0.8% quarter on quarter or 2.7% year on year thanks to a 0.6 percentage point contribution from net exports after several weak quarters and strong public demand offsetting soft growth in consumer spending. In other data expect a 0.1% rise in April retail sales (Monday), continued strength in services conditions PMIs (Tuesday) and a slight fall in the trade surplus (Thursday) to $1.3bn.

Outlook for markets

  • Volatility in share markets is likely to remain high as US inflation and interest rates move up and as issues around President Trump (trade, Mueller inquiry, etc) continue to impact, but the medium-term trend in share markets is likely to remain up as global recession is unlikely and earnings growth remains strong globally and solid in Australia. We continue to expect the ASX 200 to reach 6300 by end 2018.
  • Low yields and capital losses from rising bond yields are likely to drive low returns from bonds. Australian bonds are likely to outperform global bonds helped by the relatively dovish RBA.
  • Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning, and listed variants are vulnerable to rising bond yields.
  • National capital city residential property prices are expected to slow further as the air continues to come out of the Sydney and Melbourne property boom and prices fall by another 4% this year, but Perth and Darwin bottom out, Adelaide and Brisbane see moderate gains and Hobart booms.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
  • The $A likely has more downside to around $US0.70 as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory. Solid commodity prices should provide a floor for the $A though.
  • The formation of a coalition Government in Italy and another Goldilocks jobs report in the US saw Eurozone shares gain 1.1% on Friday and the US S&P 500 also rise by 1.1%. The positive global lead saw ASX 200 futures rise by 34 points or 0.6% pointing to a gain at the open for the Australian share market on Monday.




Week in review: No trade war but still no trade peace

Monday, May 28, 2018

The past week has again seen geopolotical issues dominate with renewed trade worries out of the US, the cancellation and then possible resurrection of the North Korean summit, rising angst around the formation of a populist government in Italy and political uncertainty in Spain. US shares managed a 0.3% gain, but Eurozone shares fell 1.3%, Japanese shares fell 2.1%, Chinese shares lost 2.2% and Australian shares fell 0.9%. Bond yields continued to blow out in Italy but declined elsewhere helped by safe haven demand. Commodity prices were mixed with gold & metals up but iron ore down and oil down as Saudi Arabia said OPEC and Russia will likely raise oil production. The $A managed a small rise despite a further rise in the $US.

No trade war, but still a long way from trade peace. Trump has been blowing all over the place on US-China trade talks in the last two weeks – no he doesn’t expect much from them, yes the benefits of the initial talks are massive, and no he’s not really pleased with the outcome. But this is just classic Trump who says what he thinks at the time, wants to appeal to his base and will say extreme things in order to get what he wants in negotiations. The good news though is that negotiations between the US and China are off to a good start and China is keen on reducing tensions with the US and the US has put the start of tariffs (due from May 22) on hold. But there is still a long way to go – a problem that took decades to build won’t be negotiated away in just a few weeks – and if there is not enough progress the threat of tariffs remains. But our view remains that ultimately a full-blown US-China trade war will be averted. In the meantime of course, the NAFTA renegotiation has a way to go, Trump has ordered a consideration of imposing tariffs on US auto imports and the EU’s exemption from US steel and aluminium tariffs will expire again on June 1 (but is likely to be extended). Given that 29% of US auto imports come from Mexico and 19% from Canada the latest move is designed to pressure them on NAFTA. But it will also impact Japan, Korea and Germany. But it’s all about Trump posturing around negotiations and like the steel and aluminium tariffs any impact is likely to be significantly watered down.

June 12 summit between Trump and Kim Jong-Un killed by the Libyan model, or maybe not?. With North Korea having flouted agreements and gone hot and cold for decades it was always debatable as to whether much would come of the summit anyway. But not having the summit doesn’t mean military conflict is on the way. The North Korean regime knows that it will get annihilated if it does anything and the US knows that a pre-emptive strike will result in mass casualties in South Korea. And in any case having cancelled the summit on Thursday, Trump did another backflip on Friday saying “we are talking to them now” and it could still be on for June 12th!

Turn down the noise on Trump. There is no denying that Trump’s comments add to market volatility and the risks around Trump are greater this year than last (with tax reform and deregulation behind us, the mid-terms approaching and the Mueller inquiry getting closer to Trump). However, much of what he says is just open mouth thought bubbles, bluster and posturing. Yes, he should be taken seriously, but not literally. For investors its best to focus on the investment fundamentals around growth, profits, interest rates, etc, and to turn down the noise on Trump.

Back to the Eurozone crisis? Investors are right to worry about a populist Government in Italy – its proposed fiscal policies will blow the Italian budget deficit through the EU limit of 3% of GDP leading to conflict with the EU, sanctions, the ECB excluding it from its bond buying program and ratings agency downgrades. However, anticipation of this and the risk that 5SM and the Northern League return to their policy of wanting Italy to exit the Euro is already pushing Italian bond yields sharply higher as bond holders try to protect against redenomination risk or default. So far this month Italian 10-year bond yields have been pushed up by 66 basis points to 2.44%. This is a long way from the 2011 crisis highs around 7%, but the more yields rise from here the more it will hit Italian banks, borrowing costs and hence the Italian economy. Ultimately the Italian Government will have to back down as a result and it will all look a bit like what happened with Syriza in Greece, with Italy remaining in the Euro (because it’s too costly to leave). But in the process, it will be bad news for Italian bonds and shares, will act as a drag on the Euro and will cause occasional bouts of volatility in share market (including Australian shares - recall the volatility around Grexit). The risk of a move by Italy to exit the Euro triggering contagion to the rest of the Eurozone though is low as countries like Spain, Portugal and Ireland are stronger than in the crisis years and popular support for the Euro is high. Political uncertainty in Spain following a corruption scandal that may see a new election doesn’t help, but does not threaten Spain’s commitment to the Euro.  

Time to remain alert but not alarmed regarding Chinese debt. This issue has been wheeled out regularly for years and the RBA had another go at it in the last week. Yes its gone up too fast, yes the growth of “shadow banking” has been an issue, yes some of the debt will turn bad and so yes it’s a risk. But there is nothing new here. China is different to most countries that get into debt problems in that it borrows from itself (so there’s no pesky foreigners to cause an FX crisis), much of the rise in debt owes to corporate debt that’s partly connected to fiscal policy (and so the odds of government bailout are high) and the key driver of the rise in debt is that China saves around 46% of GDP and much of this is recycled through the banks where it’s called debt. So unlike other countries with debt problems China needs to save less and turn more of its savings into equity than debt. The Chinese authorities have long been aware of the issue and have been working to slow debt growth. So yes, keep an eye on it but there is no need for alarm.

Major global economic events and implications

US data remains solid. While home sales slipped in April, home prices continue to rise, underlying durable goods orders rose solidly in April and the Markit business conditions PMIs rose further in May. Meanwhile the minutes from the Fed’s last meeting didn’t tell us much that we didn’t know: the meeting leant to the dovish side with Fed upbeat on the economy and on track for another hike next month, but tolerant of a temporary inflation overshoot of 2% as its consistent with the  symmetric inflation target so just because inflation goes above 2% doesn’t mean it will slam on the brakes. However, its comments are consistent with three more rate hikes this year (starting in June) whereas the money market is still not there yet.

Eurozone business conditions PMIs fell again in May. While more public holidays than normal may have played a role and they are still strong their decline relative to US PMIs is a big driver of why the Euro is now falling against the US dollar.

Japan’s manufacturing PMI also fell in May but remains consistent with moderate growth. A further fall in Tokyo’s core inflation to just 0.2% yoy highlights yet again that the BoJ is along way from being able to exit easy money. Which in turn is negative for the Yen (barring bouts of safe haven demand).

Australian economic events and implications

Australian economic data was on the soft side over the last week with skilled job vacancies falling and construction activity coming in virtually flat in the March quarter. Public construction is rising strongly as the infrastructure boom rolls on, but this is being offset by weakness in private sector construction driven by non-residential building. The latter suggests a soft input into March quarter GDP numbers to be released in early June.

What to watch over the next week?

In the US, it will be a big week on the data front with inflation and jobs data the focus. The core personal consumption deflator (Thursday) is expected to show inflation remaining at 1.9% year on year or May, just below the Fed’s target. Labour market data (Friday) is expected to show a solid 185,000 rise in payrolls, unemployment holding at 3.9% and wages growth edging up to 2.7% year on year. In other data expect: consumer confidence (Tuesday) to remain strong; May personal spending (Thursday) to have remained solid; pending home sales (also Thursday) to rise around 1%; and the May manufacturing ISM (Friday) to have remained strong at around 57-58. All of which, supports another Fed rate hike next month.

Eurozone data to be released Thursday is likely to show a unemployment remaining at 8.5% and a slight rise in core inflation to 0.8% year on year (after its April slump to 0.7%). With the latter remaining well below target an early exit from ultra-easy ECB monetary policy will remain unlikely.

Japanese labour market data (Tuesday) and industrial production (Thursday) will be released.

Chinese business conditions PMIs are likely to continue to average around recent levels consistent with solid growth.

In Australia, March quarter business investment data to be released on Thursday will be the highlight. Expect to see a 0.8% bounce in March quarter investment with investment intentions data showing ongoing signs that mining investment is getting near the bottom and that non-mining investment is edging up. Meanwhile in other data expect to see a 1% decline in building approvals (Wednesday), continuing moderate growth in credit (Thursday) and CoreLogic data for May (Friday) showing another modest fall in May home prices led by Sydney.

Source: Domain, AMP Capital.

Outlook for markets

Volatility in share markets is likely to remain high as US inflation and interest rates move up and as issues around President Trump (trade, Mueller inquiry, etc) continue to impact, but the medium-term trend in share markets is likely to remain up as global recession is unlikely and earnings growth remains strong globally and solid in Australia. We continue to expect the ASX 200 to reach 6300 by end 2018.

Low yields and capital losses from rising bond yields are likely to drive low returns from bonds. Australian bonds are likely to outperform global bonds helped by the relatively dovish RBA.

Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning, and listed variants are vulnerable to rising bond yields.

National capital city residential property prices are expected to slow further as the air continues to come out of the Sydney and Melbourne property boom and prices fall by another 5% this year, but Perth and Darwin bottom out, Adelaide and Brisbane see moderate gains and Hobart booms.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.

The $A likely has more downside to around $US0.70 as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory. Solid commodity prices should provide a floor for the $A though.



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RBA expected to cut and budget preview

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Bank worries still weighting on share market

Fed officials still upbeat