By Shane Oliver

Stronger global economic data dominated the action over the last week, offsetting some of the fears around whether President Trump will be able to pass his pro-business policies through Congress. So while Japanese shares fell 1.8% and Chinese shares lost 1%, US shares rose 0.8%. Eurozone shares gained 1.6% and Australian shares rose 1.9%. Commodity prices mostly rose and the $A rose slightly. Bond yields mostly fell.

UK starts divorce proceedings

The UK has finally lodged its notification to the European Union to formally start up to two years of divorce proceedings. Ho hum! It’s been talked about for so long that markets barely reacted. There will be a long way to go, with lots of noise. The European Union will be a tough negotiator as membership of it brings benefits and obligations, so there is a high risk of a hard Brexit. Just remember though that the UK is only 2.5% of global GDP and there has been no evidence that the Brexit vote will lead to a domino effect of other countries looking to exit as well (in fact, the three Eurozone elections since Brexit have seen less support for anti-Europe populists). So there is no need for investors to get excited about it.

Trump-land troubles

The US Congress will likely remain an ongoing source of noise for investors, but what’s new? While the failure of the Obamacare reforms has led to a quick shift to focussing on tax reform, negotiations among House Republicans around a passable health care bill appear to be continuing, so it’s not dead in the water. Talk of another government shutdown will also likely start to escalate through April as a new continuing resolution funding spending will need to be passed by April 28th. Ongoing dysfunction in Congress means that a shutdown is possible but as the 2013 experience showed, it’s not in either the Republican’s or Democrat’s interest to be seen as the cause. So our base case (70% probability) is that a deal will be worked out when required. And then, of course, around July to September the debt ceiling will need to be raised again or further suspended which might bring us back to the old “will the US government default?” debate. Again, our view is that this will be solved too but it could go down to the wire. All up, this is really just more of the same, but as long as Trump gets something through at least on tax cuts, share markets should be reasonably happy. Meanwhile, he is continuing to wind back business regulation with the latest being the lifting of a number of restrictions on energy companies and with the Administration signalling mostly modest changes to NAFTA in relation to Mexico; the Mexican Peso is up 15% from its January low.

APRA's move

APRA’s long awaited additional macro prudential tightening adds to the likelihood that the Sydney and Melbourne property markets will start to slow. The main change from APRA was an expectation that lenders limit interest-only loans to 30% of new mortgage lending (from around 40% at present), strict limits on loan-to-value ratios above 80% for interest-only loans, along with an expectation that lending to investors remains "comfortably below" the 10% growth limit, that serviceability measures remain "appropriate" and that lending to high-risk categories is “constrained”. 

Source: APRA, AMP Capital

That APRA moved again was no surprise (they should have done something last year!), but the main surprise was that the investor lending speed limit remains at 10% rather than being cut to a more reasonable 5-7%. Limiting interest-only lending may have the same effect as cutting the speed limit because around 60% or more of investor loans are interest only, but time will tell, so further action may be required.

Putting that uncertainty aside though, the latest moves by APRA, coming on the back of bank mortgage rate hikes over the last two weeks, the likelihood of action to boost affordability in the May budget (including a cut to the capital gains tax discount) and the surge in unit supply at a time of silly prices, are all likely to result in a slowdown in property price gains in Sydney and Melbourne this year ahead of a 5-10% price fall starting next year some time. In the short term, all eyes will be on Saturday's auction clearance rates to see whether there is much headline impact from APRA’s moves!

Impacts of Cyclone Debbie

Our thoughts are with those affected by Cyclone Debbie along Australia’s north east coast. While it’s too early to know the full extent of the damage, economic disruption (to crops, tourism, mining activity, etc) could knock 0.1 to 0.2% off GDP growth spread across the March and June quarters (but mainly the latter) and a boost to headline inflation via higher fruit and vegetable prices in the June quarter is likely as the area is a major supplier of bananas, tomatoes, etc. The RBA will tend to look through these effects as they will be temporary.  

Major global economic events and implications

US data over the last week was mostly strong, with consumer confidence at is highest since 2000, home prices continuing to rise, pending home sales up strongly, jobless claims remaining low, December quarter GDP growth being revised up and the goods trade deficit narrowing. Against this though personal spending remained weak in February. Core personal consumption deflator inflation rose to 1.8% year-on-year continuing to edge towards the Fed’s 2% target.

Eurozone sentiment readings were strong, with economic sentiment about as high as it ever gets and strong readings for the German IFO business conditions index. Against this, Eurozone bank lending data was weaker than expected in February and core inflation fell to 0.7% year-on-year which looks temporary but still highlights inflationary pressures are very low. 

Japanese data for February was mixed with strong industrial production and labour market data, but household spending remaining weak and core inflation stuck around zero.

China’s business conditions PMIs rose in March indicating growth continues to edge up. It’s increasingly looking like the growth up tick is broadening out beyond the initial impact of last year’s policy stimulus, in particular into private sector services companies. It’s consistent with policy makers continuing to tap the brakes (with more cities imposing housing curbs).

Australian economic events and implications

In Australia, new home sales showed a continued gradual downtrend, job vacancies remained solid and private credit growth slowed further led by weak business lending. Of most interest in the credit data was a pickup in lending to property investors to 6.7% year on year and over the three months to February it grew at annualised pace of 8.3% compared to just 4.3% a year ago. No wonder the regulators are looking to ensure it does not continue to accelerate. 

What to watch over the next week?

In the US, expect the March ISM manufacturing and non-manufacturing conditions indexes (Monday and Wednesday) to remain strong and jobs data (Friday) to show solid payroll growth of 175,000 with unemployment unchanged at 4.7% but wages growth stuck at 2.8% year on year. Trade data (Tuesday) is likely to show a reduced deficit. The US data flow in the week ahead, along with the minutes from the last Fed meeting (Wednesday), will likely to do nothing to alter expectations for another two or three Fed rate hikes this year. A vote on Neil Gorsuch’s nomination to the Supreme Court will be watched closely as a guide to future Republican/Democrat “cooperation” and the summit between Trump and China’s President will be watched to see how trade tensions evolve.

The Japanese Tankan business survey (Monday) is likely to show a further improvement in business confidence.

RBA expected to leave rates on hold

In Australia, the RBA is expected to leave rates on hold at 1.5% for the eighth month in a row when it meets on Tuesday. A rate cut is unlikely because economic growth has bounced back after its September quarter slump, the RBA expects that underlying inflation has bottomed and will gradually rise and the Sydney and Melbourne property markets are uncomfortably hot, posing financial stability risks. By the same token it's way too early to be thinking about rate hikes as underlying inflation risks staying below target for longer, the $A is too high, unemployment and underemployment at over 14% combined are way too high and out-of-cycle bank mortgage rate hikes have delivered a de facto monetary tightening any way.

The RBA has to set interest rates for the average of Australia, so raising interest rates just to slow the hot Sydney and Melbourne property markets would be complete madness at a time when growth is still fragile and underlying inflation well below target. The best way to deal with the hot Sydney and Melbourne property markets and excessive growth in property investor lending into those markets is through tightening macro prudential standards, which APRA has again moved to do. 

On the data front in Australia, expect to see a 0.2% gain in February retail sales, a 0.5% rise in building approvals and continued strength in home prices in March according to CoreLogic led by Sydney and Melbourne (all due for release Monday) and a continued trade surplus (Tuesday). The AIG’s business conditions PMIs will also be released. 

Outlook for markets

Shares remain vulnerable to a short-term pull back as investor sentiment towards them is very bullish and a lot of good news has been factored in, which has left them vulnerable to any bad news. But putting short term uncertainties aside, with valuations remaining okay, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we continue to see any pullback in shares as opportunities to “buy the dips”. Shares are likely to continue to trend higher on a 6-12 month horizon. 

With the Australian share market having broken decisively above the 5800 level, it now looks like it’s on its way to a retest of the March/April 2015 intraday highs of just below 6000.

Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. At present, bond yields are still consolidating after last year’s rise, but a resumption of the bear market is likely at some point in the months ahead seeing a gradual rise in yields.  

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher over the medium term. 

National residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of Sydney and Melbourne. 

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.

For the past year, the $A has been range bound between $US0.72 and $US0.78 and this may continue for some time yet. At some point this year though, the downtrend in the $A from 2011 is likely to resume as the interest rate differential in favour of Australia narrows (as the Fed hikes 3 or 4 times and the RBA remains on hold).

Eurozone shares gained 0.6% on Friday but the US S&P 500 fell 0.2%. Despite the softish lead from the US share market, ASX 200 futures rose 7 points or 0.1% pointing to a flat to slightly positive start for the Australian share market on Monday morning.