Headline developments of the past week

The past week saw investor caution return on the back of soft economic data and renewed worries about China and Europe. This saw shares, commodity prices and the Australian dollar fall and sovereign bonds in major countries rally. 

Chinese related news added to nervousness about a hard landing there, with the HSBC flash manufacturing conditions index falling back to a four month low this month, average house prices continuing to drift down for the sixth month in a row, the Government raising fuel prices by six to seven per cent, BHP expressing caution regarding the short term outlook for Chinese iron ore demand and implicitly revising down its longer term demand growth projections and indications that vehicle sales won’t meet forecasts. In the absence of more aggressive policy easing, worries about a hard landing in China will persist and act as a drag on Chinese shares, commodity prices, the Australian share market and the Australian dollar.

However, our assessment remains that Chinese GDP growth will be around eight per cent this year – manufacturing conditions are still around levels consistent with eight to nine per cent GDP growth, the impact on inflation from higher fuel costs is not that great as fuel is only two per cent of China’s CPI, a slowing in the rapid rate of growth in China’s iron ore demand is to be expected with a shift to a more sustainable rate of growth and there are still no indications the property market is collapsing. While policy easing in China will not be anywhere near as aggressive as was the case in 2008-09, it doesn’t need to be, but it will still be eased enough to avoid a hard landing.

European debt worries resurfaced with concerns focusing on Spain and Italian PM Monti’s difficulties in getting through labour market reforms. This has seen bond yields in Italy and Spain tick higher and bank stocks fall.

Major global economic releases and implications

US economic data was mixed. Homebuilders’ conditions were flat and housing starts, home sales and new mortgage applications all fell. However, the falls in starts followed rises in previous months and a further recovery in starts is suggested by solid gains in permits to build new homes and a rising trend in homebuilders’ conditions. Our assessment remains that a US housing recovery is getting underway. What’s more, initial unemployment claims continued to fall, a leading indicator rose and a Bloomberg survey showed the number of Americans saying the economy is getting better rose to the highest since 2004. Meanwhile, Fed Chairman Bernanke indicated the US recovery is still sub-par, implicitly leaving open the possibility of more policy easing.

European data was disappointing with falls in PMI business conditions indicators and a sharp fall in industrial new orders in January. However, while the PMI readings were weaker than expected they remain in the same range they have been for five months and at levels that point to a mild, as opposed to deep, recession.

Japanese data was generally positive with a smaller trade deficit and gains in a Reuters’ business survey.

Central banks in both Taiwan and Thailand left interest rates on hold and export data for Korea and Taiwan were a bit stronger than expected. Inflation in Singapore and Malaysia moderated in February.

Australian economic releases and implications

In Australia, the main focus was on the RBA. While the minutes from the last Board meeting repeated the message that the RBA is pretty comfortable with interest rates remaining around their longer term average levels, a speech on Monday by Governor Stevens was more timely in acknowledging recent below trend growth and he left the door open for a rate cut provided inflation is benign. As such, it looks like the March quarter inflation report due on 24 April will be the thing to watch. We think it will remain benign clearing the way for a sorely needed rate cut in May.

Meanwhile, skilled job vacancies fell in February, the Westpac leading index points to below trend growth and disappointing earnings news from David Jones highlights just how bad things are for retailers.

Australian petrol prices have pushed up towards A$1.60 a litre. The rise in petrol prices is consistent with the rise in world oil prices and in particular the Asian Tapis oil price that Australian petrol prices are based on. The rise in the world oil price has been driven by strong emerging world demand, a return to confidence in the global growth outlook and worries about a disruption to Iranian oil supplies. This has pushed the weekly petrol bill for a typical Australian family up to nearly $55 compared to around $50 a year ago. It represents another blow to household budgets and as such is more bad news for retailers. While petrol prices remain below their mid 2008 peak of $1.65 a litre they would likely blast through this if tensions regarding Iran’s alleged nuclear ambitions result in military action, as even though Saudi Arabia can make up for lost Iranian oil, the oil price would start to price in the risk of a wider disruption, such as to oil flows through the Strait of Hormuz.

Major market moves

Global share markets were initially boosted by Apple’s move to reinstate dividends and stock buybacks but most markets ended down on renewed worries about Europe and China.

Commodity prices also fell back on soft Chinese and European economic data. The oil price was also held down as Saudi Arabia signalled that it had 2.5 million barrels per day of spare capacity (which roughly matches Iranian net oil exports) and would work to ensure lower prices. Worries about China also weighed on the Australian dollar.

Reflecting the ‘risk off’ tone, bond yields retraced some of their recent rise.

What to watch over the week ahead?

In the US, expect a small rise in pending home sales (Monday), a small fall in the S&P Case/Shiller home price index (Tuesday), a small dip in consumer confidence (Tuesday) on the back of higher gasoline prices, solid gains in durable goods orders (Wednesday) and modest gains in personal income and spending (Friday).

Japanese data for unemployment, inflation, housing starts and industrial production will be released Friday.

Eurozone finance ministers meet Friday to consider an expansion in the size of Europe’s debt firewall by combining the €500bn to be in the ESM with the remaining €240bn in the EFSF. The German IFO survey will be released Monday and eurozone confidence data will be released Thursday.

In Australia, it will be another quite week for data with February quarter job vacancies (due Thursday) likely to be soft and private credit growth (Friday) expected to remain softish. The RBA’s Financial Stability Review (Wednesday) is expected to confirm the Australian financial system remains in pretty good shape.

Outlook for markets

While there will be numerous pullbacks along the way the broad trend in global shares is likely to remain up. Valuations remain attractive, particularly against very low bond yields, the risk of a eurozone meltdown has faded, momentum in global economic indicators is positive, global monetary conditions are getting easier and easier and there is lots of cash on the sidelines. Chinese and emerging country share markets may underperform in the near term but should pick up as China starts to more aggressively ease economic policy.

Rising global share markets are likely to pull the Australian share market higher but it is likely to remain a laggard on the back of high interest rates in Australia, the strong Australian dollar and worries about a hard landing in China. 

Low global bond yields in major countries suggest low returns unless Europe’s debt crisis intensifies.

The current correction in the Australian dollar may have further to go reflecting soft data in Australia and worries about China. However, the Australian dollar is likely to remain strong overall as the improving global growth outlook supports commodity prices and as Australian interest rates remain above US rates.

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