By Shane Oliver

Shares were mixed over the last week, with US shares down 0.7% and Eurozone shares down 0.1%, but Japanese shares up 2.5% and Australian shares up 0.6%. Bond yields rebounded on ECB taper talk and increased expectations for a December Fed rate hike. As a result of the latter, the $US rose and appears to be breaking higher which pushed the $A lower. This was despite a further rise in the oil price on the back of falling US crude stockpiles.

US non-farm payrolls growth of 156,000 in September tells us that the US jobs market remains solid and keeps the Fed on track for a December rate hike. But rising labour force participation, which pushed the unemployment rate up to 5% and indicates that there is still more slack in the labour market along with slow wages growth is consistent with the process of raising US interest rates gradually. Firming prospects for a December hike are taking pressure off the $A, which fell below $US0.76 over the last week. 

Another taper tantrum?

The ECB tapering its quantitative easing program is inevitable, but it’s likely to be extended first. The past week saw global bond yields pushed higher by more talk that the ECB will taper (or gradually slow) its bond purchases once its quantitative easing (QE) program ends. ECB tapering is inevitable, but it’s more likely to extend QE beyond March 2017 at the current rate of €80bn a month first given that growth is fragile, inflation is below target and political risk is high. The minutes from the last ECB meeting and comments from ECB officials remain dovish. Taper talk will likely continue though and global bond yields are poor value regardless of whether the ECB tapers sooner or later. The risk is that a 2013 style taper tantrum - if it causes a sharp rise in peripheral Eurozone bond yields - will result in QE for longer.

Global business conditions PMIs point to okay global growth. The global manufacturing PMI rose in September – with notable gains in Brazil, Japan, Europe, the UK, the US and even Australia - continuing a mild rising trend seen over the last six months.

Source: Bloomberg, AMP Capital

Consistent with this, the IMF’s global growth forecasts have stabilised. After the usual downwards revisions to the IMF’s 2016 and 2017 global growth forecasts they have now stabilised relative to the IMF’s last update in July at 3.1% and 3.4% respectively. The IMF’s 2016 growth forecast has followed the same pattern of the last few years – starting towards 4% and then ending around 3%. The 2017 forecast is likely to fall to around 3% too. 3% global growth is good for investors as it’s enough to support modest profit growth, but not so strong as to invite aggressive monetary tightening.

Source: IMF, AMP Capital

Trump v Clinton

While Hillary Clinton enjoyed a bit of a poll boost post the first presidential debate taking her lead to around 3-4%, the vice-presidential debate looks to have been won by Mike Pence, albeit its impact is usually minor, and the election outcome remains close. The focus now shifts to the next presidential election debate. Our view remains that a November 8 victory by Clinton would simply mean more of the same in the US, as Democrats would not control Congress.

But a Trump victory (or anticipation of it) would be initially negative for shares on policy uncertainty and trade war worries, push up bond yields as the US budget deficit is likely to widen and US interest rates would move higher and therefore be positive for the $US. After an initial negative reaction, shares are likely to rebound if Trump’s Reaganesque policies (tax cuts, increased infrastructure and defence spending, and deregulation) predominate over his protectionist policies. For Australian assets, a Trump victory would mean an initial share sell-off followed by a rebound, potentially higher bond yields and a lower $A.

A flash crash in the British pound (down 6% then up 5% on Friday in the Asian time zone), provided lots of interest for traders but should just be noise for well diversified long term investors. The real issue is that the UK increasingly looks headed for a hard Brexit (with Britain paying a price for border control in the form of curtailed export access to the EU). The EU is keen to discourage other countries from following Britain out, but it likely means more downside for the pound which should limit the fall-out for the British economy.  

The RBA

The RBA on hold and neutral. With no major economic developments in the last month, September quarter inflation due later this month and new Governor Philip Lowe presumably wanting to demonstrate a degree of policy continuity, it was no surprise to see rates left on hold at 1.5%. However, we remain of the view that the RBA will cut rates again at its November meeting when it reviews its economic forecasts after the release of the September quarter inflation data, particularly with the $A remaining too high. However, with economic growth holding up well, commodity prices and national income looking like they have bottomed and the new Governor perhaps preferring a period of stability, this is a close call and is critically dependent on seeing a lower September quarter inflation result. 

Major global economic events and implications

US economic data was mostly good, leaving the Fed on track for a December rate hike. The ISM business conditions indexes rebounded in September to reasonable levels, particularly for non-manufacturing which is strong, durable goods orders were revised up, the four-week moving average of jobless claims fell to its lowest since 1973, payroll employment was solid (albeit less than expected) and better employment readings in the ISM surveys point to reasonable jobs growth ahead. The trade deficit widened in August though.

Japanese data was mixed with lacklustre conditions according to the Bank of Japan Tankan’s survey, a slight improvement in September’s manufacturing conditions PMI, but a worsening in the services PMI and stronger consumer confidence.

The Reserve Bank of India surprised with a 0.25% rate cut, highlighting that global monetary conditions are still easing.

Australian economic events and implications

Australian economic data was mostly solid with a stronger-than-expected gain in August retail sales after three soft months, building approvals remaining around record levels pointing to a stronger-for-longer housing construction cycle, a rebound in September business conditions PMIs (albeit to still soft levels) and a further decline in Australia’s trade deficit (which now looks to have seen the worst). Home prices continued to rise solidly in September, with Sydney and Melbourne remaining uncomfortably strong (particularly with the supply of units surging). Finally, the Melbourne Institute’s Inflation Gauge rose solidly in September, but has been soft in the quarter as a whole with the trimmed mean measure of underlying inflation falling to just 0.8% year-on-year.

What to watch over the next week?

In the US, expect the minutes from the Fed’s last meeting (Wednesday) and a speech by Fed Chair Yellen (Friday) to repeat the message that the Fed will remain gradual in raising rates and expects to hike rates again at its December meeting. On this front, an expected 0.4% month-on-month gain in September retail sales after two weak months will be important in indicating whether the Fed is on track or not. Data on job openings (Tuesday), small business optimism (Wednesday) and producer prices (Friday) is also due. 

The US third quarter earnings reporting season will also kick off with Alcoa reporting Monday. While total earnings for S&P 500 companies are expected to be down 1.5% from a year ago, they are expected to be up slightly on the June quarter continuing an earnings recovery that has been helped by a stabilisation in the US dollar and rising trend in the oil price.

In China, expect September export growth to remain negative but import growth to slow slightly (Thursday), consumer price inflation to remain low at around 1.6% year-on-year, producer price deflation to continue to fade (both Friday) and total credit to slow after the August surge.

In Australia, expect the NAB business survey (Tuesday) to show business confidence and conditions remaining above long term average levels, housing finance (also Tuesday) to bounce back after a fall in July and the Westpac/MI survey (Wednesday) to show that consumer confidence remains around average levels. The RBA’s six monthly Financial Stability Review (Friday) will be watched mostly for more colour around the state of the housing market.  

Outlook for markets

While the period for seasonal share market weakness (August to October) so far has passed without a major mishap, we remain cautious on shares in the short term as event risk remains high for the months ahead including ongoing debate around the Fed and ECB, issues around Eurozone banks, the US election on November 8 and the Italian Senate referendum and Austrian presidential election re-run (both on December 4). However, after any short-term weakness, we anticipate shares to trend higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions and moderate global economic growth. 

Ultra-low bond yields point to a soft medium-term return potential from them, but it’s hard to get too bearish on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors. 

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up.

Cash and bank deposits offer poor returns.

Increasing confidence that the Fed will hike rates again by year end has taken some pressure off the $A in the short term and we continue to see the longer term trend remaining down as the interest rate differential in favour of Australia narrows as the RBA continues cutting rates and the Fed eventually resumes hiking, commodity prices remain low and the $A sees its usual undershoot of fair value.

Eurozone shares lost 0.9% on Friday and the US S&P 500 fell 0.3% as reasonable September jobs growth in the US kept the Fed on track for a December rate hike and the oil price dipped after recent gains. Despite the soft global lead, ASX 200 futures rose 0.1% and so I expect a modest 5-10 point gain at the open for the Australian share market on Monday.