Weekly market & economic update 17 September 2010

From

Headline developments of the past week

  • Global financial market regulators – known as the Basel Committee on Banking Supervision – announced tougher capital requirements for banks so that they can better withstand future financial crises. However, bank shares actually rose in response as the capital requirements had been anticipated and the time to comply was longer than expected. Australian banks appear to be well placed to meet the new requirements and if anything are likely to be overcapitalised.
  • The Bank of Japan intervened in currency markets to sell Yen for the first time in six years. Whether the intervention will have a lasting effect remains to be seen, but its now clear that the Yen had risen beyond the Japanese Government’s tolerance level, given the damage its rise has been causing the Japanese economy.
  • Increasing talk of additional quantitative easing in the US, or QE2 as it has become known, saw the US dollar under downwards pressure with the gold price pushed to a new record high as a result and the Australian dollar rising to its highest level since July 2008. More US quantitative easing will increase the supply of US dollars and so is negative for the currency. Gold and the Australian dollar are likely to be ongoing beneficiaries – although there may be a few bumps along the way because it may still be several months before the Fed actually starts QE2.
  • The message from central banks was mixed with central banks in New Zealand and Switzerland leaving interest rates on hold on the back of dovish comments about the outlook, but the Reserve Bank of India raising its key interest rates by 0.25% and 0.5% on the back of high inflation and a solid outlook. Reserve Bank of Australia Assistant Governor Philip Lowe delivered a relatively upbeat speech on the outlook for Asia and Australia, but his warnings about Australia’s lack of spare capacity, inflation risk and the need for consumers to exercise restraint, served to highlight the RBA’s inclination to raise interest rates further.

Major global economic releases and implications

  • US economic data was a little bit better than expected. Retail sales rose more than expected in August, industrial production continues to rise albeit slowly, the New York and Philadelphia manufacturing conditions surveys were a little bit stronger than the weak readings seen in August, initial unemployment claims unexpectedly fell and while weekly mortgage applications fell marginally this followed a very strong gain the previous week and they are now up by 12.5% since mid July, suggesting the housing sector may have found a floor after its post first time buyer tax credit slump. Small business confidence improved, but only modestly.
  • European data was soft with flat industrial production in July and flat employment in the June quarter.
  • Japanese data was mixed with a private sector survey highlighting a sharp deterioration in the outlook on the back of the strong Yen, but a strong improvement in tertiary sector activity in July.
  • After last week’s round of stronger than expected August economic data in China, a Chinese leading economic index rose solidly in July adding to the picture that China is on track for a soft landing. Meanwhile China has relented to intensifying US pressure to let the Renminbi appreciate more quickly. More gains are likely, but only taking it up by around 5% over the next 12 months.

Australian economic releases and implications

  • Australian economic data was mixed but remains consistent with solid growth. The NAB business survey for August reported a marginal easing in business conditions but a rebound in business confidence. Consumer confidence slipped 5% in September reversing a similar rise the previous month, but it remains very high consistent with reasonable growth in consumer spending. Dwelling commencements rose by less than expected in the June quarter but the previous quarter was revised up strongly. Finally, skilled vacancies and car sales rose.
  • The chart that follows, based on data from the Westpac-Melbourne Institute’s survey of consumer confidence, shows that Australian’s remain very cautious in their savings habits. In September 51.7% still regarded paying down debt or saving in bank deposits as the wisest place for savings whereas only 11.5% regarded shares as the wisest place of savings. Quite clearly the effect of the 2007-09 bear market and continuing share market volatility are continuing to weigh on investor confidence. The flipside of course is that the lack of confidence in shares is potentially positive for the share market going forward because it means that there is a lot of money sitting on the sidelines, which can come into the market once confidence improves.

Major market moves

  • Share markets generally rose over the last week on somewhat better than expected economic data and Japanese shares being helped by moves to depress the Yen. Australian shares also moved higher.
  • Whereas the $US rose against the Yen, it fell against other currencies on the back of expectations for quantitative easing and improving risk appetites. This saw the $A rise to a two year high before slipping back.
  • While oil prices fell, gold and base metal prices rose solidly.

What to watch in the week ahead?

  • In the US, August data for housing starts, permits to build new homes, house sales and a survey of home builders are likely to show signs of stabilisation after the slump caused by the ending of the first home buyers tax credit earlier this year. House prices are still likely to be under downwards pressure though. Durable goods orders are likely to show that the recovery in capital spending is continuing, albeit at a slower pace. The US Federal Reserve is expected to leave interest rates on hold and indicate that it will embark on more quantitative easing (QE2) if conditions warrant it. However, with the Fed likely to have revised down its 2011 growth forecasts to below 3% there is an outside chance that it will embark on QE2 immediately.
  • In Australia, the focus is likely to be back on interest rates with the minutes from the last RBA Board meeting and a speech by RBA Governor Glenn Stevens likely to be looked at closely for clues as to how strong the RBA’s tightening bias is and when the next rate hike might come. Given the strength in recent Australian and Chinese economic data we expect the Governor to adopt a hawkish stance.

Outlook for markets

  • After seven percent or so gains in shares from their August lows, shares are at risk of a correction or consolidation in the short term particularly with US shares up against key technical resistance, double dip worries lingering and September and October being tough months for shares. However, while near term uncertainties remain, shares are likely to see strong gains into year-end and then through 2011. Shares are very cheap relative to government bonds, investors are still very bearish which is positive from a contrarian perspective and once it becomes clear that the US/global recovery is continuing (albeit slowly) there is likely to be a big reversal of investment flows – out of government bonds and back into equities.
  • After a six percent gain since late August which has taken it to a two year high, the Australian dollar is due for a consolidation or correction, particularly if share markets see another bout of double dip fears. However, further gains in the value of the $A are likely on a six to 12 month horizon as it becomes clear that the global recovery is continuing, commodity prices are remaining strong and that Australian interest rates are still on the rise and are remaining well above global rates.
  • Double dip and deflation worries along with the prospect of more central bank government bond purchases in the US and elsewhere are likely to keep bond yields low in the short term, but medium term returns are likely to be poor reflecting low yields and excessive public debt levels in many developed countries.
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