Headline developments of the past week

• The focus over the past week was on China which undertook a surprise 0.25% increase in benchmark lending and deposit rates. This caused a blip in global financial markets as investors pondered whether this is the start of another round of policy tightening in China which might threaten Chinese growth. Our take is that Chinese authorities have simply taken the view that the growth outlook globally and in China has become a bit more favourable and so it is appropriate to take a step towards normalising interest rates while at the same time ensuring that term deposit rates keep up with inflation making it easier to keep a lid on potential asset bubbles. However, it’s hard to see Chinese tightening becoming aggressive. GDP growth slowed further to 9.6% in the year to the September quarter from 10.3% in the June quarter, signalling that the threat of overheating has well and truly receded. At the same time, while retail sales continued to accelerate in September and industrial production moderated this is consistent with the authorities desire to rebalance the economy. Secondly, its hard to say that there is an inflation problem – while inflation picked up to 3.6% in the year to September this was driven by higher food prices with non-food inflation actually falling to just 1.4%. Finally, it’s hard to see Chinese interest rates rising too far as it will make it harder to control hot money inflows. Rather Chinese policy will remain focussed on using quantitative and administrative measures to soak up the liquidity being generated by its efforts to limit the rise in the Renminbi. Overall, our take is that Chinese the rate hike is just a tap on the brakes to ensure the economy will remain under control, rather than an attempt to further crunch growth. Over the year ahead we see growth stabilising around the 9.5% level, which will be positive for the continuation of the global recovery and commodity demand.
• After a 16% rise in Chinese shares since late September, they had become overbought and due for a correction. However, with valuations remaining attractive, ongoing evidence that the economy has avoided a hard landing, hot money flooding into the country as China tries to limit Renminbi appreciation and property measures likely to make shares relatively more attractive, strong gains in Chinese shares are likely over the next six to 12 months.
• In Australia, the Minutes from the Reserve Bank’s last rate setting meeting indicated that the decision to leave rates on hold was a close one with the key drivers being that near term growth was running around trend, soft credit growth, the rise in the $A and continuing risks to the global outlook. However, the clear message remained that more interest rate hikes were likely on the way, with the RBA also noting that it could not wait indefinitely to see whether risks materialised suggesting that the case to raise rates again has already been made. Since the meeting in early October, global economic data has improved a bit, local employment and consumer confidence data have been stronger and the $A is only marginally stronger suggesting that barring an underlying September quarter inflation outcome below the RBA’s 2.5 to 2.75% expectation then a 0.25% rate hike following the November meeting is a good chance.

Major global economic releases and implications

• US economic data was mixed, again consistent with an economy muddling along at a sub-par 2% pace. On the positive side jobless claims fell, a leading index rose, a survey of home builders improved in October and housing starts rose slightly. Against this, the Philadelphia Fed manufacturing survey improved only marginally, new mortgage applications fell, permits to build new homes fell and industrial production fell 0.2% in September. Meanwhile the Fed’s Beige Book of anecdotal evidence removed references to a deceleration as had been evident in previous months but indicated continued growth, albeit at a modest pace.
• The earnings news out of the US remained positive with so far 79% of results exceeding expectations including those from Boeing, Yahoo, Goldman Sachs, EBay and McDonalds.
• European business conditions fell in October with a slight improvement in manufacturing conditions being offset by a fall in the services sector. Conditions remain consistent with growth but momentum is clearly slowing and the rebound in the euro combined with fiscal tightening is likely to lead to a further softening ahead ultimately setting the scene for renewed easing from the European Central Bank. Disruptions associated with protests against government cutbacks, as seen in France over the last week, won’t help.
• In the UK, the Conservative-led coalition provided more detail of drastic spending cuts over the next four years, which are projected to take the budget deficit down from 10.1% of GDP this year to 2.1% in the 2014-15 fiscal year. Meanwhile protests against an increase in the pension age to 62 continued in France.

Australian economic releases and implications

• Australian economic data was mixed. While motor vehicle sales rose in September skilled vacancies fell in October and the Westpac leading index fell slightly in August. Meanwhile, the terms of trade saw another big surge in the September quarter with import prices rising just 0.7%, but export prices surging another 7.8% leaving them up 27.7% over the last year. This will take the terms of trade to a new 49 year high. The continuing surge in Australia’s terms of trade is providing a huge boost to national income, employment and investment which will require further interest rate increases if it is not to spill over into higher inflation and underlines the RBA’s observation that it cannot wait indefinitely to resume raising interest rates.

Major market moves

• Global share markets were mixed in volatile trading, rising in the US and Europe, flat in Asia but weaker in Japan and Australia. In the US, stocks were buoyed by better than expected earnings results but gains were limited as the mortgage foreclosure debacle in the US continued to weigh on bank stocks. Australian and Asian shares were adversely affected by the Chinese tightening which weighed on resources stocks.
• Commodity prices generally fell in response to worries that the Chinese tightening will weigh on commodity demand and as the $US bounced from oversold levels.
• After very strong gains taking it briefly up to parity against the $US at the end of the previous week, the Australian dollar fell back as the Chinese tightening triggered profit taking and lower commodity prices, the RBA cited the strong $A as a reason not to tighten earlier this month and as the $US bounced higher.

What to watch in the week ahead?

• In the US, data for home sales are likely show a small bounce but house price data, which lags, is likely to soften. Durable goods orders are likely to show reasonable gains confirming that the corporate sector remains a source of strength in the US. US September quarter GDP growth is likely to come in around 2.2% annualised, ie no double dip but not strong enough to bring unemployment down. Data for consumer confidence and business surveys from the Texas, Richmond and Chicago Fed regions will also be released. A speech by Fed Chairman Bernanke will also be watched closely for clues regarding quantitative easing.The US profit reporting season will also continue.
• Australian September quarter inflation data will be watched closely as a guide to what the RBA might do on interest rates next month. We expect headline inflation to rise 0.7% quarter on quarter or 2.8% year on year and underlying inflation to rise by 0.6% quarter on quarter and 2.6% year on year. Expect sharp rises in prices for alcohol, tobacco and utilities to be partly offset by falls in petrol prices, health and clothing and footwear. Comments from retailers indicate that price discounting is likely to have remained a key dampener on inflation. However, unless the underlying inflation rate is below the RBA’s expectation of 2.5% to 2.75% its unlikely to have a big impact on the RBA’s next interest rate decision.
• Australian credit data will likely have remained soft in September and a speech by RBA Governor Glenn Stevens will also be watched closely.

Outlook for markets

• Shares are vulnerable to more corrective activity in the short term as the gains from late August are digested and with US quantitative easing now largely factored in. However, further decent gains are likely into year end and through 2011. Share markets have been tracing out a rising trend since the lows in early July, which points to a resumption of the cyclical bull market which started in March last year. More fundamentally, shares are very cheap relative to government bonds, investors are still wary which is positive from a contrarian perspective and the surge in global liquidity on the back of the latest round of quantitative easing getting underway in the US and elsewhere should provide a positive boost for shares.
• The Australian dollar is vulnerable to a further correction in the short-term – particularly with speculative positions and investor sentiment towards it now high. However, a further rise above parity against the $US is likely in the months ahead as commodity prices remain strong, the $US remains under pressure and Australian interest rates continue to rise well above global rates.
• 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. However, medium-term returns are likely to be poor, reflecting low yields and excessive public debt levels in many developed countries.

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Headline developments of the past week

• The focus over the past week was on China which undertook a surprise 0.25% increase in benchmark lending and deposit rates. This caused a blip in global financial markets as investors pondered whether this is the start of another round of policy tightening in China which might threaten Chinese growth. Our take is that Chinese authorities have simply taken the view that the growth outlook globally and in China has become a bit more favourable and so it is appropriate to take a step towards normalising interest rates while at the same time ensuring that term deposit rates keep up with inflation making it easier to keep a lid on potential asset bubbles. However, it’s hard to see Chinese tightening becoming aggressive. GDP growth slowed further to 9.6% in the year to the September quarter from 10.3% in the June quarter, signalling that the threat of overheating has well and truly receded. At the same time, while retail sales continued to accelerate in September and industrial production moderated this is consistent with the authorities desire to rebalance the economy. Secondly, its hard to say that there is an inflation problem – while inflation picked up to 3.6% in the year to September this was driven by higher food prices with non-food inflation actually falling to just 1.4%. Finally, it’s hard to see Chinese interest rates rising too far as it will make it harder to control hot money inflows. Rather Chinese policy will remain focussed on using quantitative and administrative measures to soak up the liquidity being generated by its efforts to limit the rise in the Renminbi. Overall, our take is that Chinese the rate hike is just a tap on the brakes to ensure the economy will remain under control, rather than an attempt to further crunch growth. Over the year ahead we see growth stabilising around the 9.5% level, which will be positive for the continuation of the global recovery and commodity demand.
• After a 16% rise in Chinese shares since late September, they had become overbought and due for a correction. However, with valuations remaining attractive, ongoing evidence that the economy has avoided a hard landing, hot money flooding into the country as China tries to limit Renminbi appreciation and property measures likely to make shares relatively more attractive, strong gains in Chinese shares are likely over the next six to 12 months.
• In Australia, the Minutes from the Reserve Bank’s last rate setting meeting indicated that the decision to leave rates on hold was a close one with the key drivers being that near term growth was running around trend, soft credit growth, the rise in the $A and continuing risks to the global outlook. However, the clear message remained that more interest rate hikes were likely on the way, with the RBA also noting that it could not wait indefinitely to see whether risks materialised suggesting that the case to raise rates again has already been made. Since the meeting in early October, global economic data has improved a bit, local employment and consumer confidence data have been stronger and the $A is only marginally stronger suggesting that barring an underlying September quarter inflation outcome below the RBA’s 2.5 to 2.75% expectation then a 0.25% rate hike following the November meeting is a good chance.

Major global economic releases and implications

• US economic data was mixed, again consistent with an economy muddling along at a sub-par 2% pace. On the positive side jobless claims fell, a leading index rose, a survey of home builders improved in October and housing starts rose slightly. Against this, the Philadelphia Fed manufacturing survey improved only marginally, new mortgage applications fell, permits to build new homes fell and industrial production fell 0.2% in September. Meanwhile the Fed’s Beige Book of anecdotal evidence removed references to a deceleration as had been evident in previous months but indicated continued growth, albeit at a modest pace.
• The earnings news out of the US remained positive with so far 79% of results exceeding expectations including those from Boeing, Yahoo, Goldman Sachs, EBay and McDonalds.
• European business conditions fell in October with a slight improvement in manufacturing conditions being offset by a fall in the services sector. Conditions remain consistent with growth but momentum is clearly slowing and the rebound in the euro combined with fiscal tightening is likely to lead to a further softening ahead ultimately setting the scene for renewed easing from the European Central Bank. Disruptions associated with protests against government cutbacks, as seen in France over the last week, won’t help.
• In the UK, the Conservative-led coalition provided more detail of drastic spending cuts over the next four years, which are projected to take the budget deficit down from 10.1% of GDP this year to 2.1% in the 2014-15 fiscal year. Meanwhile protests against an increase in the pension age to 62 continued in France.

Australian economic releases and implications

• Australian economic data was mixed. While motor vehicle sales rose in September skilled vacancies fell in October and the Westpac leading index fell slightly in August. Meanwhile, the terms of trade saw another big surge in the September quarter with import prices rising just 0.7%, but export prices surging another 7.8% leaving them up 27.7% over the last year. This will take the terms of trade to a new 49 year high. The continuing surge in Australia’s terms of trade is providing a huge boost to national income, employment and investment which will require further interest rate increases if it is not to spill over into higher inflation and underlines the RBA’s observation that it cannot wait indefinitely to resume raising interest rates.

Major market moves

• Global share markets were mixed in volatile trading, rising in the US and Europe, flat in Asia but weaker in Japan and Australia. In the US, stocks were buoyed by better than expected earnings results but gains were limited as the mortgage foreclosure debacle in the US continued to weigh on bank stocks. Australian and Asian shares were adversely affected by the Chinese tightening which weighed on resources stocks.
• Commodity prices generally fell in response to worries that the Chinese tightening will weigh on commodity demand and as the $US bounced from oversold levels.
• After very strong gains taking it briefly up to parity against the $US at the end of the previous week, the Australian dollar fell back as the Chinese tightening triggered profit taking and lower commodity prices, the RBA cited the strong $A as a reason not to tighten earlier this month and as the $US bounced higher.

What to watch in the week ahead?

• In the US, data for home sales are likely show a small bounce but house price data, which lags, is likely to soften. Durable goods orders are likely to show reasonable gains confirming that the corporate sector remains a source of strength in the US. US September quarter GDP growth is likely to come in around 2.2% annualised, ie no double dip but not strong enough to bring unemployment down. Data for consumer confidence and business surveys from the Texas, Richmond and Chicago Fed regions will also be released. A speech by Fed Chairman Bernanke will also be watched closely for clues regarding quantitative easing.The US profit reporting season will also continue.
• Australian September quarter inflation data will be watched closely as a guide to what the RBA might do on interest rates next month. We expect headline inflation to rise 0.7% quarter on quarter or 2.8% year on year and underlying inflation to rise by 0.6% quarter on quarter and 2.6% year on year. Expect sharp rises in prices for alcohol, tobacco and utilities to be partly offset by falls in petrol prices, health and clothing and footwear. Comments from retailers indicate that price discounting is likely to have remained a key dampener on inflation. However, unless the underlying inflation rate is below the RBA’s expectation of 2.5% to 2.75% its unlikely to have a big impact on the RBA’s next interest rate decision.
• Australian credit data will likely have remained soft in September and a speech by RBA Governor Glenn Stevens will also be watched closely.

Outlook for markets

• Shares are vulnerable to more corrective activity in the short term as the gains from late August are digested and with US quantitative easing now largely factored in. However, further decent gains are likely into year end and through 2011. Share markets have been tracing out a rising trend since the lows in early July, which points to a resumption of the cyclical bull market which started in March last year. More fundamentally, shares are very cheap relative to government bonds, investors are still wary which is positive from a contrarian perspective and the surge in global liquidity on the back of the latest round of quantitative easing getting underway in the US and elsewhere should provide a positive boost for shares.
• The Australian dollar is vulnerable to a further correction in the short-term – particularly with speculative positions and investor sentiment towards it now high. However, a further rise above parity against the $US is likely in the months ahead as commodity prices remain strong, the $US remains under pressure and Australian interest rates continue to rise well above global rates.
• 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. However, medium-term returns are likely to be poor, reflecting low yields and excessive public debt levels in many developed countries.

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