Weekly market & economic update – November 19 2010


Headline developments of the past week

  • Worries about Europe’s debt problems and tightening in China were again key issues for investors over the last week, and had the effect of initially pushing share markets down ahead of a reversal later on as some of the fears receded. Europe seems to be moving pretty quickly this time to try and limit the contagion from Ireland to other European countries – in fact, a bailout package for Ireland from the IMF and European Union looks imminent.
  • Concerns about an aggressive tightening in China receded a bit after Chinese authorities announced a range of administrative measures to curb inflation. These involved measures to boost the supply of key foodstuffs, subsidies for low income households, temporary price controls on necessities and a crackdown on speculation. While the merits of price controls can be debated, to the extent that China is relying on targeted administrative measures to control inflation it may help take pressure of blunter less targeted measures such as interest rate hikes. However, Friday’s hike in the banks’ required reserve ratio – the fifth this year – highlighted that macro tightening is still on the agenda. The increase in the reserve ratio is necessary to mop up the increase in the money supply being generated by the current account surplus and the managed exchange rate. We still anticipate a few interest rate hikes and a further increase in the banks’ required reserve ratio going forward, but remain of the view that they will not be aggressive enough to crunch the Chinese economy.

Major global economic releases and implications

  • US economic data over the last week was all over the place. Housing starts, weekly mortgage applications and a survey of home builders were all soft – but at least still seem consistent with housing activity having found some sort of bottom. Industrial production was flat and manufacturing surveys were mixed – weaker in the New York region but much stronger in the Philadelphia region. Clearly positive though were weekly jobless claims essentially sustaining the sharp fall seen in the previous week, a fall in mortgage delinquencies in the September quarter and a better than expected rise in a leading index for October. Producer and consumer price inflation both came in on the soft side. In fact, core consumer prices have now been flat for three months in a row and the annual rate was the lowest level every recorded (with data back to 1957). Quite clearly all of this provides support for the Fed’s commencement of QE2 – mixed economic indicators suggest that growth is still too low for comfort and inflation is verging on deflation. It is now more than 18 months since the Fed started QE1 and yet there is no sign of the hyperinflation that many were predicting when it was first announced.
  • Meanwhile, a forceful defence of the Fed’s latest round of quantitative easing (QE2) by Ben Bernanke provided confidence that the Fed will not be abandoning it, as investors might have been starting to fear given the heavy criticism it has attracted in both the US and globally since first announced.
  • In Japan, the big surprise was a rise in annualised GDP in the September quarter of 3.9% driven mostly by strong consumer spending. However, it is hard to see this pace being sustained as consumer spending falls back and the strong Yen constrains exports.
  • The pressure from rising food prices on inflation was also evident in Korea which raised its short term interest rate for the second time since the GFC to 2.5%. Further rate hikes are likely next year.  Meanwhile, GDP growth remained strong in Taiwan and Singapore in the September quarter with both growing around 10% year on year, underlining the continued strength in Asia.

Australian economic releases and implications

  • In Australia two things stand out from the minutes from the last Reserve Bank Board meeting and a speech by Deputy Governor Ric Battellino. The first is that the RBA does not see any urgency to raise interest rates again: the November move itself was finely balanced; the over and above rate hikes from the banks were probably more than the RBA expected; housing has slowed and consumers remain cautious; and we have seen a renewed intensification of worries about sovereign debt in Europe. However, the second point is that the RBA still retains an inclination to raise interest rates further. This is clearly evident in Ric Battellino’s comments that the challenge going forward will be to manage the economy in a way that contains inflation in the face of the large amount of money likely to flow into the economy in the next few years as a result of the mining boom and that over the medium term inflation is more likely to rise than fall. So putting it all together while we don’t see the next rate hike coming until February at the earliest, in a year’s time the cash rate is likely to have increased to around 5.5%.
  • Over the last week though, Australian economic data provided a messy picture. On the one hand car sales and skilled job vacancies came in on the soft side but on the other wages growth on the RBA’s preferred measure showed further signs of acceleration.

Major market moves

  • Global share markets had a roller coaster week, initially falling sharply before recovering some lost ground as a bailout for Ireland seemed to be nearing, worries about an aggressive tightening in China receded a bit, economic data and profit news came in better than expected, the successful General Motors IPO helped boost confidence and Fed Chairman Bernanke provided a strong commitment to quantitative easing. While Asian and Australian shares fell over the week, US shares were flat and Japanese and European shares actually rose. Japanese shares now seem to be benefitting from the weaker Yen.
  • It was a similarly rough ride for commodity prices and the Australian dollar with initial sharp falls giving way to some recovery as global growth concerns receded a notch.
  • It’s interesting to note that despite the gyrations in growth trades such as share markets over the past week bond yields have moved higher. While this may reflect traders unwinding excessively long positions built up through the mid year growth scare and in anticipation of QE2 it is also consistent with a greater degree of confidence in the global growth outlook.

What to watch in the week ahead?

  • In the US, October home sales data are likely to slip back a notch after strong gains in September, September quarter GDP growth is likely to be revised up slightly from the 2% annualised pace initially reported and durable goods orders are likely to have remained solid in October. The minutes from the last Fed meeting may also shed some more light on the thinking behind the Fed’s adoption of another round of quantitative easing.
  • Various European business conditions surveys for November will be watched to see how well Europe is holding up.
  • In Australia, data on construction spending and business investment will help firm up estimates for September quarter GDP growth to be released on 1st December. Capex spending is likely to show a decent rebound after a fall in the June quarter and capex plans are likely to remain strong. Meanwhile, RBA Governor Glenn Stevens’ testimony before a Parliamentary committee on Friday will be watched closely for more clues regarding the interest rate outlook.

Outlook for markets

  • After strong gains since late August, shares were vulnerable to a correction, which we have certainly seen over the last two weeks. While it’s too early to say whether we have seen the bottom or not, we continue to expect solid gains in shares into year end and through next year. Shares are cheap, particularly relative to government bonds, the risk of a double dip back into recession appears to have receded, the global liquidity backdrop is highly favourable underpinned by QE2 in the US and the corporate sector is cashed up which is likely to result in a further pickup in merger and acquisition activity, share buybacks and dividends. In the past week we have seen BHP announce a resumption of share buybacks and Nike increase its dividend payout.
  • Notwithstanding normal bumps along the way, the $A is likely to head higher as the $US and the euro remain under downwards pressure, interest rates in Australia continue to trend up, and commodity prices resume their rising trend. It’s likely that the $A will settle around $US1.10 in the year ahead.
  • Deflation worries, along with 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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