Headline developments
- In a move that had been anticipated for some time, China raised one year lending and deposit rates by 0.25% as part of an ongoing effort to keep inflation expectations in check. Further tightening is likely over the next six months. The Chinese Government is also reportedly targeting 8% growth this year and 4% inflation. The 8% growth target is best seen as a minimum because this has been the target for several years now but for the last seven years growth has always come in above it. Moreover, the increase in the inflation target to 4% from a 3% target last year suggests that the Government will be flexible in giving inflation time to fall back. Overall, we remain of the view that tightening will not become aggressive as most of the rise in inflation has been due to weather related increases in food prices, China will likely continue to heavily rely on administrative measures to control lending and inflation and a fall in China’s manufacturing conditions index or PMI in December suggests that the economy is not overheating but rather growing at a sustainable pace around 9.5%. As such, and with interest rates remaining low for a country with 12% or so nominal GDP growth, we remain of the view that Chinese economic growth will remain solid this year at around 9.5%.
- In Australia, the main story has been the flooding that has wreaked havoc in much of Queensland. Coming on the back of recent floods in NSW and Victoria this will have a significant economic impact, which we estimate to be around a 0.5% detraction from GDP (or about $6bn) spread over the December and March quarters. Disruption to Queensland coal exports will be the big driver, along with reduced agricultural production (both volumes and yield quality) and the disruption to industries such as tourism, retailing and transport. Inflation is also likely to see a short term boost in the March quarter (possibly of the order of +0.5%) mainly due to higher prices for fruit and vegetables and cereals and bread. Fruit and vegetable prices are likely to spike by 10 to 20%.
- However, while not to detract from the human suffering the floods have wreaked, there is a danger in exaggerating the economic impact (made easier by constant images of flooding on TV covering an area close to the size of France and Germany combined). The 0.5% GDP detraction is likely to be temporary with production likely to rebound sharply in the mining sector in the June quarter and in agriculture through the second half of the year. The cleanup and rebuilding (estimated to cost at least $5bn) will provide a boost to growth over time. Higher prices for coal and some soft commodities will provide an offsetting boost to national income. And to the extent that the floods underline the ending of the drought and a La Nina weather pattern they should usher in better growing conditions for farmers in the years ahead. So while the floods will likely lengthen the soft patch in Australian economic growth and further delay the next RBA tightening, possibly to May or June, they are unlikely to have a significant impact on growth this year as a whole, which we expect to be around 3.5% over the year to the December quarter. At this stage, we still see the cash rate rising to 5.5% by year end.
Major global economic releases and implications
- US economic data over the last two weeks has remained consistent with an acceleration in growth after the mid 2010 soft patch. Labour market reports have been strong, the ISM business conditions indicators rose in December, construction spending and vehicle sales rose solidly in November, holiday retail sales look to have been solid despite a slight fall in consumer confidence and while house prices fell in October a continuing recovery in pending home sales suggests that the housing sector has found a floor.
- Despite ongoing weakness in peripheral countries the recovery in Europe remains on track with gains in manufacturing indicators and broader economic sentiment in December and another very strong rise in German factory orders in November. Euro-zone retail sales remain soft though.
- Japanese economic data over the last two weeks has generally been consistent with continued recovery, with an improvement in industrial production, retail sales, housing starts, the ratio of jobs to applicants and manufacturing conditions. Consumer price deflation continued in November though, so don’t expect Bank of Japan tightening any time soon.
- The Asian growth story remains strong with a strong readings for GDP growth in Singapore (+12.5% through 2010) and exports in Korea, but inflation continued to creep higher in December in Korea, Indonesia and Thailand. At this stage it is mainly due to higher food prices but it nevertheless points to the need for higher interest rates across Asia.
Australian economic releases and implications
- Australian economic data over the last couple of weeks was generally soft with weak new home sales, a slight fall in house prices, a fall in building approvals and continuing soft growth in private sector credit. Meanwhile, commodity prices continued to surge higher in December according to the RBA’s commodity price index highlighting the ongoing boost to national income from higher export prices.
Major market moves
- Global shares have started the year on a positive note buoyed by solid economic data and increasing confidence in the sustainability of the global recovery. However, the Australian share market has been weighed down by worries about the economic impact of the floods and associated earnings downgrades.
- Commodity prices have fallen back a touch over the last week due to profit taking after huge gains in December and as the US dollar has strengthened in response to stronger US economic data.
- After ending 2010 on a 28 year high of $US1.023, the Australian dollar has slipped back below parity as the $US has strengthened and on concerns about the impact of the floods on export earnings.
- Government bond yields have generally pushed higher over the last week on the back of solid global data. Bond yields in debt troubled European countries also remain under upwards pressure in response to worries about increased bond issuance in the months ahead.
What to watch in the week ahead?
- In the US, data for December retail sales (due Friday) are likely to show reasonable growth and data for consumer sentiment and industrial production are likely to show gains. While higher gasoline prices will likely boost headline inflation (also due Friday), core inflation is likely to remain benign. The Bank of England and European Central bank are likely to leave monetary conditions unchanged.
- In Australia, retail sales for November (due Monday) are likely to rise 0.5% but this will only partially retrace the sharp 1.1% fall seen in October leaving retailers still out in the cold. Employment data (Thursday) are likely to show another 20,000 new jobs in December pushing unemployment down to 5.1%. Data for the trade balance (Tuesday), housing finance (Wednesday) and job vacancies (Wednesday) are also due for release.
Outlook for markets
- Having had strong gains through December and more broadly since August, shares are at risk of a short term correction, particularly with many technical indicators showing shares to be overbought and short term measures of investor sentiment being very high.
- However, notwithstanding the risk of a short term correction, shares are likely to put in good gains through 2011 as a whole. Shares are cheap, the run of better than expected global economic data is continuing suggesting that 2011 is on track for strong economic growth which should in turn drive another year of solid profit growth, the global liquidity backdrop is highly favourable underpinned by very low interest rates in key countries & quantitative easing 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. By end 2011 we see the Australian ASX 200 index rising to 5500, once it shrugs off the current malaise which appears to reflect a combination of worries about the floods and Chinese tightening.
- Like shares, the Australian dollar also started the year at risk of a short term correction after some strong gains. However, the broad trend is likely to remain up as the $US and the euro remain under downwards pressure, interest rates in Australia remain relatively high and high commodity prices keep the terms of trade near early 1950s highs. By year end the $A is likely to have reached $US1.10.
- While low inflation, US Fed government bond purchases and the absence of any near term monetary tightening should help keep bond yields in key advanced countries reasonably controlled in the short term, the risk of a sharp back up in global bond yields at some point is very high. Bond yields in key advanced countries are still well below longer term sustainable levels and the record inflows into bond funds seen in recent years are at risk of becoming record outflows. Fortunately, bond yields in Australia are more in line with long term sustainable levels so the risk of a back up in yields and sharp capital losses for investors in Australian bonds is less than is the case for global bonds.
Headline developments
· In a move that had been anticipated for some time, China raised one year lending and deposit rates by 0.25% as part of an ongoing effort to keep inflation expectations in check. Further tightening is likely over the next six months. The Chinese Government is also reportedly targeting 8% growth this year and 4% inflation. The 8% growth target is best seen as a minimum because this has been the target for several years now but for the last seven years growth has always come in above it. Moreover, the increase in the inflation target to 4% from a 3% target last year suggests that the Government will be flexible in giving inflation time to fall back. Overall, we remain of the view that tightening will not become aggressive as most of the rise in inflation has been due to weather related increases in food prices, China will likely continue to heavily rely on administrative measures to control lending and inflation and a fall in China’s manufacturing conditions index or PMI in December suggests that the economy is not overheating but rather growing at a sustainable pace around 9.5%. As such, and with interest rates remaining low for a country with 12% or so nominal GDP growth, we remain of the view that Chinese economic growth will remain solid this year at around 9.5%.
· In Australia, the main story has been the flooding that has wreaked havoc in much of Queensland. Coming on the back of recent floods in NSW and Victoria this will have a significant economic impact, which we estimate to be around a 0.5% detraction from GDP (or about $6bn) spread over the December and March quarters. Disruption to Queensland coal exports will be the big driver, along with reduced agricultural production (both volumes and yield quality) and the disruption to industries such as tourism, retailing and transport. Inflation is also likely to see a short term boost in the March quarter (possibly of the order of +0.5%) mainly due to higher prices for fruit and vegetables and cereals and bread. Fruit and vegetable prices are likely to spike by 10 to 20%.
· However, while not to detract from the human suffering the floods have wreaked, there is a danger in exaggerating the economic impact (made easier by constant images of flooding on TV covering an area close to the size of France and Germany combined). The 0.5% GDP detraction is likely to be temporary with production likely to rebound sharply in the mining sector in the June quarter and in agriculture through the second half of the year. The cleanup and rebuilding (estimated to cost at least $5bn) will provide a boost to growth over time. Higher prices for coal and some soft commodities will provide an offsetting boost to national income. And to the extent that the floods underline the ending of the drought and a La Nina weather pattern they should usher in better growing conditions for farmers in the years ahead. So while the floods will likely lengthen the soft patch in Australian economic growth and further delay the next RBA tightening, possibly to May or June, they are unlikely to have a significant impact on growth this year as a whole, which we expect to be around 3.5% over the year to the December quarter. At this stage, we still see the cash rate rising to 5.5% by year end.
Major global economic releases and implications
· US economic data over the last two weeks has remained consistent with an acceleration in growth after the mid 2010 soft patch. Labour market reports have been strong, the ISM business conditions indicators rose in December, construction spending and vehicle sales rose solidly in November, holiday retail sales look to have been solid despite a slight fall in consumer confidence and while house prices fell in October a continuing recovery in pending home sales suggests that the housing sector has found a floor.
· Despite ongoing weakness in peripheral countries the recovery in Europe remains on track with gains in manufacturing indicators and broader economic sentiment in December and another very strong rise in German factory orders in November. Euro-zone retail sales remain soft though.
· Japanese economic data over the last two weeks has generally been consistent with continued recovery, with an improvement in industrial production, retail sales, housing starts, the ratio of jobs to applicants and manufacturing conditions. Consumer price deflation continued in November though, so don’t expect Bank of Japan tightening any time soon.
· The Asian growth story remains strong with a strong readings for GDP growth in Singapore (+12.5% through 2010) and exports in Korea, but inflation continued to creep higher in December in Korea, Indonesia and Thailand. At this stage it is mainly due to higher food prices but it nevertheless points to the need for higher interest rates across Asia.
Australian economic releases and implications
· Australian economic data over the last couple of weeks was generally soft with weak new home sales, a slight fall in house prices, a fall in building approvals and continuing soft growth in private sector credit. Meanwhile, commodity prices continued to surge higher in December according to the RBA’s commodity price index highlighting the ongoing boost to national income from higher export prices.
Major market moves
· Global shares have started the year on a positive note buoyed by solid economic data and increasing confidence in the sustainability of the global recovery. However, the Australian share market has been weighed down by worries about the economic impact of the floods and associated earnings downgrades.
· Commodity prices have fallen back a touch over the last week due to profit taking after huge gains in December and as the US dollar has strengthened in response to stronger US economic data.
· After ending 2010 on a 28 year high of $US1.023, the Australian dollar has slipped back below parity as the $US has strengthened and on concerns about the impact of the floods on export earnings.
· Government bond yields have generally pushed higher over the last week on the back of solid global data. Bond yields in debt troubled European countries also remain under upwards pressure in response to worries about increased bond issuance in the months ahead.
What to watch in the week ahead?
· In the US, data for December retail sales (due Friday) are likely to show reasonable growth and data for consumer sentiment and industrial production are likely to show gains. While higher gasoline prices will likely boost headline inflation (also due Friday), core inflation is likely to remain benign. The Bank of England and European Central bank are likely to leave monetary conditions unchanged.
· In Australia, retail sales for November (due Monday) are likely to rise 0.5% but this will only partially retrace the sharp 1.1% fall seen in October leaving retailers still out in the cold. Employment data (Thursday) are likely to show another 20,000 new jobs in December pushing unemployment down to 5.1%. Data for the trade balance (Tuesday), housing finance (Wednesday) and job vacancies (Wednesday) are also due for release.
Outlook for markets
· Having had strong gains through December and more broadly since August, shares are at risk of a short term correction, particularly with many technical indicators showing shares to be overbought and short term measures of investor sentiment being very high.
· However, notwithstanding the risk of a short term correction, shares are likely to put in good gains through 2011 as a whole. Shares are cheap, the run of better than expected global economic data is continuing suggesting that 2011 is on track for strong economic growth which should in turn drive another year of solid profit growth, the global liquidity backdrop is highly favourable underpinned by very low interest rates in key countries & quantitative easing 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. By end 2011 we see the Australian ASX 200 index rising to 5500, once it shrugs off the current malaise which appears to reflect a combination of worries about the floods and Chinese tightening.
· Like shares, the Australian dollar also started the year at risk of a short term correction after some strong gains. However, the broad trend is likely to remain up as the $US and the euro remain under downwards pressure, interest rates in Australia remain relatively high and high commodity prices keep the terms of trade near early 1950s highs. By year end the $A is likely to have reached $US1.10.
· While low inflation, US Fed government bond purchases and the absence of any near term monetary tightening should help keep bond yields in key advanced countries reasonably controlled in the short term, the risk of a sharp back up in global bond yields at some point is very high. Bond yields in key advanced countries are still well below longer term sustainable levels and the record inflows into bond funds seen in recent years are at risk of becoming record outflows. Fortunately, bond yields in Australia are more in line with long term sustainable levels so the risk of a back up in yields and sharp capital losses for investors in Australian bonds is less than is the case for global bonds.
