The past week has seen a swing to “risk off” with shares, commodities and growth currencies like the $A all weak on worries about Spain capped off by a disappointing jobs report in the US. After a strong March quarter some sort of consolidation or correction is inevitable and so this may be what we are starting to see.
- The focus in Europe is shifting to Spain which faces an extremely difficult balancing act in implementing more austerity to reduce its budget deficit but not so aggressively that the recession deepens only worsening the deficit. Spain’s public debt at just over 70% of GDP is way below the 120% plus of Greece, but its heading in the wrong direction and its banks are at risk should the economic downturn intensify. These concerns were reflected in a poor bond auction which saw Spanish 10 year bond yields pushed above 5.7% for the first time since January, which in turn has pushed bond yields higher in Italy & France. This will need to be watched closely.
- The minutes from the Fed’s last meeting signalled there was no need for more easing unless growth slowed again and certainly didn’t help investor sentiment. However, the minutes are heavily dated given numerous comments by Fed Chairman Bernanke in the period since the meeting that the US recovery remains fragile with the implication that easy policy will have to remain in place and that further quantitative easing is still possible, particularly with less than expected jobs growth in March appearing to vindicate Bernanke’s concerns.
- A week ago I thought an RBA rate cut was “quite likely” at its April meeting. But no such luck, with the RBA leaving rates on hold. The case to cut interest rates is overwhelming: GDP growth is running well below trend; key sectors of the economy such as retailing, construction, manufacturing, tourism & the financial sector are depressed with the mining boom providing an insufficient offset; the labour market is weakening; fiscal drag equal to around 2.5% of GDP is about to hit the economy; and wages growth and inflation are benign. And now even the trade boost to the economy is showing signs of softening. However, the RBA has at least moved to a strong easing bias in acknowledging output growth is below forecast and below trend but decided to put off a cut until it gets a look at the March inflation data. We think it will be benign and clear the way for a May cut.
- However, the RBA should have cut in February and the delay is needlessly threatening the economy. Having admitted growth is weaker than expected it would have made more sense to get a cut out of the way rather than make it contingent on a CPI statistic that could temporarily surprise on the upside resulting in a further delay.
Major global economic releases and implications
- US economic news was mixed, with solid ISM manufacturing and services conditions indexes, a strong rise in weekly retail sales, another rise in mortgage applications and a further fall in jobless claims on the one hand but a much softer than expected gain in payroll employment in March (+120,000 versus market expectations for a 205,000 gain) and disappointing readings for auto sales and construction. While the March payroll report was soft, our take is that it doesn’t signal a sudden downturn in the US economy. Good weather likely pulled some employment forward into previous months and falling jobless claims and rising employment plans in the ISM surveys point to decent ongoing employment gains ahead. So it looks like more noise than signal.
- Japanese data was also positive with mostly stronger readings in the Tankan survey and stronger auto sales.
- European news was mixed following the decision of finance ministers to cap new bailout lending to €500bn, rather than increase it to €740bn as had been flagged. While the funding will be available earlier than previously indicated and €500bn should be enough to cover any further assistance to Portugal and Spain’s funding needs over the next two and half years, it wouldn’t cover Italy’s requirements. The smaller than hoped for amount has made it less clear how much G20 nations will be prepared to contribute via the IMF. On the data front March Euro-zone manufacturing PMIs were unchanged from earlier estimates, but services PMIs were revised up slightly. Both are consistent with a mild recession. The bad news though was that Euro-zone retail sales and German factory orders were both weak and the unemployment rose further to 10.8%. In Italy it is at a record high with around one third of youth unemployed. As expected the ECB left interest rates on hold and President Draghi made it clear that any talk of exit from easy monetary policies is premature.
- The news out of China also remains mixed, but consistent with a soft landing. Official PMIs rose in March and while the HSBC PMI fell it was above the flash estimate and in any case all are at levels consistent with 8%. Meanwhile, average residential property prices fell for the seventh month in a row. While concerns about a hard landing remain, comments by Premier Wen Jiabao have struck a dovish tone and suggest further monetary easing is imminent. Finally, China announced a further opening of its domestic asset markets to foreign investors. Given the experience of the last few years I can’t see a huge rush in, but it is good news longer term.
- India saw its manufacturing PMI fall sightly in March but remain solid.
Australian economic releases and implications
- Australian economic data remained disappointingly weak with a sharp fall in building approvals, flat house prices, soft retail sales, weak readings for business conditions in the manufacturing and services sectors and another surprise trade deficit in February. The trade turnaround from last year’s surpluses to deficits so far this year is concerning. While it appears to be at least partly driven by temporary disruptions at the very least it looks like trade will be a significant detractor from March quarter GDP growth, which coming on the back of poor readings for housing construction and retail sales points to yet another quarter of below trend growth.
Major market moves
- Global shares fell and bonds rallied on worries about a renewed intensification of the Euro-zone crisis and a poor jobs report in the US. Global weakness & the lack of an RBA rate cut also weighed on Australian shares.
- Global growth worries and a stronger $US also weighed on commodity prices. Weak commodity prices and soft Australian economic data for retail sales, housing and trade saw the $A pushed back below $US1.03.
What to watch over the week ahead?
- Chinese economic data releases for March will likely be the key focus of the week ahead. We expect inflation (Monday) to have remained around 3.2% after a sharp fall in February, growth in exports and imports (Tuesday) to remain soft, March quarter GDP growth (Friday) to have slowed to 8.5%, but March data for money supply and loan growth (Wednesday), industrial production, retail sales and investment (all due Friday) to have accelerated. Overall expect the data to point to a soft landing but with plenty of scope to ease policy if need be.
- In the US, expect headline inflation (Friday) to have been boosted by gains in gasoline prices but core inflation to have remained benign. The Fed’s Beige book of anecdotal evidence will also be released Wednesday.
- In Australia expect more soft readings for business confidence (Tuesday) and consumer confidence (Wednesday), a 1% fall in housing finance (Wednesday) and a further 10,000 fall in employment (Thursday) pushing unemployment up to 5.3%, from 5.2% in February.
Outlook for markets
- While I don’t see a re-run of the last two years where shares peaked around April only to fall 15 to 20%, it does seem that the ride ahead will become a bit rougher. After strong rises in the March quarter, the easy gains are likely behind us: Europe is still a potential source of mishaps given upcoming elections in Greece and France, budget problems in Spain, austerity fatigue and rece sion; next year’s fiscal drag equal to 3.5% of GDP in the US may worry investors as could a soft patch in economic data after the strong patch of late; and China hard landing fears remain.
- However, any correction should be mild – say 5 to 10% rather than 15 to 20% – and we still see share markets higher by year end. Shares are cheaper than was the case a year ago – particularly against very low bond yields, the risk of a Euro-zone banking meltdown has faded, momentum in global economic indicators is more positive, global monetary conditions are getting easier and there is lots of cash on the sidelines. Chinese and emerging country share markets should pick up as China starts to more aggressively ease economic policy.
- If the RBA continues to hold fast on interest rates and hard landing fears remain in China Australian shares will likely to remain a laggard. However, a rate cut from the RBA and another easing in China could change this.
- Low bond yields in major countries suggest low returns unless Europe’s debt crisis intensifies. Don’t expect a bond yield melt up though, as higher inflation and US monetary tightening are still a long way off.
- The current correction in the $A may have further to go reflecting soft data in Australia and worries about China. However, the $A is likely to remain strong overall as the continuing global recovery supports commodity prices and as Australian interest rates remain above US rates.