Global monetary easing continued over the past week with the Reserve Bank of India cutting banks’ required cash ratios and the Bank of Japan increasing the size of its quantitative easing program and extending it by six months till the end of 2013.
- The Reserve Bank of India’s easing may in part be a response to recent stepped up reform efforts by the Indian Government but it was fairly modest and its failure to cut its official interest rate reflects the constraint imposed by persistently high inflation.
- The Bank of Japan’s move is more significant and highlights the pressure that US QE3 is putting on countries around the world to ease monetary conditions further if they want to prevent their currencies from rising against the $US. Unfortunately, based on recent experience it’s doubtful whether Japan’s QE program will be enough to match the Feds or to meet its 1% inflation goal for this year.
- In terms of the European debt crisis the main outstanding issues at present are Greece and Spain. Spain seems to be hoping that new reforms (possibly to be announced on September 27) and the threat of ECB action will enable it to avoid seeking formal assistance. Our view remains that this is unlikely though, but we could easily go through another bout of short term market nervousness where a rebound in Spanish bond yields then forces it to seek help from the Euro-zone bailout fund and the ECB. However, whether Spain does it proactively or reactively the end result is likely to be the same in triggering ECB bond buying. Reports that it is in talks with the European Commission regarding proposed reforms necessary to obtain assistance are a positive sign.
- Greece has taken a back seat lately, but it still risks hitting the headlines again. The Greek PM is having difficulty reaching agreement with his coalition partners on budget cuts as required by the troika of the EU, ECB and IMF. Ultimately agreement is likely though and in return Europe is likely to grant it more time to meet its commitments because it doesn’t want to take risks with a Greek exit from the Euro-zone. But this may not be resolved for another month or so.
- Tensions between China and Japan have clearly escalated again with disputed islands being the focus this time around. While scary, it’s hard to see the issue going too far as both sides are pragmatic and unlikely to want to risk their trade relationship, eg Japan is China’s third biggest export market. On top of this, uncertainty is continuing to build regarding the Chinese leadership transition ahead of the National Congress in October.
Major global economic releases and implications
- US economic data remained consistent with continued moderate growth. The bright spot remains housing where home builder conditions rose to their highest level in six years and housing starts, permits and home sales are continuing to trend higher all adding to confidence that the housing recovery is continuing to gather steam. Manufacturing conditions surveys were a bit more mixed though – falling slightly for the New York region, but improving slightly in the Philadelphia region. The flash PMI produced by Markit for the US remained at 51.5 indicating that manufacturing conditions remain sub-par but reasonable and a bit better than suggested by the widely followed ISM index. Jobless claims fell but have been stuck in a range all year showing little improvement, which is consistent with why the Fed announced QE3 on an open ended basis.
- In Europe, investment analyst sentiment as measured by the ZEW index picked up substantially in September, but flash business conditions PMIs remained soft with a fall in services conditions offsetting an improvement in manufacturing resulting in a slight fall in the composite PMI taking it to a new cycle low. The overall readings for Euro-zone PMIs are at levels consistent with our expectations for a 1% GDP contraction in the Euro-zone this year, but hopefully should start to pickup by year end to be consistent with our expectation for modest positive growth next year.
- Japanese economic data remained soft with another fall in exports and a weak activity index for July.
- HSBC’s flash Chinese manufacturing PMI was little changed in September indicating that while conditions haven’t deteriorated they haven’t picked up yet either. One positive though was that new orders picked up a bit. Meanwhile average house prices continued to rise in August after a few months of gains, but the gains seem to be losing momentum again which may be a positive sign if it allows the authorities to become a bit more aggressive in providing stimulus for the broader economy.
- The softening in Asian exports continues and was highlighted by a falls in Singaporean and Korean exports.
Australian economic releases and implications
- In Australia, the minutes from the RBA’s last rate setting meeting revealed a significantly more dovish tone than was evident in the statement released straight after the meeting, with significant discussion regarding the risks to global growth, and China in particular, and the risks to the mining boom and a closing observation that the benign inflation outlook provides scope to ease policy if needed. We remain of the view that the RBA will cut the cash rate to 2.75% over the next six months, starting with a 0.25% rate cut next month. The ongoing strength in the $A at a time when the mining boom is loosing momentum and the rest of the economy is weak is only adding to the urgency for more rate cuts.
- It was pretty quite on the data front in Australia. Car sales were strong in August and the Westpac Leading Index continued to point to subdued annual growth.
Major market moves
- After rising almost 5% in response to the ECB’s bond buying plan and QE3 from the Fed over the previous two weeks, global shares took a breather, slipping slightly over the past week on profit taking not helped by soft data in Europe and China and a bit of uncertainty regarding Greece. Chinese shares fell sharply not helped by the dispute with Japan and uncertainty about the leadership transition. Australian shares rose slightly though helped by a rebound in iron ore prices, which boosted miners, and heightened expectations for interest rate cuts following dovish comments from the RBA.
- Just like global share markets, commodity prices slipped with a sharp fall in the oil price on the back of higher US inventories. Softer commodity prices and expectations for RBA rate cuts saw the $A fall back below $US1.05.
- Bond yields fell back in the US, Germany, the UK and Australia and continued to fall in Spain.
What to watch over the week ahead?
- In the US, expect a modest further gain in home prices for July (due Tuesday), a rise in consumer confidence (also Tuesday), further gains in new home sales (Wednesday) and pending home sales (Thursday) but a fall back in headline durable goods orders (also Thursday). Data for personal income and spending and a Chicago regional manufacturing conditions survey will be released Friday.
- In the Euro-zone, September readings for economic confidence are likely to remain subdued consistent with an ongoing “mild” recession.
- Japanese data to be released on Friday is expected to show softness in retail sales and industrial production along with ongoing price deflation.
- In Australia, it will be a quite week on the data front. Expect new home sales (Monday) and private sector credit growth (Friday) to have remained soft. On Tuesday the RBA’s six monthly Financial Stability Review is likely to conclude that the Australian financial system remains in pretty good shape and speeches by RBA officials on Tuesday and Wednesday will be watched closely for any clues on interest rates.
Outlook for markets
- After the strong bounce in shares on the back of recent policy moves by the ECB and Fed, shares are vulnerable to a short term pause or pull back particularly given outstanding issues regarding Spain and Greece and ongoing uncertainty regarding China. However, it’s doubtful that the broad rising trend in shares since early June will be derailed. The ECB’s bond buying program is likely to see the European debt crisis gradually settle down, the Fed is providing a huge shot in the arm for the US economy and global share markets, more decisive policy easing is likely in China once the leadership transition is resolved next month and in Australia the RBA is on track for more interest rate cuts. With shares remaining cheap, particularly against bonds, we see further gains into year end. If there are any set backs in the weeks ahead they should be seen as a good buying opportunity.
- While sovereign bonds in safe countries are a good diversifier, bond yields in major countries remain very low and point to low medium term bond returns as investor confidence returns over time. Corporate debt is a better proposition for those after income but not willing to accept the volatility that comes with shares.
- The short term outlook for the $A is somewhat messy. US QE3, foreign central bank buying and prospects for improved global growth and higher commodity prices into next year are positive. But against this, uncertainties regarding China, soft bulk commodity prices and the likelihood of RBA rate cuts are negatives. The likely outcome is for a volatile range of between $US0.95 to $US1.10.