President Obama’s win in the US Presidential election, with Democrats retaining the Senate and the Republicans retaining the House means more of the same in terms of divided US government.
- Attention has now turned to the need to scale back the fiscal cliff by year end, the need to raise the debt ceiling by March and the need to come up with a long term plan to get America’s budget under control in order to avoid more ratings downgrades. It’s well known that the fiscal cliff package of tax hikes and spending cuts equal to 4.3% of GDP that will kick in on January 1 under current law will likely knock the US economy into recession if it’s not reduced to a more manageable amount. Negotiations are likely to be difficult. Fortunately, the Republican House leadership has signalled some willingness to compromise on raising tax revenue if government spending is also cut, which is not inconsistent with President Obama’s requirement for a balanced approach. It’s also worth noting that this is Obama’s last term, so he might be inclined to compromise, perhaps around his $250,000 threshold for the continuation of the Bush tax cuts. He would probably also prefer to leave a legacy of having avoided another recession while at the same time putting in a place a plan to bring America’s budget under control, rather than the alternative of extended trench warfare with the Republicans, recession and more ratings downgrades.
- So while there is a high risk of no deal on the fiscal cliff by year end, the most likely outcome is a deal in December to reduce the fiscal cliff to a more manageable 1.5 to 2% of GDP for 2013. This could well come as part of a grand bargain on long term deficit control because it will enable the Republicans to trade off something they don’t want (ie some increase in taxes) for something they want in return (ie savings on entitlements).
- The average gain in US shares from election day to the end of the year when the incumbent party has won has been 1.9% (versus -0.6% when the incumbent party loses), but as the falls post the election over the past week highlight, we likely need more certainty regarding a resolution of the fiscal cliff for this to be seen.
- The Greek Parliament approved more austerity and reform measures, as required by the EU, ECB and IMF. While more austerity won’t be good for the Greek economy, its nothing compared to the austerity that would follow if it stopped receiving funding from the rest of Europe and the IMF. Euro-zone finance ministers are likely to consider the Greek bailout on Monday but a decision may not be made till later in November.
- Data for October adds to confidence that growth in China has bottomed with growth in industrial production (+9.6% year on year), retail sales (+14.5%), investment (+20.7%) and exports (+11.6%) all accelerating relative to growth in September and all better than expected. This is now two months in a row of improving momentum in Chinese growth. At the same time inflation fell more than expected to just 1.7% highlighting plenty of scope for further policy stimulus if needed. Meanwhile President Hu Jintao unveiled a target to double GDP by 2020 which requires GDP growth to average 7% pa, which is consistent with the current five year plan.
- In Australia, the RBA left interest rates on hold citing signs that rate cuts were having a positive impact, slightly higher than expected inflation and slightly better global news. Our assessment is that it was a lost opportunity to provide a further boost to the non-mining parts of the economy – which are still far more subdued than would normally be the case this far into a rate cutting cycle – to ensure that such sectors will be strong enough to take over from the fading mining sector next year. A downwards revision to the RBA’s 2013 growth forecast from around 3% growth to a little below 2.75% along with references to rates being appropriate “for the time being” and to monitoring non-mining demand as the peak in resource investment approaches suggest it retains an easing bias. While a December cut is a close call, we think the RBA will ultimately have to act on its easing bias and cut interest rates further over the next six months in order to boost non-mining activity.
Major global economic releases and implications
- US economic data was mixed with a slight fall in the non-manufacturing ISM index, falls in weekly mortgage applications and retail sales and a fall in job openings. Jobless claims fell but this may reflect the disruption from Hurricane Sandy making it harder for jobless people to file claims, suggesting a spike higher is likely at some point. On the clearly positive side though, consumer sentiment rose in early November despite Hurricane Sandy and the trade deficit was much smaller than expected in September and when combined with stronger data for construction and inventories suggests September quarter GDP growth will be revised from 2% to around 3%.
- European data was soft with a services sector PMI down more than originally reported for October, sharp falls in industrial production and soft growth in Euro zone retail sales. The ECB disappointingly acknowledged the poor economic outlook but failed to provide any new monetary stimulus. It will be forced to in the next few months though. The Bank of England also made no changes to current interest rates or its quantitative easing program.
- Japanese data was soft with weakness in a leading index and falls in economic sentiment and machine orders.
Australian economic releases and implications
- Australian economic data was mixed. Employment surprised on the upside with 11,000 jobs in October and unemployment remaining flat at 5.4%. Against this annual jobs growth is just 0.6% year on year, hours worked are actually down 1.2% over the last year and a continuing slide in ANZ job ads points to soft labour market conditions ahead. While retail sales rose 0.5% in September, retail sales volumes actually fell in the September quarter. The AIG’s services conditions index remained weak. House prices rose in the September quarter but by a less than expected 0.3% and the TD/Melbourne Institute Inflation Gauge pointed to continued benign inflation.
Major market moves
- Global shares fell sharply – down 2.4% in the US and down 2.5% in Europe – as investors fretted about whether the US fiscal cliff will be resolved. Soft economic data, worries about Greece and another storm in New York didn’t help. Australian shares proved to be remarkably resilient though, ending basically flat over the week.
- Reflecting the risk off tone, bonds rallied, except in Spain and Italy, but commodity prices were mixed. It’s also noteworthy that the Australian dollar actually rose with the RBA’s decision to leave rates on hold clearly helping to offset the currency’s normal tendency to go down with global share markets.
What to watch over the week ahead?
- In China, the 18th Communist Party Congress will end around Tuesday with the unveiling of China’s new leadership. No major surprises are expected with Xi Jinping likely to be President and Le Keqiang expected to be Premier. Similarly no major policy changes are likely with the Chinese Government likely to continue on its path of providing only modest stimulus to an economy where growth looks to have bottomed.
- In Europe, the main focus will be on a finance ministers meeting on Monday that will likely see discussion regarding Greece’s aid program, but possibly the delay of any decision till late November. Greece has passed the austerity and reform measures asked of it and there is little stomach for letting Greece go given the threat of contagion with uncertainties still hanging around Spain and Italy. Euro-zone September quarter GDP growth (Thursday) is expected to show a small contraction in GDP of around -0.2%, continuing the mild recession.
- In the US expect a slight fall in October retail sales (Wednesday) after a strong rise in September, not helped by the disruption from Hurricane Sandy at the end of the month. Manufacturing conditions surveys for the New York and Philadelphia regions are expected to show continued modest growth as is industrial production data. Inflation data (Thursday) is expected to remain benign. The minutes from the Fed’s last meeting will be released Wednesday, but its doubtful they will show much that is new.
- Japan’s September quarter GDP (Monday) likely fell 0.9%, signalling the possible start of yet another recession.
- In Australia, expect housing finance (Monday) to show a continued but very gradual uptrend, business conditions and confidence to remain sub par according to the September NAB business survey (Monday) and consumer confidence (Wednesday) to also remain subdued not helped by the RBA’s decision to leave interest rates on hold. Wages data will also be released Wednesday and is likely to show that wages growth remains benign.
Outlook for markets
- Given the US fiscal cliff and unresolved issues in Europe, the rough patch in global shares that began in mid September may have a bit further to run. However, the broad rising trend in shares is likely to remain intact. Right now US shares are on good support sitting around their rising 200 day moving average, which hopefully should hold just as it did back in June. More fundamentally, shares remain cheap, monetary conditions are ultra easy and a pick-up in global growth on the back of easing by the Fed, a likely solution to the US fiscal cliff, the ECB’s bond-buying program and improving momentum in China should support profit growth in 2013. Australian shares are being given an added impetus by lower RBA interest rates which should help boost profit growth in 2013. As a result we see further gains in share markets by year-end and through 2013.
- While sovereign bonds in safe countries are a good diversifier, bond yields are very low and point to low medium-term bond returns. Corporate debt is a better proposition for those after income.
- The outlook for the Australian dollar remains messy. Uncertainties regarding China and RBA rate cuts are negatives. But quantitative easing in the US (QE3), central bank buying and prospects for improved global growth are positives. The likely outcome is for a US$0.95 to US$1.10 range, with the risk on the downside.