The past week was somewhat confusing in financial markets.
- US economic data remained surprisingly solid helping to push US shares higher, Japanese shares continued to surge helped by the confirmation of a new more pro stimulus leadership for the Bank of Japan and European shares were helped by a relaxation of fiscal austerity along with Ireland’s successful return to the bond market for funds and a successful Spanish bond auction.
- Against this though Chinese shares continued to fall in response to the mixed economic data released over the previous weekend and as the central bank Governor warned about the need to be vigilant about inflation and this weighed on many Asian shares and resources stocks. A much stronger than expected jobs report also caused a mid week fall in Australian shares on fears that it may mean an early rate hike. But as is often the case in bull markets the fall in Australian shares was short lived as buyers moved in to take advantage of the dip resulting in a 1.75% surge on Friday leaving the market basically unchanged over the last week.
- In terms of China our assessment is that while the risks have swung from a hard landing towards higher inflation, growth is not strong enough to result in a significant inflation threat that justifies a generalised monetary tightening. In fact, the PBOC Governor said that “monetary policy will stay prudent and neutral” this year, suggesting no big change.
- In Australia, the reported 71,000 surge in jobs for February looks way too good to be true. It’s not consistent with the weak trend in job ads and business hiring plans or the anecdotes of job layoffs. The reported 38,000 surge in Victorian jobs does not sit at all well with the slump in final demand in that state reported in the December quarter national accounts. And the unemployment rate which is often a good sign of labour market trends was dead flat at 5.4% contradicting the so-called jobs surge. As such, while the labour market may be stronger than feared, the reported surge in jobs in February doesn’t justify the big turnaround in interest rate expectations seen over the past week. Expect a much softer jobs report for March.
- Japan has taken another big step towards ending deflation with PM Abe’s dovish picks for Governor and deputy Governors confirmed by the Japanese parliament. New Governor Haruhiko Kuroda has committed to do “whatever we can” to end deflation so his appointment clears the way for far more quantitative easing from the Bank of Japan. The Japanese Yen is likely on its way to around ¥105 against the $US and ¥110 against the $A and this should help underpin further strong gains in Japanese shares which are already up 21% year to date.
- European leaders, supported even by German Chancellor Merkel, confirmed that they are prepared to relax budget austerity and allow more time for France, Spain and Portugal to bring down their deficits. This is a big move in the right direction as the aggressive pace of austerity was only making the recession in these countries worse.
Major global economic events and implications
- US economic news remains favourable with stronger than expected retail sales in February suggesting that consumer spending is holding up well despite tax hikes for high income earners and higher payroll tax, a strong rise in industrial production in February, a continuing fall in jobless claims, a rise in small business optimism in February, improved CFO and CEO optimism for the March quarter and only a slight fall in weekly mortgage applications despite a 15% gain the previous month. Despite earlier fears to the contrary, March quarter GDP growth looks solid with annualised growth of around 2.5 to 3% likely. Meanwhile inflation remains benign.
- There are more positive signs in terms of long term deficit reduction in the US with President Obama reportedly trying to convince Democrats to agree to reform entitlement programs in order to make them sustainable over the long term.
- Japanese economic data remained mixed with gains in business and consumer confidence but a steeper than expected fall in services conditions.
- Indian industrial production surprised on the upside in January, but so too did February inflation readings. Fortunately though core wholesale price inflation continues to fall.
Australian economic events and implications
- Australian economic data painted a mixed picture. Consumer sentiment built on its February surge with strong readings for buying major household items, cars and dwellings. February employment data was strong but unbelievably so. Housing finance data for January was messy with a fall in the number of commitments for owner occupiers but gains in the value of finance commitments for both occupiers and investors. And on the soft side, business confidence and conditions weakened a touch in February. The bottom line is that green shoots of recovery remain, but they are grossly exaggerated by the jobs data. For now rates are on hold, with the risks remaining of one or two more rate cuts in the next six months, with rate hikes still a year away.
Major market moves
- Share markets were mixed. US shares rose 0.6% and European shares rose 0.1% on solid data releases and Japanese shares surged another 2.3% on expectations for more monetary easing but Chinese shares fell 1.7% on growth and inflation worries and this dragged on most Asian share markets. Australian shares were virtually unchanged despite a mid week plunge on China worries and misplaced fears regarding Australian interest rates.
- Commodity prices generally rose helped by stronger US economic data and the Australian dollar was boosted by the strong Australian jobs report.
What to watch over the next week?
- In the US, the Fed is expected to leave monetary policy unchanged (Wednesday) with quantitative easing continuing at the pace of $US85bn a month. We don’t expect any imminent slowing of the QE program, but it may start to be reduced in size through the second half of the year if economic growth continues to improve. Apart from the Fed, the main focus will be on the latest round of housing related data with modest gains expected in a home builders’ index (Monday), housing starts and permits (Tuesday), house prices and existing home sales (Thursday). The flash Markit manufacturing conditions PMI is likely to remain solid and the Philadelphia Fed’s regional manufacturing index is likely to have picked up (both due Thursday).
- In Europe, preliminary March business conditions PMIs (Thursday) will be watched closely for any impact from the Italian election. We expect the broad rising trend to remain in place. In Italy, the President will start the consultation process to determine whether a new Government can be formed or whether fresh elections will be required.
- In China, the HSBC flash manufacturing PMI (Thursday) will be watched closely for any bounce back after February’s fall.
- In Australia, the minutes from the RBA’s last meeting are likely to confirm that it retains an easing bias but that it is in no hurry to act on it thanks to improved global conditions, signs that rate cuts are getting some traction and the stimulatory impact of past rate cuts still in the pipeline. Data for car sales, skilled vacancies and goods imports will also be released. Speeches by various RBA officials will be no doubt be watched closely for guidance as to how the RBA is treating the February spike in employment and what it means for interest rates.
Outlook for markets
- Shares remain vulnerable to a deeper correction than the wobbles seen in recent weeks. However, any set backs in shares are likely to remain mild and the broad trend is likely to remain up. Equity valuations remain reasonable, the strengthening growth outlook points to stronger profits ahead and investors are likely to increasingly switch from low yielding cash and bonds into shares as confidence continues to build ensuring solid “buy on the dips” demand. A pick up in M&A activity from cashed up lowly geared companies is also likely to be a big positive for shares this year. So notwithstanding the usual bumps along the way this all adds up to a positive backdrop for share markets.
- Sovereign bonds are becoming more and more vulnerable as the improving global, and Australian, growth outlook will likely see bond yields move higher over the year ahead resulting in capital losses for investors in them.
- The outlook for the Australian dollar remains messy. Mixed Australian economic data is a negative but quantitative easing in the US and now Japan is a positive. The likely outcome is for a $US0.95 to $US1.10 range.
