The big development of the past week has been Japan taking another huge step down the path of reflation with the Bank of Japan under the new dovish leadership of Governor Kuroda more than delivering on expectations for more aggressive monetary easing.
- The BoJ doubled monthly asset purchases which will double the monetary base (cash and bank reserves) by the end of next year in order to achieve 2 percent inflation in two years time. To put this in perspective the BoJ will be purchasing $US75bn a month of bonds, ETFs and REITs which adjusting for the size of the Japanese economy is equivalent to the Fed doing $US225bn a month in quantitative easing.
- In other words its far more aggressive than US QE3, which amounts to $US85bn a month. The new found vigour with which Japan is seeking to shake off more than a decade of deflation is comparable to the battle against high inflation kicked off by the US Fed in the early 1980s under Paul Volcker. While many will debate whether it will be successful, Japan is doing all the right things: boosting the money supply in an aggressive high profile way and encouraging companies to raise wages to help boost inflationary expectations.
- Reflecting this, the Yen resumed its downtrend and Japanese shares rebounded taking the Nikkei briefly above 13000 for the first time since 2008. We remain of the view that by year end the Yen will have fallen to 105 against the $US and 110 against the $A and that Japanese shares will see further very strong gains this year. I was looking for the Nikkei to rise 30% this year but that now looks too conservative and the gain could end up being closer to 40%, of which it has so far done 23%.
- The BoJ’s monetary reflation is very positive for Japan in that deflation has been a key drag on Japanese growth for the last 15 years and its also positive for the global economy as Japan is still the world’s third biggest economy and its monetary easing will encourage other countries, notably key competitors such as Korea and Taiwan, to ease monetary policy more as well.
- For Australia, while the rise in the $A versus the Yen is a negative for inbound tourism from Japan, its unlikely to have much impact on Australian manufacturers as they don’t export much to Japan or on resource exports which in fact are likely to benefit as Japanese economic growth picks up. Quite clearly Australian consumers could be big winners with the 20% plus gain in the $A seen over the last six months likely to lead to lower prices for Japanese imports of things like cars and electronic goods and lower prices for Japanese holidays. This in turn will further help ensure that Australia’s inflation rate remains benign.
- Much less positively in the Asian region has been the sabre rattling from North Korea. Hopefully this just settles down in the weeks ahead as we have seen in the past, but with a new North Korean leader and the US possibly less willing to respond with aid than it has been in the past the risks are arguably a bit higher now so it’s worth keeping an eye on. Bird flu is also appearing again in China, but with a potentially more dangerous strain.
Major global economic events and implications
- US economic news was mixed with falls in the ISM business conditions indexes in March and much softer than expected jobs data, but against this a rise in the Markit manufacturing conditions PMI (which has the advantage of a bigger survey than the ISM index), a pick up in construction spending, another rise in weekly mortgage applications and a pick up in weekly retail sales data. The weaker than expected 88,000 gain in US payrolls in March, means that a tapering or ending of quantitative easing is unlikely any time soon.
- German factory orders rose more than expected in February, but Eurozone final business conditions PMIs for March remained weak and retail sales fell 0.3%. What’s more Eurozone unemployment reached a record high of 12%, with a range of 4.8% in Austria to 26.3% in Spain and 26.4% in Greece. Against this backdrop it was disappointing to see the ECB leave monetary policy unchanged, although it “stands ready to act”.
- In Japan, the Tankan survey showed an improvement in business conditions between the December and March quarters albeit by less than had been expected. This contrasts with a manufacturing conditions PMI which rose solidly in March, which being more timely is probably a better guide to how the Japanese economy is faring.
- Chinese manufacturing and non-manufacturing conditions PMIs rose in March supporting the view that the softer readings for some indicators seen in February owed more to Lunar New Year holiday distortions than anything more fundamental. They are consistent with March quarter growth remaining steady at around 8%. House prices rose further in March with property tightening measures yet to impact.
- While North Korean sabre rattling continues to pose a threat, Korean exports are showing a positive trend and inflation remains benign.
Australian economic events and implications
- In Australia, there were no surprises from the Reserve Bank which left interest rates on hold yet again in the face of a number of indications that rate cuts are working but noting that the benign inflation outlook provides scope to ease again if needed. Economic data provided more signs that rate cuts are working with retail sales up strongly for a second month in a row in February, building approvals picking up, house prices continuing to rise solidly in March and services sector conditions improving for the third month in a row.
- To be sure not all indicators are picking up, eg, manufacturing conditions fell in March and new home sales fell in February after four months of gains. But mixed indicators are common at turning points in the interest rate cycle and right now the evidence is suggesting that we are either at or very close to the bottom for rates.
Major market moves
- Shares were mostly down over the past week. US shares fell 1% and European shares fell 1.5% on mixed economic data and the failure of the ECB to ease further. Chinese shares fell another 0.6% and Australian shares fell 1.5% with resources stocks remaining under pressure. However, Japanese shares surged after the BoJ announced more aggressive monetary easing, ending the week 3.5% higher.
- Commodity prices fell on growth worries, and this also weighed on the $A against the $US. However, the plunge in the Yen saw the $A surge above 100 Yen for the first time since before the GFC.
- Bond yields fell sharply on safe haven demand, but with Italian and Spanish yields also down sharply.
What to watch over the next week?
- In the US, the minutes of the Fed’s last meeting (Wednesday) are likely to highlight further discussion regarding the benefits and costs of quantitative easing, but with the benefits still seen as dominating. At this stage though its hard to see any reduction in the size of monthly asset purchases anytime soon.
- On the data front, expect retail sales growth (Friday) to have slowed to just 0.1% after the surprisingly strong gain of 1.1% in February, but highlighting a solid gain through the March quarter as a whole. Producer price data is likely to show that inflationary pressures remain benign, while consumer sentiment is likely to have increased (both due Friday). The US March quarter profit reporting season will also start to get underway with Alcoa reporting Monday.
- Chinese March economic data will start to flow with inflation (Tuesday) expected to fall back to 2.5% from 3.2% in February reflecting a fall back in food prices, exports likely to slow after a surge in February but imports likely to return to growth (Wednesday) and bank lending expected to pick up after slowing in February.
- Against a back drop of benign inflation and constrained growth, the Bank of Korea is expected to cut its official interest rate by another 0.25% on Thursday.
- In Australia, business confidence and conditions in the NAB survey (Tuesday) are expected to resume their rising trend after falling in February, consumer confidence (Wednesday) is expected to have held on to recent gains but employment (Thursday) is likely to reverse some of the unbelievably strong 71,500 surge seen in February with a 5,000 fall with unemployment remaining unchanged at 5.4%.
Outlook for markets
- Shares remain vulnerable to a further correction in the short term as overbought conditions are worked off. Technical indicators for US shares, including declining breadth during the recent run to record highs and gains being led by defensive stocks, also warn of a further correction.
- Possible triggers for further weakness include North Korean tensions, political uncertainty in Italy and maybe even bird flu. However, any further set back in shares is likely to remain mild and the broad trend is likely to remain up. Equity valuations remain reasonable, the strengthening growth outlook led by the US 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, such as the one we are going through now, this all adds up to a positive backdrop for share markets.
- Notwithstanding some short term support as equities correct, sovereign bonds are 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 Japan is a positive. The likely outcome is for a $US0.95 to $US1.10 range.