Weekly market & economic update week ending 22 November
25
Nov
2013
From Shane Oliver - AMP chief economist
Key events of the past week and implications
- The past week was dominated yet again by ongoing noise around when the Fed will start to taper its quantitative easing program. While the news that tapering will likely commence in coming months should hardly be new to anyone it still creates a bit of nervousness. This saw most share markets fall and bond yields rise.
- The basic message from the Minutes from the Fed’s last meeting and various Fed officials including Chairman Bernanke is that: the timing of the start to tapering remains dependent on improved confidence regarding the growth outlook; that if economic conditions improve as the Fed expects it could start in coming months (ie Decembers out to March) and that the Fed is working on strengthening its forward guidance to stress that interest rates will remain low for longer to offset the negative impact on bond yields of cutting back bond purchases. While our base case is for tapering to start early in the New Year as opposed to in December, in reality it’s too close to call and if the November payroll report due in two weeks is strong the odds will clearly favour a December taper, particularly if US politicians reach a budget deal by the December 13 deadline.
- While the prospect of tapering will likely continue to cause concern in financial markets we remain of the view that its impact will be less than many fear. First, it will only occur because the Fed is more confident the US recovery is sustainable. Second, tapering is not tightening as it will just mean a gradual reduction in the amount of asset purchases (maybe from $US85bn a month to $US75bn a month initially). Third, the Fed will likely couple the start to tapering with a move to further push out expectations for the first rate hike. Finally, by the time tapering happens it will be factored into most markets unlike when it was first talked about in May.
- While the Fed is debating when to taper it should be noted that the advanced world is set to have easy or even easier monetary policy for a long time. Bernanke has stressed that tapering does not mean interest rates will rise anytime soon. Moreover, both the ECB and Bank of Japan are on alert to provide more monetary stimulus, not less. This provides a reasonably supportive back drop to investment markets.
- Comments in a speech by RBA Governor Stevens that he is open minded on foreign exchange intervention to lower the $A combined with ongoing taper talk in the US helped push it lower. But it doesn’t look like the RBA is even close to undertaking intervention as Steven’s speech extolled the benefits of the free float, he was not sure by how much the $A is overvalued and he pointed out that intervention is not costless. The mere threat of intervention though helps strengthen the jawboning the RBA is trying to use to push the $A lower. My view remains that the broad trend in the $A is down and this will ultimately see it fall back to around $US0.80 in the years ahead.
- The debt ceiling noise continued in Australia but it’s a non-event for investors. Does the Federal Government’s debt ceiling need to be raised? Yes, as the current $300bn ceiling will be reached next month. Will it be raised? Yes, both sides of politics agree on this. Does it matter if it’s raised to $400bn or $500bn? No, as it will take 3 years or so to reach the $400bn level and once that’s reached it will just be raised again anyway.
Major global economic events and implications
- US economic data continues to point to a possible pickup in economic growth. Retail sales were solid in October despite the government shutdown, the Markit manufacturing conditions PMI rose to a solid 54.3 in November led by strong gains in new orders and production, unemployment claims fell sharply and weekly mortgage applications had a nice bounce. The NAHB homebuilder conditions index held at solid levels but is still down from past cyclical highs. Existing home sales fell again in October but this may have been due to delayed processing due to the shutdown. Meanwhile inflation remains benign with headline inflation falling to 1% year on year, which of course gives the Fed plenty of flexibility.
- The composite Eurozone business conditions PMI disappointingly fell slightly in November, due a fall in the services PMI even though the manufacturing PMI rose slightly. The composite is still well up from its lows, but still points to a slow recovery. It highlights the need for more ECB stimulus, which it seems to be considering.
- A weekend split in Silvio Berlusconi’s party in Italy, suggests the Italian Government is likely to remain stable for now. As a result Eurozone risk has fallen another notch.
- In China, the reaction to the detailed Plenum reforms was positive. Meanwhile housing inflation averaged across 70 cities accelerated further to 10.9% over the 12 months to October, but interestingly this masked a 0.1% decline in October itself so maybe it’s starting to slow. HSBC’s flash manufacturing conditions PMI fell slightly in November but remains in a very mild rising trend and points to growth remaining around the 7.5% level, so all ok.
Australian economic events and implications
- The minutes from the Reserve Bank Board’s last meeting added little that was new with the RBA seeing mounting evidence that the economy is responding to lower interest rates and continued benign inflation but noting again that the $A remains “uncomfortably high” and needs to fall. Once more it left open the door to another rate cut but our view remains that given the economy does seem to be responding to past rate cuts and that the full effect is not yet evident the RBA will keep rates on hold ahead of the next move being a rate hike, but not till around September/October next year. It is clear from the minutes though that the RBA is much more concerned about the high $A than rising house prices, which it sees as just the expected effect of low interest rates, all of which makes it clear that the risk is still on the downside for rates.
- Australian economic data was light on with skilled vacancies down but looking like they are stabilising and marginal gains in leading economic indicators put together by Westpac and the Conference Board.
Major market moves
- Share markets were under pressure again from taper talk over the last week, which resulted in a somewhat volatile ride. This didn’t help Australian shares which have also been under a bit of pressure lately due to 14 capital raising requiring about $3.5bn to be raised. Chinese and Japanese shares managed gains though, the former on the back of the Plenum and Japan on the back of renewed weakness in the Yen.
- Commodity prices were mixed, but the $A was pushed lower by a combination of taper talk in the US and more jawboning from the RBA including talk of intervention in the foreign exchange market.
- Bond yields rose virtually everywhere on the back of Fed taper talk.
What to watch over the next week?
- In the US, expect a bounce in pending home sales (Monday) after softness in September and reasonably solid housing starts data (Tuesday) along with continued gains in house prices (also released Tuesday). Expect underlying durable goods orders and consumer sentiment (both Wednesday) to show a bounce.
- Eurozone economic confidence data (Thursday) is likely to confirm that the economic recovery remains very gradual at this stage. Unemployment (Friday) is likely to have remained around 12.2% in October, and November inflation is likely to remain very low at around 0.8% year on year.
- Japanese household spending, labour market data and industrial production (all Friday) will be watched for further evidence that Abenomics is working, with CPI data likely to show further evidence that deflation is ending but that inflation remains very low.
- In Australia, the focus will likely be on September quarter investment data (Thursday) including investment intentions. Business investment in the September quarter is at risk of a fall given a 4% gain in the June quarter and capex plans are likely to confirm that mining investment has peaked and that the outlook for non-mining investment remains weak, but it’s doubtful the investment outlook will have changed much since the last survey three months ago. Meanwhile, September construction data (Wednesday) will also contribute to expectations for September quarter GDP growth. Private credit (Friday) is likely to show continued slow growth.
Outlook for markets
- Shares appear to have hit a consolidation or mild correction phase after very strong gains from early October lows which had left them vulnerable. A bring forward of the potential timing of the start to tapering in the US has largely been the trigger with a rash of capital raising not helping in Australia. However, this is likely just a pause ahead of the resumption of the rising trend as valuations are reasonable, monetary conditions are set to remain very easy and profits are likely to improve next year as global and Australian growth picks up. Australian shares remain on track to hit 5500 or even higher by year end, with a little help from a Santa rally.
- Government bond yields are likely in a gradual upwards trend as the global economy continues to pick up momentum and as Fed tapering eventually occurs. Low yields and an unwinding of years of massive inflows point to poor sovereign bond returns ahead. However, dovish forward guidance from central banks is likely to help ensure the rising trend in yields remains gradual.
- Expect the $A to be buffeted in the short term between signs Australian rates have bottomed and stable growth in China but talk of Fed tapering & RBA jawboning. The medium term trend in the $A is likely to remain down.
By Dr Shane Oliver, Head of Investment Strategy & Chief Economist
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