Weekly market & economic update – week ending 28 March
31
Mar
2014
From Shane Oliver - AMP chief economist
Investment markets and key developments over the past week
- The past week has seen somewhat messy and mixed trading in share markets – down slightly in the US but up mostly elsewhere – as economic data was mostly okay and hopes build for some sort of stimulus in China but Ukraine worries continue to impact. Bonds generally rallied, partly helped by a relaxation of fears that Fed tightening was coming earlier than previously expected. Commodity prices were mixed but the $A pushed higher partly on the back of somewhat upbeat comments from RBA Governor Stevens which in turn has forced shorts to close out their positions as the currency pushed through key technical levels.
- Ukraine tensions remain. The G7 agreed on further sanctions, but it looks like they will only be applied if Russia escalates the situation by moving to occupy more of Ukraine. Ethnic violence in east Ukraine is worth watching as it could still lead to civil war and become a pretext for Russian intervention on the grounds of “protecting Russians”. The border troop build-up by Russia is clearly maintaining the tension, although it could just be part of Russia’s strategy to pressure Ukraine to not move too far to the west. In short, the risks around Ukraine remain high but I remain of the view that it’s just another distraction for investors. It won’t derail the European or global economic recoveries or the bull market in shares. Meanwhile Ukraine looks likely to get $US14-18bn in support from the IMF in return for economic reforms, but it will be a long process before it gets back on track (even if Russia backed off) – not that that’s much of an issue for global investment markets.
- In Japan, the long awaited April Fool’s Day sales tax hike from 5% to 8% is unlikely to drive Japan back into recession as occurred after the last hike in 1997. While it will leave an air pocket (as spending was pulled forward to avoid it) conditions are very different versus 1997. In contrast to 1997: Japan now has quantitative easing (with the BoJ looking at doing more if needed) and fiscal stimulus, property prices are rising, bank lending is rising, banks do not have large non-performing loans and business confidence has been rising.
- In Australia, while some economists are finally giving up on hopes for further rate cuts and RBA Governor Steven’s can see encouraging evidence of a handover from mining led growth to broader growth this does not mean a rate hike is imminent. Yes there is increasing evidence that non-mining activity is on the mend led by a likely boom in housing construction but against this uncertainty remains about how smooth the transition from mining to non-mining driven demand will be, worries about China and the resurgence in the value of the $A add to this uncertainty and meanwhile inflation is benign. Our view remains that the RBA will be leaving interest rates on hold at least for the next five months, ahead of rate hikes gradually getting underway around September/October.
Major global economic events and implications
- US economic data was okay. Home sales fell in February on poor weather and core durable goods were softish. Against this, December quarter GDP growth was revised up to 2.6% reflecting stronger sales, the flash Markit manufacturing and services PMIs were both strong at 55.5 in March, house prices continue to rise, consumer confidence rose to a six year high and jobless claims fell. And while core durable goods orders were disappointing in February various business surveys point to strong business investment ahead. Rising momentum in national accounts profits also augurs well for capex and employment. Overall the US economy remains on track for stronger growth. Meanwhile Fed clarification of Janet Yellen’s comment about rates rising about six months after the end of QE has continued with the Fed’s Evan’s saying its “at least six months”.
- Eurozone manufacturing and services conditions PMIs fell in March but only marginally (perhaps Ukraine worries didn’t help) and remain at levels consistent with a continuing but gradual economic recovery. Interestingly it seems various ECB policy makers are becoming more open to the idea of deploying some form of quantitative easing to head off deflation if needed. The gradual nature of the recovery, combined with very low inflation and soft money supply and bank lending growth mean further ECB easing is still on the table.
- In Japan, a rise in small business confidence, stronger retail sales, a fall in the unemployment rate, another rise in the jobs to applicant ratio and a rise in inflation to 1.5% are positive signs.
- While another fall in China’s HSBC flash manufacturing conditions PMI suggests growth continued to slow in March, it could be argued that it’s now so weak that its good. The PMI is now back at the low end of the range that it’s been in for the last three years or so which level in the past has been associated with policy easing and I suspect the same will occur this time around. The falling Renminbi and Premier Li’s comments about speeding up construction spending suggests that this may already be getting underway.
Australian economic events and implications
- There were no major data releases in Australia, so the focus was mainly on the RBA. The RBA’s Financial Stability Review indicated a degree of comfort with the Australian financial system highlighting that banks are well capitalised, their resilience to funding shocks continues to improve and that households are continuing to manage their finances with greater prudence. While the RBA cautioned banks against easing lending standards, warned home buyers not to expect the cyclical upswing in house prices to continue indefinitely and noted that the housing market was an area to watch, overall it does not appear too concerned about a housing bubble. The housing market is not likely to be a trigger in the near term for higher interest rates.
What to watch over the next week?
- In the US, expect the ISM manufacturing conditions index (Tuesday) to improve slightly based on various regional surveys already released, a similar improvement in the ISM services index (Thursday) and a further pick up in non-farm payroll growth (Friday) to around 200,000, and a fall in the unemployment rate to 6.6%. Fed Chair Yellen is likely to use a speech on Monday to water down her comments about a six month lag between the end of quantitative easing and the first rate hike perhaps saying the gap is likely to be “at least” six months.
- The ECB (Thursday) will probably leave monetary conditions unchanged, but an easing cannot be ruled out and it likely retain a clear easing bias. March inflation (Monday) is likely to have remained very low leaving the door open for more ECB easing.
- In Japan, February industrial production (Monday) is expected to have slowed a bit after a huge surge in January and the latest Tankan business survey (Tuesday) is expected to show solid conditions in the March quarter but a slight deterioration in the outlook on the back of fears regarding the 1 April sales tax hike.
- In China, the official manufacturing PMI (Tuesday) is expected to follow the HSBC flash PMI lower, but only fall to around 50 (from 50.2) given its focus on larger manufacturers and that the later timing of this survey means that it may have seen more of a pick-up in industrial production following the Chinese new year break.
- In Australia, the Reserve Bank (Tuesday) is expected to leave interest rates on hold for the seventh month in a row. While confidence is building that non-mining activity will take over from mining investment as a driver of growth, uncertainty remains about how smooth the transition will be with intensifying concerns about China and a stronger $A adding a bit to the uncertainty. As a result, the RBA is expected to reiterate that a period of stability in interest rates is appropriate. A speech by Governor Stevens later in the week is likely to reiterate the same message. What will be interesting is whether the RBA will revert to describing the $A as “uncomfortably high” again as at its now actually above the levels it was last December when the RBA last used those words.
- On the data front in Australia, expect to see continued signs of a gradual pick up in credit growth (Monday), a 1% fall in building approvals (Wednesday) as payback for a 7% gain in January, a slight slowing in retail sales (Thursday) after nine consecutive months of growth and another solid trade surplus in February (also Thursday). Data for new home sales, the TD Securities Inflation Gauge, the AIG manufacturing PMI, house prices and job vacancies will also be released.
Outlook for markets
- Worries about the emerging world – notably China and Ukraine at present – along with growing uncertainty as to when the US Fed will start to raise interest rates as growth there recovers from its winter freeze are likely to ensure that 2014 will be a more volatile year for shares. A 10 to 15% correction is likely at some point along the way this year. However, the broad trend in share markets is likely to remain up reflecting the combination of reasonable valuations, better earnings on the back of improved economic growth and easy monetary conditions helping to entice investors to switch out of cash and bonds and into shares. Our year-end target for the ASX 200 remains 5800.
- A slow rising trend in bond yields on the back of gradually improving global growth combined with low yields to start with means pretty subdued returns from government bonds. Cash and bank deposits also continue to offer pretty poor returns.
- The short covering rally in the $A is likely to take it up to around $US0.95. However, the broad trend in the $A is likely to remain down reflecting softer commodity prices, a reversion to levels that offset Australia’s high cost base and a decline in Australia’s growth relative to that in the US.
By Dr Shane Oliver, Head of Investment Strategy & Chief Economist
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