The past week saw most share markets pull back partly due to a perverse reaction to the ECB and partly (or most likely) because after a strong bounce markets had become overbought and due for a bout of “profit taking”. Australian shares were an exception though getting a boost from a further rise in the iron ore price. Oil and gold prices also rose but metal prices fell. Meanwhile, bond yields mostly rose as expectations for negative interest rates globally were wound back a bit, US interest rate expectations rose a bit and the US dollar fell which enabled the $A to briefly push above $US0.75.

The ECB more than delivered, but inadvertently shot itself in the foot (hopefully temporarily). Whichever way you look at it the ECB delivered much more than generally expected: its monthly quantitative easing program was increased from €60bn to €80bn; it will now include buying corporate debt; new cheap financing programs for banks (what the ECB calls TLTRO) will start in June with an interest rate as low as -0.4%; and the rate of interest on bank deposits at the ECB will be cut to -0.4% (from -0.3%). The problem was that President Draghi indicated he doesn’t anticipate more rate cuts which caused bond yields to rise, the Euro to rise and shares to sell off. While Draghi’s comments were perhaps too heavy handed and unhelpful its likely markets will ultimately settle down and see the ECB’s move as very positive. First, Draghi’s comments were likely aimed at limiting expectations for any squeeze on bank margins. Second, given concerns about banks his real message is that “the emphasis will shift from [negative] rates…to other non-conventional instruments [like QE and TLTRO]” and it’s likely that ECB officials will stress this in the period ahead. Third, the overall easing announced by the ECB is much bigger than expected and buying corporate debt should help bring the recent blow out in corporate bond yields back down with a flow on to bank borrowing costs. The focus on corporate debt and cheap bank financing is all about making sure that the recent turmoil around Eurozone bank shares is not allowed to mess with the monetary transmission mechanism in Europe. Finally, the ECB and Draghi signalled even more determination to get inflation back up to its mandate “without undue delay” and Draghi even flagged a willingness to let inflation run above the 2% target for some time if it spends a long time below it. This is all about boosting inflation expectations. But it also alludes to making its quantitative easing program open ended as the US QE3 program was. So overall we give the ECB a big tick.

Closer to home the Reserve Bank of NZ also eased over the last week cutting its official cash rate to 2.25% from 2.5%. While New Zealand is in a different position to Australia having come from a brief tightening cycle, it does have similar concerns regarding its currency being too strong.

In Australia, consumer sentiment data highlighted a renewed degree of caution when it comes to investing. When asked what is the wisest place for savings, the March survey showed a dip in those nominating shares (from an already low 9.9% in the December survey to 7.6%), a sharp fall in those nominating real estate (from 23.4% to 14.7%) and an increase in those nominating either bank deposits or paying down debt (from 44% to 51.8%). Quite clearly share market volatility has weighed on sentiment towards shares but it also looks like all the latest talk about a property crash has weighed on sentiment towards property.

Major global economic events and implications

It was a quiet week on the US data front with a slight fall in small business optimism and a continuing rise in inventories highlighting the more difficult environment for US manufacturers, but a sharp fall in US jobless claims to a five month low telling us the jobs market remains strong. Meanwhile the message from Fed officials was mixed with Vice Chair Fischer pointing to what may be “the first stirrings of an increase in inflation”, but Governor Brainard sounding much more cautious and arguing for patience until the outlook becomes clearer.

Japanese data was soft with falls in economic sentiment, consumer confidence, machine tool orders and slower growth than expected in money supply and bank lending.

German industrial production rose much more than expected in January and factory orders fell by less than expected.

Chinese exports and imports for February fell much than expected warning that Chinese demand for imports and global demand for Chinese goods is soft. That said there is a danger in reading too much into Chinese economic data at the start of the year given the distortions that the floating Lunar New Year holiday can cause. Meanwhile, Chinese CPI inflation rose more than expected in February but this was driven by higher food prices with non-food inflation falling to just 1% year on year. Producer price deflation continued to show signs of waning though.

Australian economic events and implications

Australia saw softness in housing finance and confidence measures continue to bounce around long term average levels. The message from January housing finance commitments is that investor finance is continuing to slow and owner occupier finance, which was filling the gap, may be too. That said it’s premature to read too much into one month’s worth of data. Meanwhile, consumer confidence fell slightly in March – perhaps not surprising given all the talk about cuts to tax concessions – and business confidence was unchanged in February. Hard to get excited though with both around long term average levels. But business conditions actually improved in February (consistent with various PMIs) with employment and capex intentions running around solid levels.

What to watch over the next week?

The focus in the week ahead will remain on central banks with both the Bank of Japan and the Fed meeting. The Fed (Wednesday) won’t be raising interest rates – with the market attaching just a 4% probability to a hike in the week ahead – but it is likely to indicate that while it intends to raise interest rates further this year it is aware of the risks of slower global growth and so will proceed cautiously. In particular, the Fed’s median “dot plot” showing Fed decision makers’ expected path for interest rates going forward is likely to show more interest rate hikes this year, but only three 0.25% hikes down from four. This compares to market expectations for no more than one, but the Fed and the market are likely to come closer together.

On the data front in the US expect to see a further gain in US retail sales (Monday) after allowing for the impact of falling gasoline prices, strength in homebuilding conditions (Tuesday) and housing starts (Wednesday) and a fall in industrial production (also Wednesday). Inflation data to be released Wednesday will likely show a fall at the headline level due to lower gasoline prices but will be watched for a further pick up at the underlying level. Manufacturing conditions surveys will also be released for the New York and Philadelphia regions along with data on job openings.

Meanwhile, the Bank of Japan is unlikely to cut its deposit rate further into negative territory after the bad reaction to its January cut, but it could undertake an expansion of its quantitative easing program.

In Australia, it’s back to the monthly employment lottery on Thursday. For what its worth we expect a 10,000 gain in jobs and unemployment staying at 6%. The RBA will also release the minutes from its last meeting on Tuesday, but they are a bit dated given GDP and other data released since then.

Outlook for markets

Shares have had a good bounce, but having become overbought are now vulnerable to a pull back. Worries about the Fed will no doubt dominate in the week ahead and of course uncertainty remains regarding China. So whether we see a retest of February lows remains to be seen. Beyond the near term uncertainties though, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate economic growth.

Very low bond yields – with many sovereign bonds now having negative yields – point to a soft medium term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation. Bonds in higher yielding countries like Australia, the US and maybe even China are relatively attractive.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but growth is likely to pick up in Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with the RBA expected to cut the cash rate to 1.75%.

The delay in Fed tightening and stronger data in Australia pose further short term upside risks for the $A. However, just as we saw with the early 2014 9% bounce in the $A, any short term strength in the $A is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the RBA eventually resumes cutting the cash rate or at least resorts to jawboning and the Fed eventually resumes hiking, commodity prices remain weak and the $A undertakes it’s usual undershoot of fair value.

By Shane Oliver, AMP Capital

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Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

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