• America’s payroll employment report for June provided a positive surprise. There was robust job gains of +288,000 and the US unemployment rate fell to 6.1% which is a near 6 year low. Given these encouraging job gains, the US central bank is likely to continue their strategy of gradually tapering asset purchases  (“Quantitative Easing”) until their completion in late 2014. However there are growing prospects that the US central bank will raise interest rates earlier than the market currently expects in mid 2015.
• Australia’s economic data provided mixed news. Nominal retail trade fell in May with sharp declines in department store and clothing sales. This could be due to Australian consumers being concerned over the Federal Budget’s higher taxes and spending cut measures and the jobs market. By contrast, residential building approvals surged in May. For the Reserve Bank, these mixed results for May’s retail sales and building approvals are likely to keep the RBA’s “very accommodative” 2.5% cash interest rate intact over coming months.
• The Reserve Bank (RBA) Governor Glenn Stevens issued warnings to housing investors and currency traders. The RBA Governor warned that if there was a “further big run up in prices” for housing with “overconfident expectations” and “increases in household leverage”, then this would be a “matter for concern”.  For the Australian Dollar, the RBA considers this is “uncomfortably high” as “most measures would say it is overvalued”. Hence “investors are underestimating the likelihood of a significant fall”.

What to watch over the week ahead?

• Australia labour force data for June will provide an important gauge of economic activity and confidence.  Job gains have been solid this year by averaging nearly +20,000 per month. However Australia’s unemployment rate has only marginally improved from 6.0 % to 5.8%. June’s result is likely to be on the softer side with only +10,000 extra jobs and unemployment edging up to 5.9% given the recent run of mild retail spending data and weaker consumer sentiment. However housing finance data for May should show solid rise in credit approvals given the strong rise in housing construction and housing prices witnessed so far this year.
• American corporations start their June quarter earnings season next week. Corporate earnings are expected to rise by a solid +6% for the past year according to Reuters. Given that US shares are at historic highs, there will be a heightened sensitivity to any earnings surprises or disappointments over the next few weeks.
• Financial markets will also concentrate on the Federal Reserve’s (FED) meeting minutes for June. These meeting minutes may provide some guidance on when the US central bank will end the asset purchases program (i.e. “Quantitative Easing”) this year and the possible timetable for raising interest rates in 2015. American economic data due next week is on the thin side. There is the NFIB small business survey for June which should see further gains in confidence.
• China’s Consumer Price Index and monetary aggregates for June are due next week. This data will provide a timely measure of inflation pressures and credit growth. Modest results for June inflation & monetary data will provide the Chinese central bank with flexibility to relax policy if needed to support economic growth.

Outlook for markets

• Global shares are vulnerable to a correction after the strong run in the first half of 2014. There are numerous possible catalysts for this correction in coming months. These include the US central bank rapidly winding back their policy stimulus and moving steadily towards raising interest rates, political risks in Iraq and Ukraine, or perhaps disappointment in Europe given a frail economic recovery and fragile financial system.
• However the strategic climate is still favourable for Global Shares. So the broad trend over the next few years is likely to remain up for Global Shares. Fundamentals remain favourable for Global Shares given reasonable current valuations, improving profits with rising economic activity and low Global interest rates. Hence any short term correction in Global Shares is seen as a buying opportunity.
• Government Bond yields should resume their gradual rising trend given improving Global growth and the US central bank moving towards raising interest rates in 2015. Hence the current low yields in Government bonds, cash and bank deposits are not attractive and should deliver very low returns over the coming year.

Major global economic releases and implications

• America’s ISM business surveys indicate that the US economy rebounded sharply in the second quarter after the harsh winter weather. The ISM manufacturing survey edged lower by -0.1 to 55.3 in June. Given that May’s ISM reading was a 5 month high, June’s reading is still very encouraging for US activity. The ISM Services survey marginally fell by -0.3 to 56.0 in June. Yet this is close to a 9 month high. These ISM surveys are consistent with strong +3% Real GDP growth in the June quarter.
• Europe’s unemployment is slowly coming down with the “very gradual” economic recovery. May’s unemployment rate for the Euro area is 11.6% which is an improvement on 12% unemployment rate recorded at the same time last year. However unemployment rates in some countries are still disturbingly high with Greece (26.8% unemployment) and Spain (25.1%) topping the distress list. For the European Central Bank (ECB), this labour market distress ensures that interest rates will remain low for a long time. The ECB kept their key policy interest rate at 0.15% at July’s meeting. The ECB President Dr Mario Draghi acknowledged that Europe’s economy was still in a “very gradual recovery”.
• China’s official PMI manufacturing survey shows an encouraging rise in business activity and confidence. June’s PMI rose by +0.2 to 51.0 which is its highest reading in the past six months. This PMI suggests that China’s economic growth has modestly accelerated towards a solid +7.5% Real GDP annual pace.
• Japan’s business surveys are giving mixed readings. The Bank of Japan’s Tankan survey for the June quarter shows that April’s consumption tax rise has dented business confidence. However this appears a temporary impact as the Tankan ‘outlook’ responses indicate a rebound in the September quarter. Solid gains for Japan’s PMI manufacturing survey and the Shoko Chukin small business survey for June also suggest that economic activity is set to revive in the second half of 2014.

Australian economic releases and implications

• Nominal retail sales fell sharply by -0.5% in May compared to the expected +0.1% gain. The sharpest falls were recorded in department stores (-2.6% mom), clothing and footwear (-2.3%) and household goods (-0.9%).  Previous months were also revised down be a cumulative -0.4%. So May’s result is a significant disappointment. Over the past year, nominal retail sales have increased by +4.6%.
• Residential housing approvals recovered strongly in May with a +9.9 monthly gain.  There was a robust rebound in the volatile apartments sector which rose by 27% in May while private housing rose by a more modest +0.5%.
• Hence these mixed results for May’s retail sales and building approvals are likely to keep the RBA’s “very accommodative” 2.5% cash interest rate intact. So the RBA’s mantra of “the most prudent course is likely to be a period of stability in interest rates” should continue to be chanted in Martin Place over coming months.

Major market moves

• Global shares generally had a positive week. American shares (S&P 500) rose +1.4% to a record high.   Both Germany’s DAX and Britain’s FTSE recorded strong gains of +2.3%. Japan’s TOPIX also benefitted by rising +2.6% for the week.  Australia’s ASX 200 rose by a solid +1.7% for the week.
• Government Bond Yields in America and Britain responded negatively to the better US economic data and the prospects of higher interest rates sooner in 2015.  American 10 year Government Bond yields rose by +10 basis points to yield 2.64% while British 10 year Gilt yields rose by +11 basis points to 2.75%. For Australian 10 year bond yields, there was milder upward pressure as yields rose by +5 basis points to 3.59%.

By Bob Cunneen, Senior Economist

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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) makes no representation or warranty 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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