• The Reserve Bank Governor Glenn Stevens delivered a speech “Economic Possibilities”

A coach rallies his players

• The Reserve Bank Governor has delivered a powerful speech that could only be described as a “call for action”. And the speech was clearly targeted at the conservativeness of the business sector – a theme that the Governor has been focussing on for some time. It is a detailed speech. It applauds Australia’s successes. It implores Australian business people to believe in themselves and take greater risks. It was the type of speech that a coach delivers to his players. It is definitely a speech worth reading.
• The conclusion to the speech pulls no punches: “maximising our economic possibilities in the modern world requires sustained efforts at adaptation and innovation, at doing things better and, perhaps most of all, a willingness to take the occasional risk. I would be confident that we have, or can develop, the relevant capabilities. The only question is whether we are sufficiently determined to succeed in deploying them.”
• Stevens effectively delivers a pep talk. He praises the response by business to the changing structure in the economy by lifting productivity, “The good news is that businesses can respond to that, and they are doing so.”But Stevens says that the process needs to continue. But he questions “whether our overall business environment is conducive enough to risk-taking and innovation, and whether we are doing enough to develop the relevant competencies.”
• But in responding to the issue of “whether we have the competencies, across multiple dimensions, to be effective in the modern global economy?” Stevens effectively responds in the affirmative by lauding Australia’s success in hosting the G20. “The feedback I have received from my counterparts has been universally and strongly positive. They judge that the Australian presidency has, by the metrics that count, been very successful.”
• And the pep talk continues: “It wasn’t achieved by any effortless superiority; it owed to careful preparation, astute use of some of our natural advantages and continuous effort over a long period. But that’s where success always comes from, really. The only question is: how badly do we want it?”
• Stevens notes Australia’s success in putting the issue of infrastructure on the table, and again the “coach” calls for action: “There is an opportunity here, including for Australia, to do something of value over the years ahead. Of course, we will need to be serious and to put in the effort over an extended period – in all the above areas. If we don’t put in that effort, not much actual infrastructure will be delivered. But if we are serious, a lot could be achieved.”
• The Reserve Bank Governor attempts to set the record straight with his views on housing.
• “Credit outstanding to households in total is rising at about 6–7 per cent per year. I see no particular concern with that.”
• “It is not clear whether price increases will continue or abate. Furthermore, it is not to be assumed that investor activity is problematic, per se. A proportion of the investor transactions are financing additions to the stock of dwellings, which is helpful. It can also be observed that a bit more of the ‘animal spirits’ evident in the housing market would be welcome in some other sectors of the economy.”
• “Nor, let me be clear, have we seen these dynamics, thus far, as an immediate threat to financial stability. The Bank’s most recent Financial Stability Review made that clear. So we don’t just assume that all this is a terrible problem.”
• The Reserve Bank Governor does acknowledge that there are signs in the investor housing market where“some people might be starting to get just a little overexcited.” The Reserve Bank is working with other agencies on reviewing lending standards. But he makes clear the purpose of the review. “Let’s be clear what this is not about. It is not an attempt to restrain construction activity. On the contrary, it is an attempt to stretch out the upswing. Nor is it a return to widespread attempts to restrict lending via direct controls.”
• The Reserve Bank Governor makes it clear that rates aren’t set to rise to address the strong growth in investor housing lending: “The economy has spare capacity. Inflation is well under control and is likely to remain so over the next couple of years. In such circumstances, monetary policy should be accommodative and, on present indications, is likely to be that way for some time yet. But for accommodative monetary policy to support the economy most effectively overall, it’s helpful if pockets of potential over-exuberance don’t get too carried away.”
• The aim of the Reserve Bank is not to snuff out the lift in housing lending and thus lift in construction, rather it is to extend it: “A sustained period of strong construction will be more helpful from the point of view of encouraging growth in non-mining activity – and also, surely, from a wider perspective: housing our growing population in an affordable manner.”
• The clear take-aways from the Reserve Bank Governor’s speech:
• Australians should take pride in the successful hosting of the G20. And Australia should focus on the success achieved in lifting productivity growth. But we shouldn’t rest on our laurels but rather should be determined to build on our successes. “The only question is: how badly do we want it?”
• The Reserve Bank Governor stresses: “if we are serious, a lot could be achieved.”
• The Reserve Bank Governor wants to extend the lift in home construction as a means of lifting non-resource investment and housing our population. But he also wants to ensure that any signs or investor over-exuberance are contained.

Some salient points about housing

The Reserve Bank Governor attempts to set the record straight with his views on housing.

• “Credit outstanding to households in total is rising at about 6–7 per cent per year. I see no particular concern with that.”
• “It is not clear whether price increases will continue or abate. Furthermore, it is not to be assumed that investor activity is problematic, per se. A proportion of the investor transactions are financing additions to the stock of dwellings, which is helpful. It can also be observed that a bit more of the ‘animal spirits’ evident in the housing market would be welcome in some other sectors of the economy.”
• “Nor, let me be clear, have we seen these dynamics, thus far, as an immediate threat to financial stability. The Bank’s most recent Financial Stability Review made that clear. So we don’t just assume that all this is a terrible problem.”

The Reserve Bank Governor does acknowledge that there are signs in the investor housing market where“some people might be starting to get just a little overexcited.” The Reserve Bank is working with other agencies on reviewing lending standards. But he makes clear the purpose of the review. “Let’s be clear what this is not about. It is not an attempt to restrain construction activity. On the contrary, it is an attempt to stretch out the upswing. Nor is it a return to widespread attempts to restrict lending via direct controls.”

The Reserve Bank Governor makes it clear that rates aren’t set to rise to address the strong growth in investor housing lending: “The economy has spare capacity. Inflation is well under control and is likely to remain so over the next couple of years. In such circumstances, monetary policy should be accommodative and, on present indications, is likely to be that way for some time yet. But for accommodative monetary policy to support the economy most effectively overall, it’s helpful if pockets of potential over-exuberance don’t get too carried away.”

The aim of the Reserve Bank is not to snuff out the lift in housing lending and thus lift in construction, rather it is to extend it: “A sustained period of strong construction will be more helpful from the point of view of encouraging growth in non-mining activity – and also, surely, from a wider perspective: housing our growing population in an affordable manner.”

The bottom line

The clear take-aways from the Reserve Bank Governor’s speech:

• Australians should take pride in the successful hosting of the G20. And Australia should focus on the success achieved in lifting productivity growth. But we shouldn’t rest on our laurels but rather should be determined to build on our successes. “The only question is: how badly do we want it?”
• The Reserve Bank Governor stresses: “if we are serious, a lot could be achieved.”
• The Reserve Bank Governor wants to extend the lift in home construction as a means of lifting non-resource investment and housing our population. But he also wants to ensure that any signs or investor over-exuberance are contained.

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Australian bonds – a waiting game.

The rally in global bond markets has extended far beyond many observers’ expectations, with investors seemingly unwilling to allow any retreat from record low yields.

The liquidity glut created by central banks is forcing investors across the spectrum – from reserve managers to life insurance companies – to stretch valuations even further from economic fundamentals. Australian bonds have also been caught up in this yield-grabbing frenzy and, on some valuations, look expensive.

Asian buying has been particularly prevalent, as Japanese insurers look to diversify their large JGB holdings. That said there is no shortage of ‘bond bears’ waiting to challenge the bond market’s recent strength on stronger signals from central banks.

However, we advise caution. Given external vulnerabilities, notably a weaker Chinese economy, and Australia’s own uncertain domestic demand profile, the Reserve Bank of Australia (RBA) is likely to hold rates steady for longer than US and other major central banks. In the central banking world of shifting doves and hawks, a firmly neutral RBA gives welcome refuge for safe-haven flows, and so we continue to prefer Australian bonds on a cross-market basis.

Turning to look at the prospects for economic growth; previous investment in production capacity? should continue to support Australia’s external sector. However, while net exports added substantially to growth in the first half of the year, we expect some moderation going forward. The picture on the housing side is more complex. The contribution of residential construction to the economy remains elevated, as a contraction in mortgage-spreads has given investors and homebuyers access to record-low borrowing rates. Yet the Bank appears to be increasingly monitoring the risks that the buoyant housing market may pose to wider financial stability. Expectations that a bubble in the housing market will lead to higher interest rates in the near term appear wide of the mark however. Instead, the RBA looks likely to focus on macro-prudential tools, including efforts to curb excessive investor finance and reinforce sound lending practices.

There are other factors at play. Specifically, the high exchange rate raises concerns around domestic demand. An elevated Australian dollar will exert downward force on unit labour costs as the lack of external competitiveness forces greater internal competition.

For Australia, the real exchange rate remains significantly overvalued, creating difficulties for trade-sensitive sectors. During 2014, the currency has remained stubbornly high in the face of lower interest rate differentials and declining terms of trade. Nevertheless, like many other central banks, the RBA seems happy to wait for a shift in US Federal Reserve policy to do most of the heavy lifting.

Recent RBA minutes highlight concern around accuracy in economic forecasting, given the unusual global financial and economic environment. Ironically, this can have the effect of bolstering belief in the RBA’s forward guidance, as improving forecasts and official data can be met with a tinge of scepticism, keeping front-end rates firmly anchored.

From a monetary policy perspective, the most likely scenario at present is for the RBA to examine how the mining investment cycle recedes and the non-mining investment cycle recovers. Business investment intentions lend cause for optimism, although the RBA remains wary that ‘animal spirits’ may be lacking.

From a cautiously optimistic stance, we feel it would take a marked deterioration in either economic outlook or inflation to alter the current stable trajectory of monetary policy. If anything, the RBA’s apparent preference for macro-prudential tools in tackling any imbalances in the housing market reinforces our view that policy rates are unlikely to move any time soon.

In a world where central bank liquidity is king, this should be enough for investors in front-end ‘carry’ trades, as the path of least resistance, to continue benefitting. Ten-year Australian yields should pay some lip-service to global bond market developments and the much anticipated sell-off, although for the reasons outlined above we expect further yield compression versus the US.

By Liam O’Donnell – Investment Director, Standard Life Investments

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David Bassanese

Anticipation of an increase in US interest rates in 2015 drove a rise in the US dollar, falling commodities prices and a sustained sell-off in the Australian equities market during the month of September, according to BetaShares’ Global Market Review.

The review, which analyses performance across seven major asset classes, found that international equities was the best performer for the month, experiencing 3.7% growth as increased confidence in the economy drove the US share market higher. The price of international equities in real terms also increased as the Australian dollar headed towards a four-year low against the US dollar.

US dollar strength was a major theme in global markets in September, with the greenback rising 6.8% against the Australian dollar over the month. Continued weakness in iron ore prices was also a major contributing factor to the weak AUD, said BetaShares Chief Economist David Bassanese.

“The fear of an end to quantitative easing hurt commodities and commodity exporting equity markets such as Australia’s – and emerging markets like Brazil – particularly hard,” Mr Bassanese said. “The strength of the US dollar added another negative factor to increasing commodity supplies and only modest global growth, making it hard to be positive on the commodity price outlook.”

Australian bonds and listed property also fell over the month, as the sell-off in the local equities market suppressed any increase in bond yields as a result of anticipated Fed tightening. Low global inflation and geopolitical tensions were likely to drive a further fall in yields by the end of the year, which could also affect the property sector, said Mr Bassanese.

“Unless the RBA moves to an easing policy bias again, 10-year bond yields are likely to head back to 4% p.a. by year end,” Mr Bassanese said. “While property is holding up well thanks to the uplift in residential construction and high land values, it could also be at risk of underperformance once the increase in bond yields begins.”

Looking ahead, Mr Bassanese noted an expectation of further international equities outperformance, with the Australian dollar moving down to 85 cents by the end of the year. “Given falling commodity prices and the AUD’s still uncomfortably high real level, I would expect medium-term weakness against the US dollar, the Euro and the Pound,” he said.

“This should drive global equities outperformance against the Australian market in unhedged terms, with the current pullback in global equities likely only a correction in a broader bull market.”

Click here for a copy of the full Global Market Review is attached.

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• 

  Car sales lifted in September

  New home sales rise: New home sales rose by 3.3 per cent in August after slumping by 5.7 per cent in July. Sales of detached houses rose by 0.5 per cent in August and multi-unit sales rose by 19.8 per cent.

• Car sales hit record highs. New car sales rose by 2.5 per cent in September compared with a year earlier. A total of 94,978 vehicles were sold in September – the highest reading on record for a September month.
• Over the year 345,504 new sports utility vehicles (SUVs or 4WDs) were sold, a record 30.9 per cent of total vehicle sales.
• Services activity contracts: The Performance of Services index fell by 4 points to 45.4 in September.

What does it all mean?

• The lift in new home sales activity comes after a slide in the prior month. And while there are signs of a consolidation in housing activity, new home sales are up over 12 per cent on a year ago. Given that council approvals have hit record highs and fixed mortgage rates have been cut by some of the banks, it is clear that homebuilding and home renovations will be the linchpin of the Australian economy growth story over the coming year.
• Interestingly the economic momentum is shifting from resource states and territories to those regions where home construction is rising fastest – such as NSW. The Reserve Bank would be more comfortable with the lift in new home sales and strength in home building and it is unlikely to look to shift interest rate settings any time soon.
• The industry body representing the car industry has released the latest new car sales data and it was certainly a positive surprise. Not only were car sales up 2.5 per cent in September on a year ago, but a total of 94,798 new vehicles were sold – a record for a September month. Improved job security and the best car affordability since the 1970s are all serving to boost new vehicle sales.
• The star performer continues to be sports utility vehicles (SUVs). Sales of SUVs were up almost 15 per cent on a year ago and now make up a record 30.9 per cent of total vehicle sales. In effect one in every three vehicles sold is a SUV.

What do the figures show?

New home sales

• New home sales rose by 3.3 per cent in August, after falling by 5.7 per cent in July. Apartment sales rose by 19.8 per cent while detached house sales rose by 0.5 per cent.
• In August 2014 seasonally adjusted detached house sales increased by 11.1 per cent in New South Wales and by 2.0 per cent in Western Australia. Detached house sales fell by 6.8 per cent in South Australia, 6.0 per cent in Victoria and 0.7 per cent in Queensland.

New car sales:

• According to the Federal Chamber of Automotive Industries (FCAI), new car sales rose by 2.5 per cent over the year to September 2014. In September, 94,978 new vehicles were sold. And over the year to September, 1,119,236 vehicles were sold, down further from the record 1,141,483 new vehicles sold on the year to July 2013.
• Passenger car sales fell by 4.1 per cent over the year, sports utility vehicles were up by 14.6 per cent and “other” vehicles sales were up by 2.3 per cent. In the year to September 345,504 SUVs were sold, a record 30.9 per cent of total vehicle sales. Of total car and SUV sales, SUVs accounted for a record 38.8 per cent of the total.

Performance of Services

• The PSI index fell by 4.0 points to 45.4 in September. A reading below 50 points indicates contraction of the services sector. All components fell in September except employment, selling prices and capacity utilisation.
• The Housing Industry Association releases data on the sales of new homes each month. The HIA collects the data each month from a sample of Australia’s largest 100 home builders. The survey covers around 14 per cent of the home building industry.
• The Federal Chamber of Automotive Industries releases estimates of car sales on the third business day of the month. The figures highlight the strength of consumer spending as well as conditions facing auto & components companies.
• The Performance of Services index is released by Australian Industry Group each month. The PSI is designed to provide a guide to conditions in retail, financial and other service sectors.
• The economy continues to gain momentum after a pause around Budget time. Given strong car affordability and better consumer confidence levels, demand for cars should remain healthy, supporting a raft of businesses.
• The ongoing lift in new home sales and housing construction will support broader growth and employment. Over the next few months the job market data is taking on a higher degree of importance. Once the Reserve Bank is confident that unemployment has peaked, it will be more inclined to start the ‘normalisation’ of interest rates.

What is the importance of the economic data?

• The Housing Industry Association releases data on the sales of new homes each month. The HIA collects the data each month from a sample of Australia’s largest 100 home builders. The survey covers around 14 per cent of the home building industry.
• The Federal Chamber of Automotive Industries releases estimates of car sales on the third business day of the month. The figures highlight the strength of consumer spending as well as conditions facing auto & components companies.
• The Performance of Services index is released by Australian Industry Group each month. The PSI is designed to provide a guide to conditions in retail, financial and other service sectors.

What are the implications for interest rates and investors?

• The economy continues to gain momentum after a pause around Budget time. Given strong car affordability and better consumer confidence levels, demand for cars should remain healthy, supporting a raft of businesses.
• The ongoing lift in new home sales and housing construction will support broader growth and employment. Over the next few months the job market data is taking on a higher degree of importance. Once the Reserve Bank is confident that unemployment has peaked, it will be more inclined to start the ‘normalisation’ of interest rates.

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• 

  Housing approvals rose for the second month in a row.

  Dwelling approvals: Dwelling approvals rose by 3.0 per cent in August and are up 14.5 per cent over the year. Over past 12 months a record 197,571 dwellings were approved – marking the highest result on record.

• Trade deficit narrows: Australia’s trade deficit narrowed by $288 million to a deficit of $787 million in August – largely in line with forecasts.
• Exports to China eased for the fourth straight month with receipts of $98.5 billion for the year to August. Exports to the US hit a near 5-year high of $10.42 billion in the year to August.
• Reserve Bank Assistant Governor, Malcolm Edey, and Head of Financial Stability Department, Luci Ellis, appeared before the Senate Committee. The RBA officials stressed that no specific macro-prudential controls have been ruled in or out although restrictions on loan to valuation ratios (LVRs) were considered unlikely.

What does it all mean?

• The latest economic data was clearly encouraging – particularly the lift in dwelling approvals. Dwelling approvals rose for the second straight month in August and hit record highs when viewed over the past 12 months. At the same time the trade deficit narrowed.
• Over the past 12 months there were 197,571 approvals to build new homes, marking the highest result on record. And despite the fact that approvals have consolidated over the past few months it is pretty clear that housing activity is going to be the backbone of Australia’s growth story over the coming year.
• Keep in mind that dwelling approvals (16,810) are holding over 24 per cent above decade averages, underpinned by pivotal private sector house approvals, suggesting that home building is set to lift further over the second half of 2014.
• Lower interest rates, strong population growth, improving affordability, and pent up housing demand will see the housing sector gather pace over the medium term. In addition the recent cuts to fixed interest rates by the major banks will spur a further round of home building.
• The lift in approvals will appease policymakers to some degree. Fundamentally, the growth in house prices has been driven by a lack of stock, and a substantial lift in new housing stock should ensure more sedate price growth over the longer term.
• The latest trade figures were more positive than in recent times. Australia recorded its fifth consecutive trade deficit, but the August deficit of $787 million was the smallest deficit over that period. In addition the recent slide in the Australian dollar is yet to filter to through to the trade accounts and should support a lift in exports in the next result.
• From a broader sense Australia is certainly less vulnerable to external shocks than compared with the past and the demand for Australian resources will continue to underpin the trade accounts. That is not just an ongoing lift in iron ore volumes, but also the anticipated lift in LNG exports. And to some degree the slide in commodity prices will be offset by the fall in the Australian dollar.
• Interestingly Australia’s exports to China and the US are looking more encouraging. Australia’s exports to China held just shy of $100 billion the year to August, and account for over 36 per cent of Australia’s total exports. And exports to the US hit a near 5-year high of $10.42 billion in the year to August. No doubt the lift in growth across the super economies bodes well for Australia’s external growth prospects.
• While rate hikes are off the near term agenda, it is unlikely that the Reserve Bank will shift away from its “interest rate stability” rhetoric any time soon. A few solid months of robust employment would be required to change the “on hold” message. The data suggests that the Reserve Bank will continue to keep a neutral view on rates with a slightly dovish skew.

What do the figures show?

Building Approvals:

• Dwelling approvals rose by 3.0 per cent in August after rising by 2.1 per cent July. Approvals are up 14.5 per cent over the year. Over past 12 months a record 197,571 dwellings were approved – marking the highest reading on record.
• The current number of dwelling approvals (16,810) is well above the decade average (13,555) and five-year average (14,291).
• House approvals fell by 1.4 per cent in August (private sector down 1.8 per cent). Meanwhile ‘lumpy’ apartment approvals rose by 9.2 per cent in August after rising by 3.0 per cent in July.
• House approvals are up 12.6 per cent over the past year while apartments are up 17.1 per cent.
• Across states in August: NSW approvals rose by 2.9 per cent; Victoria rose by 15.5 per cent; Queensland rose by 1.4 per cent; South Australia rose by 11.3 per cent; Western Australia fell by 16.2 per cent; Tasmania fell by 0.6 per cent.
• The value of all commercial and residential building approvals rose by 0.5 per cent in August after falling by 10.9 per cent in July. Residential approvals rose by 3.0 per cent with new building up by 3.4 per cent and alterations & additions up by 0.4 per cent. Commercial building fell by 4.5 per cent in August after falling by 27 per cent in July.

International trade:

• Australia’s trade deficit narrowed by $288 million to a deficit of $787 million in August. The July trade balance was revised from a deficit of $1,359 million to a deficit of a $1,075 million.
• In August, exports of goods and services fell by 1.5 per cent (goods down by 1.9 per cent) while imports of goods and services fell by 2.5 per cent (goods down 3.1 per cent). Exports are down 4.7 per cent on a year ago, while imports are down by 5.1 per cent.
• Rural exports fell by 4.2 per cent in August while non-rural exports fell by 0.1 per cent.
• Within imports, consumer imports fell by 0.9 per cent in August with capital goods imports up by 5.9 while intermediate goods imports fell by 8.7 per cent.
• Consumer goods imports are down 2.6 per cent on a year ago while capital goods imports are down by 8.2 per cent and intermediate goods imports are down by 3.3 per cent.
• The net services deficit narrowed marginally by $26 million to $878 million in August.
• Australia’s exports to China eased further from record highs, posting earnings of $98.5 billion in the year to August. And down from a record $100.6 billion in the year to April. Annual exports were up 19.1 per cent on a year ago and accounted for 36.13 per cent of Australia’s total exports, just down from a record high of 36.73 per cent in the year to April.
• Australia exports to the US hit a near 5-year high of $10.42 billion in the year to August. The share of exports going to the US hit a 3½-year high of 3.82 per cent.
• Australia’s imports from China eased from a record $50.3 billion in the year to July to $50.0 billion in the year to August, up 10.2 per cent on a year ago and accounting for a record 19.99 per cent of Australia’s total imports.
• Australia’s rolling annual trade surplus with China stood at $48.5 billion in August, easing further from the record high of $51.1 billion in April.

Senate Economics Committee – Inquiry into Affordable Housing

• Reserve Bank Assistant Governor, Malcolm Edey, and Head of Financial Stability Department, Luci Ellis, appeared before the Senate Committee today. Their opening statement can be found here.
• To date, the transcript of the Senate hearing is not available.
• Key points:
• One key measure of affordability – the repayment on a typical new housing loan expressed as a ratio to disposable income – “has fluctuated around a broadly stable average over the past three decades, with average repayments varying between around 20 and 30 per cent of disposable incomes.”
• “the ratio of housing prices to incomes is at the top of its historical range; but…
  over time, this has been more than offset by falls in financing costs, so that the typical repayment burden as a share of income is not particularly high. This of course does not rule out affordability problems in particular market segments or for particular types of households.”
• The composition of housing finance has become unbalanced with investor demand dominating, especially in Sydney & Melbourne.
• The RBA officials stressed that no specific macro-prudential controls have been ruled in or out although restrictions on loan to valuation ratios (LVRs) were considered unlikely.
• The RBA officials were at pains to point out that the strength of investor housing demand was largely limited to Sydney and Melbourne. The key would be to devise controls that didn’t discourage new housing supply that was required to meet strong demand and lead to more sustainable growth of home prices.
• The Bureau of Statistics’ monthly Building Approvals release contains figures on local council approvals to build residential structures such as homes and units as well as commercial premises such as offices and shops. Approval is one of the first stages of the construction ‘pipeline’ and is thus a key leading indicator of future activity. An increase in approvals would point to stronger future activity for construction-related companies.
• The monthly International Trade in Goods and Services release from the Bureau of Statistics provides estimates on exports and imports of physical goods (such as coal, beef and computers) and services (such as travel receipts). The balance of goods and services (BOGS) is a narrower description of Australia’s external position than the current account estimates. The import data is a useful gauge of consumer and business spending while exports reflect global demand as well as domestic influences such as drought.
• The Reserve Bank would be heartened by the second wind in dwelling approvals. Housing activity is no doubt supporting the overall lift in spending and will continue to absorb the weakness in mining investment.
• Overall the economy is on a solid footing and remains fundamentally sound. Given the low interest rate environment, falling Australian dollar and the lift in home prices, the Reserve Bank is likely to be watching for an improvement in labour market conditions before thinking about a lift in interest rates. We expect the Reserve Bank to maintain a neutral monetary policy stance, while keeping a close eye on the transition of growth from mining investment to other parts of the economy. Rates are expected to remain on hold over the rest of 2014.

What is the importance of the economic data?

• The Bureau of Statistics’ monthly Building Approvals release contains figures on local council approvals to build residential structures such as homes and units as well as commercial premises such as offices and shops. Approval is one of the first stages of the construction ‘pipeline’ and is thus a key leading indicator of future activity. An increase in approvals would point to stronger future activity for construction-related companies.
• The monthly International Trade in Goods and Services release from the Bureau of Statistics provides estimates on exports and imports of physical goods (such as coal, beef and computers) and services (such as travel receipts). The balance of goods and services (BOGS) is a narrower description of Australia’s external position than the current account estimates. The import data is a useful gauge of consumer and business spending while exports reflect global demand as well as domestic influences such as drought.

What are the implications for interest rates and investors?

• The Reserve Bank would be heartened by the second wind in dwelling approvals. Housing activity is no doubt supporting the overall lift in spending and will continue to absorb the weakness in mining investment.
•  Overall the economy is on a solid footing and remains fundamentally sound. Given the low interest rate environment, falling Australian dollar and the lift in home prices, the Reserve Bank is likely to be watching for an improvement in labour market conditions before thinking about a lift in interest rates. We expect the Reserve Bank to maintain a neutral monetary policy stance, while keeping a close eye on the transition of growth from mining investment to other parts of the economy. Rates are expected to remain on hold over the rest of 2014.

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Just a minor lift in Aussie dwelling prices.

Australian dwelling prices took a breather in September after posting solid rises over the previous three months.  The small 0.1% increase means that prices are now 18.8% above the May 2012 trough and exceed the previous peak in October 2010 by 10.0%.  Annual growth has eased from a peak of 11.5% in April 2014.

Australia’s two largest cities, Sydney and Melbourne, have been driving the lift in national house prices.  Dwelling prices in Sydney rose by 0.8% in September while they fell by the same amount in Melbourne.  Prices rises in Sydney have shown no sign of slowing and are being fuelled largely by investor interest.  In Melbourne, however, dwelling price momentum has cooled largely in response to a lift in supply.  The forward looking indicators suggest that a lift in supply is forthcoming in Sydney.

Low interest rates and the expectation of future capital gains mean that investors in Australia are currently the major driver of the property market.  Lending to investors has risen substantially over the past year.  One consequence is that rental growth is likely to be weak as the proportion of dwellings available for lease lifts.

Policy makers have been showing increasing signs of concern at the investor driven property price surge.  Last week, the RBA published its semi‑annual Financial Stability Review (FSR) which echoed concerns in the September Board minutes around increased leverage on house price speculation.   The Bank has revealed it is in discussion with APRA and others about what steps “might be taken to reinforce sound lending practices”.  The debate about macroprudential policy has taken off as a result.

The RBA will front the Senate’s economics committee tomorrow for a special hearing on Thursday to explain the risks associated with the housing boom and the potential for macroprudential policy to be introduced.  We will be watching that space closely.

From a rates perspective, the rhetoric from the RBA around house prices has taken any further cuts right off the table and together with other factors will ultimately put rate hikes onto the agenda.

Table 1: RP Data‑Rismark Dwelling* Prices, September 2014

*All dwellings, median price.**Values are for houses only up to August

Click here to read the report.

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• Share markets had a rough week weighed down by a combination of worries about the Fed, tough action against US companies seeking to reduce their tax by relocating outside the US, worries about Chinese growth, geopolitical concerns and worries about the loss of breadth in the US share market rally. The poor global lead, falling iron ore prices and the retreat of foreign investors to the sidelines saw the Australian share market give up its gains for the year. Weakening share markets saw bonds rally across the board suggesting in part that investors fear that talk of US rate hikes is premature. The outlook for relatively tighter monetary policy in the US versus other major regions saw the US dollar continue to rally, leaving it up nearly 7% over the last three months, and this is also weighing on commodity prices. The falling iron ore price and the rising $US saw the $A continue its slide.
• Geopolitical threats are continuing. While the global threat from the Ukraine conflict seems to be receding a bit, the conflict with IS in the Middle East is hotting up bringing with it the threat of global terrorist activity. So far global oil supplies are not under threat, with the oil price running below the levels when IS in Iraq first started hitting the headlines. But increasing prospects for the deployment of ground forces in Iraq by the US and its allies and talk of the terrorist threat are weighing on investor confidence. Terrorist attacks are horrible in terms of their human consequences and there is no doubt that an IS terrorist attack in a western country would be taken badly by share markets. But the experience with various Al-Qaida related attacks (9/11, Bali Bombing, 2005 London bombings, etc) is worth recalling: after an initial negative impact share markets bounced back as it was clear that there would not be a major economic impact and it seemed the effect on markets weakened as the terror threat continued. It only took just over a month for the US share market to recover from its 12% post 9/11 slump and it took the UK share market 1 day to bounce back from its 1.3% fall on the day of the July 2005 London bombings.
• In Australia, the Reserve Bank’s Financial Stability Review expressed concern that the housing market is becoming too speculative and that if left unchecked poses risks to the broader economy for when the property cycle turns back down. As a result APRA has stepped up its surveillance of the banks and given the desire to avoid a rate hike at this point the RBA is discussing with APRA further steps that may be taken to ensure sound lending practices are maintained, particularly with respect to property investors. The focus looks like it may be on tougher capital requirements and interest rate tests banks apply when assessing new loans rather than restrictions on loan to valuation ratios. It’s likely that if the property market does not soon cool an announcement could be made in the next few months. To the extent that the use of macro-prudential controls might delay the first rate hike further into 2015, it could be good news for existing home borrowers.
• The term “macro prudential controls” is really just the latest buzzword for the failed credit rationing policies used prior to the 1980s. The RBA would be well aware of the risk of unintended consequences – eg, the potential impact on first home buyers many of whom are investors these days and in forcing borrowers into the shadow banking system – but it no doubt feels such controls are better than raising interest rates right now.
• The Australian dollar is continuing to slide helped by an ascendant US dollar, the continuing slide in the iron ore prices (now down 41% year to date) and the possibility that the use of macro-prudential controls to slow the housing market will further delay the first rate hike in Australia. Comments by Reserve Bank of NZ Governor Wheeler that the level of the $NZ was “unjustified and unsustainable” also helped as they apply just as much to the level of the $A. I remain of the view that by year end the $A will have fallen through the January low of $US0.8660 on its way to around $US0.80 over the next year or so. A lower $A will help rebalance the economy.

Major global economic events and implications

• US economic data remains mostly strong. While existing home sales surprisingly fell in August new home sales surged to a six year high, the Markit PMIs for September remained solid and durable goods orders continue to trend higher. While Fed officials are continuing to provide mixed messages on the timing of rate hikes its noteworthy that a couple of hawks will not be voting members at the Fed next year and so their calls for an earlier move by the Fed should be ignored. Our view remains that the Fed won’t start raising rates till around the June quarter, but the 7% gain in the $US since June has probably not been lost on Janet Yellen who would be thinking its delivering a de facto monetary tightening.
• Eurozone PMIs continued to edge down in September leaving them at levels consistent with only modest growth and ECB President Draghi described the recovery as losing momentum. There was a slight improvement in money supply and credit momentum, but not enough to allay the mounting pressure on the ECB.
• A slight fall back in Japan’s manufacturing conditions PMI for September was disappointing but leaves in place a gradual recovery after the April tax hike induced fall. Japanese core inflation excluding the impact of the tax hike is continuing to run around 0.5% year on year, which is better than deflation but not much of a buffer really. The latest leg down in the value of the Yen should help provide a further boost to inflation though.
• While Chinese officials continue to indicate there won’t be any major policy stimulus, it’s worth noting similar comments were made earlier this year before various mini-stimulus measures were introduced. An unexpected slight rise in the HSBC flash PMI for September helped relieve Chinese growth fears a bit.

Australian economic events and implications

• In Australia, job vacancies fell slightly over the 3 months to August according to the ABS but this followed  a 5.3% gain over the previous six months and skilled vacancies rose in August for the 11^th month in a row so the basic picture remains one of forward looking indicators pointing to stronger jobs growth ahead.

What to watch over the next week?

• In the US, the main focus will be on the ISM manufacturing and services indexes (due Wednesday and Friday respectively) which are both expected to remain strong and employment data (Friday) which is expected to show a 210,000 gain in payrolls for September and unemployment unchanged at 6.1%. Consumer spending data (Monday) is also expected to show that the Fed’s preferred inflation measure remained benign with a fall to 1.4% year on year.
• In the Eurozone, business confidence data (Monday) is likely to have weakened a bit further and September inflation (Tuesday) is likely to be just 0.3% year on year. Despite this, the ECB (Thursday) is unlikely to announce further monetary easing but may provide details of its proposed QE program involving asset backed securities.
• Japanese data for jobs, household spending, industrial production, labour cash earnings and housing starts due Tuesday will be watched for signs of further improvement following the impact of the April sales tax hike, but the September quarter Tankan business survey (Wednesday) is likely to have weakened slightly.
• In China, the official PMI (Wednesday) is likely to be little changed from the 51.1 reading for August.
• In Australia, given the RBA’s concern about the property market, credit data (Tuesday) and RP Data house price figures (Wednesday) for September may see greater than normal interest. Expect to see overall credit growth remaining modest but interest will be on whether growth in credit going to property investors accelerated from the roughly 10% annualised pace seen over the last few months. RP Data is expected to show that house price gains remained strong in September. Meanwhile, expect a modest gain in retail sales (Wednesday), a renewed deterioration in the August trade deficit (Thursday) and solid building approvals (also Thursday).

Outlook for markets

• Shares remain at risk of further short term weakness particularly ahead of the end of US quantitative easing next month, the US mid-term elections in November and as we are still in a seasonally weak part of the year for shares. Australian shares are also vulnerable in the short term to further falls in the iron ore price and as foreign investors stay on the sidelines as the $A falls.
• However, this is likely to be nothing more than a healthy correction, allowing shares to let off a bit of steam, and should be seen as a buying opportunity as the cyclical bull market in shares likely has further to go. We still don’t see the signs of shares being over valued, over loved and over bought normally seen at major market tops. Valuations remain okay, global earnings are continuing to improve on the back of gradually improving economic growth, global monetary conditions are set to remain easy and there has been no sign of investor euphoria.
• Although the falling $A is initially a drag on the Australian share market as foreign investors retreat to the sidelines, after a while it will start to become a source of support as it flows through to upwards revisions to earnings expectations. Roughly speaking each 10% fall in the value of the $A boosts company earnings by 3%.
• Low bond yields will likely mean soft returns from government bonds, particularly as we continue to edge closer to the start of a gradual interest rate tightening cycle in the US.
• The combination of soft commodity prices, the likelihood the Fed rate hikes before the RBA and relatively high costs in Australia are expected to see the broad trend in the $A remain down. Expect to see it fall to around $US0.80 in the next year or so.

By Dr Shane Oliver, Head of Investment Strategy & Chief 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) 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.

The post Weekly market & economic update – week ending 26 September, 2014 appeared first on AdviserVoice.

Financial Accounts; Population; Job Vacancies; Final Budget Outcome

• Household wealth stood at a record $7,780.6 billion at the end of June, up $97.4 billion or 1.3 per cent over the quarter. In per capita terms, wealth rose to a record $330,841 in the June quarter, up $2,860 over the quarter
• Population: Australia’s population grew by 111,500 people over the March quarter to 23,452,700. Annual population growth eased from 1.72 per cent to 1.69 per cent. Population growth is above decade averages in just NSW (32 per cent above decade averages) and Victoria (14 per cent above decade averages).
• Baby boom: In the year to March, 306,500 babies were born, just shy of the record 312,200 babies born in the year to September 2013. A total of 231,500 people migrated to Australia over year to March, well off the low of 172,100 in the year to December 2010.
• Job vacancies: Job vacancies fell by 0.7 per cent in the three months to August – the first fall in three quarters. Job Vacancies are up 4.1 per cent on a year ago.
• The final Federal Budget deficit for 2013/14 was $48.5 billion. The result was inflated by the contribution to bolster the Reserve Bank’s balance sheet.
• The Reserve Bank Governor was a panel discussant at the Melbourne Economic Forum. The Governor once again reiterated the concerns about the lift in house prices and “unbalanced” investor demand. The Governor was sceptical about using macroprudential tools “as a panacea” but is open to using them to ensure sustainable housing and  lending practices.

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• Global share markets mostly rose over the last week helped by indications from the Fed that it’s still in no hurry to raise interest rates, expectations that the ECB might have to provide more stimulus, the Scottish No vote removing risks over UK assets and the continuing slide in the Yen to a six year low providing a boost to Japanese shares. Chinese shares fell but only slightly thanks to signs of monetary easing. The combination of poor Chinese economic data and the falling $A weighed heavily on the Australian share market as foreign investors tend to retreat to the sidelines whenever the $A is under threat.  Bond yields were little changed but the $US continued its ascent which in turn saw the Australian dollar remain under pressure and falling below $US0.90.
• The US Federal Reserve provided no surprises with another $US10bn taper to its QE program leaving it on track to end next month and an ongoing assessment that considerable labour market slack remains and that a “considerable time” is likely to elapse between the end of QE and the first rate hike. However, the Fed is incrementally continuing to become less dovish with Fed officials’ “dot plot” of interest rate expectations getting revised up slightly and Janet Yellen highlighting that the timing of the first rate hike is dependent on how the economy performs. Our assessment remains that the Fed can afford to take its time for now, but in the June quarter next year it will start to gradually raise rates. The anticipation and then the reality of this could cause bouts of share market volatility – particularly whenever there is a run of strong US economic data, but it’s unlikely to derail the bull market as rate hikes will be reflecting strong economic and profit conditions.  Only when interest rates reach onerous levels will there be a significant problem, but that will be a fair way off.
• Thankfully common sense prevailed in Scotland and the No vote won. This is good news for UK and Scottish assets and more broadly for the Eurozone as other pro-independence movements likely the Catalonians in Spain weren’t given the encouragement a Scottish Yes vote might have provided. Catalonia’s potential referendum for November will be the next one to watch though.
• The Ukraine crisis may be heading towards a resolution of sorts, with the Ukrainian Parliament granting a degree of autonomy to the eastern regions currently in conflict. There may still be more to go before the conflict is resolved, but with Russia describing the move as positive we may be getting to the point where Ukraine starts to recede as an issue for investment markets.
• In Australia, the minutes from the RBA’s last meeting repeated the “period of stability” mantra on interest rates but expressed more concern about the growth in investor housing credit and house prices. The RBA is stuck between a rock – in terms of the risk of accelerating house prices – and – a hard place in the form of the Australian dollar which remains too high, despite recent falls. The best approach is likely to be more jawboning to the effect that home buyers need to be cautious and that the $A remains overvalued. If the property market does not cool down a bit and the $A remains too high, I suspect that the RBA may then be tempted to go down the path of encouraging APRA to raise the risk weighting for home loans rather than start raising interest rates.
• Right now the Australian dollar is going in the right direction helped by the Fed’s gradual move towards monetary tightening. There is a bit of technical support around $US0.89 but I expect that by year end the $A will have fallen through the January low of $US0.8660 on its way to around $US0.80 over the next year or so. A lower $A will provide a shot in the arm for trade exposed sectors of the economy at a time that we need them to perk up as mining investment slows.

Major global economic events and implications

• US economic data was mostly favourable with solid growth readings but low inflation. Industrial production unexpectedly slipped in August, but strong regional manufacturing surveys point to a bounce back this month. While housing starts and permits fell this was only after a huge surge in July and a stronger than expected gain in the NAHB homebuilder index points to strength head. Finally, jobless claims fell and household net wealth rose 10% over the last year, providing a strong wealth boost. Meanwhile, inflation remains low with headline and core CPI inflation falling to 1.7% year on year in August which partly explains why the Fed is in no hurry.
• Bank take-up of the ECB’s first auction of cheap funding under its new Targeted Long Term Refinancing Operation (TLTRO) program was around half expectations at €83bn, which may partly reflect bank caution ahead of the ECB’s review of the quality of their assets. So hopefully the next auction in December will see more interest, but in the meantime it puts pressure on the ECB to quickly ramp up its quantitative easing program.
• In China a sharp fall in the MNI business indicator suggests that the growth slowdown may have continued into September and home prices continued to fall in August with average prices down just over 1% with virtually all cities seeing falls. Meanwhile, the Chinese central bank may be reacting to the growth slowdown with reports that it is providing RMB500bn to the major banks and a fall in the 14 day money market rate. While a cut to the PBOC’s 12 month benchmark interest rate would be more appropriate as Chinese interest rates remain too high for the Chinese private sector, its latest moves are welcome and highlight that the authorities are prepared to support growth.

Australian economic events and implications

• There were only secondary data releases in Australia over the last week and they were all soft. Auto sales and the Westpac leading index both fell in August and the weekly ANZ Roy Morgan consumer confidence index fell slightly.

What to watch over the next week?

• Globally, the main focus in the week ahead will be the release of September business conditions PMIs (Tuesday) in China, Europe and the US. The flash HSBC manufacturing PMI for China will be watched to see whether the latest slowdown continued into September, Eurozone PMIs are expected to remain off their previous highs and the US PMI is expected to remain strong.
• In terms of other US data, expect further gains in existing homes sales (Monday) and new home sales (Wednesday), a fall back in headline durable goods orders (Thursday) after the aircraft inspired surge seen in July but a continuing trend rise in underlying orders and another upwards revision to June quarter GDP growth (Friday) to 4.6% annualised from 4.2%.
• Japanese inflation data will be released Friday, but is being boosted by the April sales tax hike. Excluding this it’s likely to remain around 0.5% year on year on a core basis, which is better than the deflation that prevailed for a long time but still has a fair way to go to reach the 2% inflation target.
• In Australia, the RBA’s half yearly Financial Stability Review (Wednesday) is likely to indicate that the financial system remains in good shape, but express concern that the residential property market may be getting too hot and potentially posing risks for financial stability in the future if it continues to hot up. Speeches by RBA Governor Stevens (Thursday) and Assistant Governor Richards (Friday) will be watched for further comments on how the RBA sees the risks around the property market, the broader economic outlook and the $A. They are likely to reinforce the rates on hold message. Data for job vacancies will also be released.

Outlook for markets

• Shares are still at risk of occasional corrections particularly ahead of the end of US quantitative easing next month, the US mid-term elections in November and with September and October often proving volatile for shares. Australian shares are also vulnerable in the short term to further falls in the iron ore price and as foreign investors stay on the sidelines as the $A falls.
• However, occasional corrections are healthy in allowing shares to let off a bit of steam and should be seen as a buying opportunity as the cyclical bull market in shares likely has further to go. We still don’t see the signs of shares being over valued, over loved and over bought normally seen at major market tops. Valuations remain okay, global earnings are continuing to improve on the back of gradually improving economic growth, global monetary conditions are set to remain easy and there is no sign of investor euphoria.
• Our year-end target for the ASX 200 remains 5800. Although the falling $A is initially a drag for the Australian share market as foreign investors retreat to the sidelines, after a while it will start to become a source of support as it flows through to upwards revisions to earnings expectations. Roughly speaking each 10% fall in the value of the $A boosts company earnings by 3%.
•  Low bond yields will likely mean soft returns from government bonds, particularly as we continue to edge closer to the start of a gradual interest rate tightening cycle in the US.
• The combination of soft commodity prices, the likelihood the Fed will start raising interest rates ahead of the RBA and relatively high costs in Australia are expected to see the broad trend in the $A remain down. Expect to see it fall to around $US0.80 in the next year or so.

By Dr Shane Oliver, Head of Investment Strategy & Chief Economist

————-

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.

The post Weekly market & economic update – week ending 19 September, 2014 appeared first on AdviserVoice.

George Lucas

Two events are set to grab the most attention this week – the outcome of the US Federal Reserve’s policy meeting and the referendum on Scottish independence. Both are important for currency markets, which is where most of the action has been taking place recently.

Dollar domination

The US Dollar continues to rally boosted by the relative strength of the US economy. We believe this theme has a lot further to run as the divergence widens between the US, Japan and the Eurozone with regards to the outlook for monetary policy.

Further support for the US Dollar came in the form of a technical note issued by economists at the San Francisco Federal Reserve who pointed out that market expectations for the path of US interest rates is lower than that anticipated by the Federal Open Market Committee (FOMC).

This also caused a sell-off in US long bonds with 10-year treasury yields back up to around 2.60% (from below 2.40%) in a matter of weeks.

These events demonstrate the sensitivity of markets to what the Fed has to say after this week’s meeting. The focus will be on nuances in the Fed’s language that indicate any potential amendment to the pledge to keep rates on hold for a “considerable time”.

Looking at recent data – including stronger retail and lending figures as well as lower petrol prices, job growth and easier lending conditions – we expect the market will need to get used to the idea of a sooner-than expected rate rise, most likely in the second quarter of next year.

Scottish referendum

The British Pound has been weakening against the US Dollar driven by shifts in yield differentials and the fall in the Euro.

If the Scots vote ‘aye’ to their referendum for independence this week, there is likely to be further fallout for the Pound. Longer term, there will be other implications across the European region.

China numbers disappoint

Numbers released by China over the weekend were disappointing and likely to lead to more stimulus measures. The poor data included:

• Lower fixed-asset investment driven by cooling property investment
• Reduced industrial production driven by a slowdown in infrastructure spending
• Lower-than-expected retail sales despite recent indicators suggesting the labour market remains strong
• A slowdown in year-on-year outstanding credit growth – a drop in outstanding social financing from 15.9% y/y in July to 15.1%.

Whilst all these credit indicators are a negative for China in the near term, it’s a good sign that there is a focus on weaning China off its dependence on credit to a more sustainable growth trajectory.

Finally, Australia

A final word on Australia where the economy is still adjusting to a sharp slowdown in mining investment but is doing better than expected. We expect the RBA to maintain its view and keep the target cash rate at its current low level of 2.5%.

With regards to currency, the Australian Dollar is currently the only G10 currency that is up against the USD for the year.

By George Lucas, Managing Director, Instreet Investment

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