Chief Economist and Head of the Investment Strategy team
Most share markets had a good week helped by improved confidence regarding US growth, increasing signs that the global oil market is rebalancing, helping the oil price and energy shares, and Greece and its creditors agreeing a new debt deal. US shares rose 2.3%, Eurozone shares gained 3.4%, Japanese shares rose 0.6%, Australian shares gained 1% but Chinese shares fell 0.5%. Oil and metal prices gained and the Australian dollar fell as the US dollar rose. Bond yields were little changed but peripheral European yields fell on the Greek deal.
The message from the US Federal Reserve (the Fed) remains that a rate hike is getting closer, but July still looks more likely than June. Fed regional presidents continue to wax lyrical on rate a hike (which makes me wonder whether Fed transparency is really a cacophony) but it’s worth reiterating that many of them don’t vote and they tend to be more hawkish than key Fed decision makers. Comments by Fed Chair Janet Yellen and Governor Jerome Powell were more meaningful in indicating a likely rate hike in the coming months if economic data comes in as expected, but suggesting no great urgency for June over July, and a need to manage the risks and ongoing caution in raising rates. It’s a close call but July still seems more likely.
Why are markets so far more relaxed about a Fed rate hike? Several reasons: 1/ more confidence in US/Chinese and global growth; 2/ Fed caution and delays have provided confidence it is not going to be reckless; 3/ the global oil market is rebalancing, helping stabilise the oil price and reducing the risks for oil producers; and 4/ less concern about a collapse in the renminbi. Of course this could all change if the US dollar takes off big time again, but so far so good.
While the oil market may be rebalancing (with supply cutbacks in the US & outages in Canada, Nigeria and Libya) this is not the case for iron ore where the price is on its way back down as the global steel glut remains. After spiking to $US70/tonne early this year it’s now back around $US50 a tonne.
Brexit risk receding? Polls appear to be edging in favour of a remain outcome from the 23 June referendum as opposed to a leave. In my view the case to leave is dubious because it would be a big negative for the UK financial sector and would either harm UK free trade with the EU (if no trade deal is agreed after a leave vote) or lead to reduced national sovereignty if a trade deal is cut (because the UK would have to agree to EU rules but have no say in setting them). Perhaps this logic is starting to set in. The end of the migration crisis in Europe (sea arrivals have collapsed to 12,000 in April from 220,000 last October) may also help the remain case.
No Grexit scare this summer. I know it didn’t get much coverage (why bother to report good news, it doesn’t sell), but Greece, the EU and the IMF agreed a new debt deal which will see €10bn disbursed. This is good news because it means there won’t be another Grexit scare this summer. Bond yields in Spain and Italy also fell in response.
Major global economic events and implications
US data again provided mixed messages over the last week. On the one hand business conditions PMIs slipped in May and core durable goods orders were weak in April. However against this home prices continue to rise, new and pending home sales surged, the advance goods trade balance for April was better than expected, jobless claims fell again and March quarter GDP growth was revised up slightly to 0.8%. The overall impression remains that US growth has bounced back in the current quarter with the Atlanta Fed’s GDPNow GDP tracker now running at 2.9%, but growth is averaging out around 2% or slightly less, so the trend is still not overly strong. However this is a long way from the recession obsession of earlier this year.
The news out of Europe was okay. Sure, PMIs fell in May, but only fractionally and they continue to point to moderate growth.
Japanese data was soft with a further fall in the May manufacturing conditions PMI to a weak 47.6 and a higher trade surplus due to weaker imports. GDP may be falling again. Meanwhile, national core inflation remained low at just 0.7% yoy in April, with Tokyo data pointing to a further fall in May. Expect more fiscal and monetary stimulus in the next month or so.
Australian economic events and implications
In Australia, the business investment slump continues with March quarter construction and capital expenditure data (or capex) falling more than expected. Mining investment remains the main driver and business plans point to ongoing, mainly mining driven weakness, over the year ahead. The ABS’ capex intentions surveys are continuing to fall compared to estimates made a year ago (see the next chart) and point to a roughly 20% decline in capex in the next financial year driven by a further 35% slump in mining investment. So capex remains an ongoing detractor from growth.
However, there are some positives. Dwelling construction rose again in the March quarter and the slump in mining investment over the year ahead will take it back to around its long-term norm as a share of GDP, so its growth detraction will fade (see the next chart). The outlook for non-mining investment is starting to look a bit less bleak with non-mining capex plans edging up from year-ago levels. That said, the economy will still need help from lower interest rates and a lower Australian dollar to help offset the growth gap over the year ahead from falling mining investment.
RBA Governor Stevens provided a solid defence of the RBA’s inflation targeting approach, indicating he “does not agree” with proposals to adjust the target. I agree.
What to watch over the next week?
In the US, the May manufacturing conditions ISM (Wednesday) and jobs data (Friday) will be watched as a guide as to how the US economy performed in May, and both will take on greater than normal significance ahead of the Fed’s June 14-15 meeting. The manufacturing ISM index is expected to fall slightly to around 50.5, payroll employment is expected to rise by an okay 170,000, unemployment is expected to fall back to around 4.9% and average wage earnings growth may edge up slightly from 2.5% year on year. Meanwhile, expect stronger personal spending for April but core private consumption inflation remaining around 1.6% year on year, continued gains in home prices and an improvement in consumer confidence (all due Tuesday) and a solid reading for the non-manufacturing ISM (Friday).
In the Eurozone, the ECB (Thursday) is unlikely to announce any changes to its monetary stimulus program given the big extra stimulus it provided earlier this year. Expect confidence readings for May (Monday) to hold around levels consistent with moderate growth, core inflation for May to have remained low at around 0.7% year on year and unemployment (both Tuesday) to have edged down to 10.1%.
In Japan, expect solid jobs data but soft household spending and industrial production (Tuesday). PM Abe is likely to announce a delay in the consumption tax hike.
Chinese manufacturing PMIs for May (Wednesday) are expected to slip slightly from April levels. So the message out of China is likely to remain one of continued growth around 6.5% to 7%. No bust but no growth acceleration either.
In Australia, the key focus will be on March quarter GDP (Wednesday) which is expected to show growth of 0.7% qoq and annual growth slowing back to around trend of 2.7% yoy helped along by consumer spending, housing investment and net exports but constrained by falling capex. Meanwhile, expect falls in April data for new home sales (Monday) and building approvals (Tuesday) after solid gains in March, continued moderate credit growth (also Tuesday) and a 0.2% gain in April retail sales (Thursday). Data for home prices, the trade deficit and PMIs will also be released.
Outlook for markets
Expect short term share market volatility to remain high, with significant event risk in the next month or so (Fed meeting, Brexit vote, Spanish election, Australian election) and the fear of “sell in May and go away, come back on St Leger’s Day”. However, beyond near-term volatility, we still see shares trending higher this year helped by a combination of relatively attractive valuations, ultra easy global monetary conditions and continuing moderate global economic growth.
Very low bond yields point to a soft medium-term return potential, but it’s hard to get bearish in a world of fragile growth, spare capacity and low inflation.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors.
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 price growth is likely to pick up in Brisbane.
Cash and bank deposits offer poor returns.
After its recent fall from U$S0.78 the Australian dollar is technically oversold and due for a bounce. However, any bounce is likely to be limited and the longer-term downtrend looks to be resuming as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed resumes hiking, commodity prices remain in a secular downswing and the Australian dollar sees its usual undershoot of fair value.