Keep an eye on the RBA – The Experts

Keep an eye on the RBA

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By Shane Oliver

Investment markets and key developments over the past week

Global share markets pushed higher over the last week as solid economic data and ongoing talk of US tax reform more than offset continuing North Korea worries. US shares rose 0.7%, Eurozone shares gained 1.3% and Japanese shares rose 0.3%. Chinese and Australian shares were flat though. Bond yields generally rose but commodity prices were mixed with oil and copper up but gold and iron ore down. The $A fell, reflecting a stronger $US and a falling iron ore price.

September saw US shares up 1.9%, Eurozone shares up 4.4% and Japanese shares up 3.6% compared to a 0.6% decline in Australian shares. Softer earnings prospects are likely to see Australian shares remain a relative underperformer for a while yet.

Don’t exaggerate the significance of the German election. The election result which saw reduced support for Angela Merkel’s Christian Democrat Union (CDU) led coalition and the Social Democrats in favour of the far right anti Euro Alternative for Deutschland and the pro Europe Free Democrat Party has led to concerns about what it means for Europe.  A so called “Jamaica coalition” with the CDU/CSU, Free Democrat Party and the Greens looks doable but will take months to negotiate (they always do) and the FDP may seek to hold European integration back. However, there is a danger in exaggerating all this. First, the AfD only got 12.6% of the vote – this is not Brexit or Trump! Second, the AfD’s support largely owes to the 2015 immigration crisis which has already subsided and Merkel will likely undertake a further strengthening of border controls. Third, the very pro-EU Greens will act as a counterbalance to the FDP in a coalition government. Finally, Germans are very pro Euro with 81% support for it so talk of a threat to the Euro is grossly exaggerated. Move on to the next issue!

Speaking of elections, Japan’s PM Shinzo Abe confirmed an election for October 22. Early strong poll support for the new Party of Hope with which the Democrat party is now merging, suggests that Abe and the LDP are not guaranteed of victory. However, it’s doubtful the new party will have enough time to fully get its act together so Abe is most likely to win but with a reduced majority. Abe has already announced that part of the 2019 consumption tax increase will be used to finance new spending and more fiscal easing is likely. If Abe is returned as we expect it’s unlikely to change the relative attractiveness of Japanese assets (positive on shares, negative on the Yen).

Finally, again on elections, the October 1 Catalan independence referendum – to the extent that it even occurs given Spanish Government moves to block it – is unlikely to be of significant relevance to global investors. It’s essentially a Spanish issue with not much relevance to the Eurozone. Under the Spanish constitution the referendum is illegal (hence the moves to stop it by the Spanish Government) and opinion polls show that around 56% of the Catalan population view it as such. Polls also show that less than 35% of Catalans support independence, down from nearly 50% in 2012 and around 55% would prefer to stay in Spain with more autonomy – although there is a risk the Spanish Government moves to stop the referendum will boost pro-independence support. But given all these issues and that the disrupted referendum won’t be able to be interpreted as providing any mandate, independence is a long way off if at all and even if it is eventually achieved Catalonia wants to stay in the Euro, so the whole issue has little to do with the survivability of the Euro.

Major global economic events and implications

US activity data was mostly solid, but core inflation remains weak. August home sales were down on hurricane effects and low inventory levels and the hurricanes dampened August household spending, but home prices are rising solidly, consumer confidence remains strong, August durable goods orders were robust and regional manufacturing conditions indexes are strong. While core private consumption deflator inflation surprised on the downside for August at 1.3% year on year, it is likely to pick up a bit by year end. Fed Chair Yellen provided balanced comments on monetary policy, reiterating the case to be gradual in raising rates but not too gradual. This is consistent with our view that the Fed will hike rates again in December, all of which is positive for the US dollar. More details were provided of US tax reform plans – they have a long way to go to make it through Congress but our view remains that ultimately some form of tax cuts will be passed early next year. Which would also add to upwards pressure on the $US.

Strong Eurozone activity data but still low inflation. Eurozone economic confidence rose again in September, supporting the view that growth in Europe has picked up. Against this inflation remains well below target, with core inflation falling to 1.1% yoy (from 1.2%), suggesting that the ECB will remain cautious in moving to slow money printing.

Strong Japanese activity data but still low inflation (too). Japanese labour market indicators and industrial production remained strong in August and household spending growth picked up. Core inflation rose to 0.2% yoy, but it’s still well below the Bank of Japan’s 2% objective. So don’t expect any early exit from ultra easy monetary policy in Japan.

Chinese profit growth accelerated in August to 24% year on year (from 16% in July) and while the Caixin manufacturing PMI fell slightly in September, the official manufacturing and services PMIs rose, suggesting any growth slowdown is mild.

Australian economic events and implications

It was a relatively quiet week on the data front in Australia. ABS job vacancies for August remained strong, pointing to continuing solid jobs growth and credit growth remained moderate with an ongoing moderation in the growth of credit to property investors relative to owner occupiers. Two things are particularly worth highlighting though from the last week.

First, for the first time in years the latest Federal budget update showed an improvement with the final 2016-17 underlying budget deficit coming in $4.4 billion lower than had been estimated in the May Budget. This is good news, but wages growth needs to pick up for the improvement to continue.

Second, population growth remained robust at 389,000 people or 1.6% over the year to the March quarter, with immigration offsetting slowing natural growth. All of which provides a strong support for economic growth, helps slow the ageing of the population compared to other countries and underpins strong underlying demand for housing. The latter in turn helps reduce the risk of a property price crash. This is particularly the case in Victoria where the population is growing by a whopping 2.4% year on year or by nearly 150,000 in contrast to population growth in NSW of 1.6% yoy or 123,000. Its little wonder that the Melbourne property market is holding up better than Sydney’s and if this continues its likely that Melbourne property prices will rise relative to those in Sydney.

In terms of unit supply it’s worth noting that Rider, Levett, Bucknall residential crane count rose further in September to 551 (compared to 128 three years ago) with Sydney rising to 298 cranes and Melbourne rising to 124. Falls in building approvals suggest that we are at or close to the peak but there is clearly still a big pipeline of work to be completed.

Source: RLB Crane Index, AMP Capital

What to watch over the next week?

In the US, the focus is likely to be on September jobs data (Friday) which is likely to have been temporarily distorted by the impact of hurricanes Harvey and Irma, so expect payrolls to be up by a relatively subdued 90,000. Unemployment is likely to have remained at 4.4% though and wages growth is likely to be rise slightly to 2.6% year on year. Meanwhile expect the September ISM manufacturing conditions index (Monday) and the non-manufacturing conditions index (Wednesday) to remain strong. Fed Chair Yellen has another speech on Wednesday.

In the Eurozone, expect unemployment (Monday) to have fallen to 9% in August.

In Japan, the September quarter Tankan business conditions survey is expected to show continued strength.

In Australia the RBA is expected to leave interest rates on hold for the fourteenth month in a row. Improving global growth, strong business confidence and jobs growth, the RBA’s own expectations for a growth pick up and already high levels of household debt argue against a rate cut. But record low wages growth, low underlying inflation, the impending slowdown in housing construction, risks around the consumer and the strong $A argue against a rate hike. We agree that the next move in rates is likely to be up, but for now the downside risks are still significant and as such we remain of the view that its way too early to start raising rates just yet.

On the data front in Australia, expect CoreLogic home price data (Monday) to show some continued moderation in Sydney (and hopefully Melbourne) property price growth in September, building approvals to rise 1% (Tuesday), retail sales to show modest growth of 0.2% and the trade surplus (both Thursday) to improve. Business conditions PMIs are likely to remain solid.

Outlook for markets

We remain in a seasonally volatile time of the year for shares, North Korean risks remains high and Wall Street is overdue for a decent 5% or so correction which would affect other share markets. However, beyond short term uncertainties we remain in a sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions – so we remain of the view that the broad trend in share markets will remain up. This should eventually drag Australian shares up from the range bound malaise they have been in since June.

Low starting point bond yields and a likely rising trend in yields will likely drive poor returns from bonds.

Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.

Residential property price growth in Sydney and Melbourne is likely to have peaked with a slowdown likely over the next year or two, but Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.25%.

While further short term upside in the $A is possible, our view remains that the downtrend from 2011 will ultimately resume as the Fed continues to tighten and the RBA remains on hold into next year.

Published: Monday, October 02, 2017

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