31 March 2017
Stronger global economic data dominated the action over the last week, offsetting some of the fears around whether President Trump will be able to pass his pro-business policies through Congress. So while Japanese shares fell 1.8% and Chinese shares lost 1%, US shares rose 0.8%. Eurozone shares gained 1.6% and Australian shares rose 1.9%. Commodity prices mostly rose and the Australian dollar rose slightly. Bond yields mostly fell.
The UK has finally lodged its notification to the European Union to formally start up to two years of divorce proceedings. Ho hum! It’s been talked about for so long that markets barely reacted. There will be a long way to go with lots of noise. The European Union will be a tough negotiator as membership of it brings benefits and obligations so there is a high risk of a hard Brexit. Just remember though that the UK is only 2.5% of global gross domestic product and there has been no evidence that the Brexit vote led to a domino effect of other countries looking to exit as well (in fact the three Eurozone elections since Brexit have seen less support for anti-Europe populists). So there is no need for investors to get excited about it.
US Congress will remain an ongoing source of noise for investors but what’s new? While the failure of the Obamacare reforms has led to a quick shift to focussing on tax reform, negotiations amongst House Republicans around a passable health care bill appear to be continuing so it’s not dead in the water. Talk of another government shutdown is also likely start to escalate through April as a new continuing resolution funding spending will need to be passed by 28 April. Ongoing dysfunction in Congress means that a shutdown is possible but as the 2013 experience showed it’s not in either the Republican’s or Democrat’s interest to be seen as the cause. So our base case (70% probability) is that a deal will be worked out when required. And then of course around July to September the debt ceiling will need to be raised again or further suspended which might bring us back to the old “will the US government default?” debate. Again our view is that this will be solved too but it could go down to the wire. All up this is really just more of the same but as long as Trump gets something through at least on tax cuts, share markets should be reasonably happy. Meanwhile, he is continuing to wind back business regulation with the latest being the lifting of a number of restrictions on energy companies and with the Administration signalling mostly modest changes to the North American Free Trade Agreement in relation to Mexico, the Mexican Peso is up 15% from its January low.
The Australian Prudential Regulation Authority’s long awaited additional macro prudential tightening adds to the likelihood that the Sydney and Melbourne property markets will start to slow. The main change from the Australian Prudential Regulation Authority was an expectation that lenders limit interest only loans to 30% of new mortgage lending (from around 40% at present), strict limits on loan to value ratios above 80% for interest only loans along with an expectation that lending to investors remains “comfortably below” the 10% growth limit, that serviceability measures remain “appropriate” and that lending to high risk categories is “constrained”.
Source: APRA, AMP Capital
That the Australian Prudential Regulation Authority moved again was no surprise (they should have done something last year!), but the main surprise was that the investor lending speed limit remains at 10% rather than being cut to a more reasonable 5-7%. Limiting interest only lending may have the same effect as cutting the speed limit because around 60% or more of investor loans are interest only, but time will tell so further action may be required. Putting that uncertainty aside though, the latest moves by the Australian Prudential Regulation Authority, coming on the back of bank mortgage rate hikes over the last two weeks, the likelihood of action to boost affordability in the May budget (including a cut to the capital gains tax discount), the surge in unit supply at a time of silly prices are all likely to result in a slowdown in property price gains in Sydney and Melbourne this year ahead of a 5-10% price fall starting next year some time. In the short term all eyes will be on Saturday’s auction clearance rates to see whether there is much headline impact from the Australian Prudential Regulation Authority’s moves!
Our thoughts are with those affected by Cyclone Debbie along Australia’s north east coast. While it’s too early to know the full extent of the damage, economic disruption (to crops, tourism, mining activity, etc.) could knock 0.1 to 0.2% from gross domestic product growth spread across the March and June quarters (but mainly the latter). It will also likely give a boost to headline inflation via higher fruit and vegetable prices in the June quarter as the area is a major supplier of bananas, tomatoes, etc. The Reserve Bank of Australia will tend to look through these affects as they will be temporary.
Major global economic events and implications
US data over the last week was mostly strong with consumer confidence at its highest since 2000, home prices continuing to rise, pending home sales up strongly, jobless claims remaining low, December quarter gross domestic product growth being revised up and the goods trade deficit narrowing. Against this though, personal spending remained weak in February. Core personal consumption deflator inflation rose to 1.8% year on year continuing to edge towards the US Federal Reserve’s 2% target.
Eurozone sentiment readings were strong with economic sentiment about as high as it ever gets and strong readings for the German IFO business conditions index. Against this, Eurozone bank lending data was weaker than expected in February and core inflation fell to 0.7% year-on-year which looks temporary but still highlights inflationary pressures are very low.
Japanese data for February was mixed with strong industrial production and labour market data but household spending remaining weak and core inflation stuck around zero.
China’s business conditions Purchasing Managers’ Index data rose in March indicating growth continues to edge up. It’s increasingly looking like the growth up tick is broadening out beyond the initial impact of last year’s policy stimulus in particular into private sector services companies. It’s consistent with policy makers continuing to tap the brakes (with more cities imposing housing curbs).
Australian economic events and implications
In Australia new home sales showed a continued gradual downtrend, job vacancies remained solid and private credit growth slowed further led by weak business lending. Of most interest in the credit data was a pickup in lending to property investors to 6.7% year on year and over the three months to February it grew at annualised pace of 8.3% compared to just 4.3% a year ago. No wonder the regulators are looking to ensure it does not continue to accelerate.
What to watch over the next week?
In the US, expect the March Institute for Supply Management manufacturing and non-manufacturing conditions indices (Monday and Wednesday) to remain strong and jobs data (Friday) to show solid payroll growth of 175,000 with unemployment unchanged at 4.7% but wages growth stuck at 2.8% year on year. Trade data (Tuesday) is likely to show a reduced deficit. The US data flow in the week ahead along with the minutes from the last US Federal Reserve meeting (Wednesday) will likely to do nothing to alter expectations for another two or three rate hikes this year. A vote on Neil Gorsuch’s nomination to the Supreme Court will be watched closely as a guide to future Republican/Democrat “cooperation” and the summit between Trump and China’s President will be watched to see how trade tensions evolve.
The Japanese Tankan business survey (Monday) is likely to show a further improvement in business confidence.
In Australia, the Reserve Bank of Australia is expected to leave rates on hold at 1.5% for the eighth month in a row when it meets on Tuesday. A rate cut is unlikely because economic growth has bounced back after its September quarter slump, the Reserve Bank of Australia expects that underlying inflation has bottomed and will gradually rise and the Sydney and Melbourne property markets are uncomfortably hot posing financial stability risks. By the same token its way too early to be thinking about rate hikes as underlying inflation risks staying below target for longer, the Australian dollar is too high, unemployment and underemployment at over 14% combined are way too high and out of cycle bank mortgage rate hikes have delivered a de facto monetary tightening any way. The Reserve Bank of Australia has to set interest rates for the average of Australia so raising interest rates just to slow the hot Sydney and Melbourne property markets would be complete madness at a time when growth is still fragile and underlying inflation well below target. The best way to deal with the hot Sydney and Melbourne property markets and excessive growth in property investor lending into those markets is through tightening macro prudential standards, which the Australian Prudential Regulation Authority has again moved to do.
On the data front in Australia, expect to see a 0.2% gain in February retail sales, a 0.5% rise in building approvals and continued strength in home prices in March according to CoreLogic led by Sydney and Melbourne (all due for release Monday) and a continued trade surplus (Tuesday). The AIG business conditions Purchasing Managers’ Index data will also be released.
Outlook for markets
Shares remain vulnerable to a short term pull back as investor sentiment towards them is very bullish and a lot of good news has been factored in which has left them vulnerable to any bad news. But putting short term uncertainties aside, with valuations remaining okay, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we continue to see any pullback in shares as opportunities to “buy the dips”. Shares are likely to continue to trend higher on a 6-12 month horizon.
With the Australian share market having broken decisively above the 5,800 level, it now looks like it’s on its way to a retest of the March/April 2015 intraday highs of just below 6,000.
Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. At present bond yields are still consolidating after last year’s rise, but a resumption of the bear market is likely at some point in the months ahead seeing a gradual rise in yields.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher over the medium term.
National residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of Sydney and Melbourne.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.
For the past year the Australian dollar has been range bound between $US0.72 and $US0.78 and this may continue for some time yet. At some point this year though, the downtrend in the Australian dollar from 2011 is likely to resume as the interest rate differential in favour of Australia narrows (as the US Federal Reserve hikes 3 or 4 times and the Reserve Bank of Australia remains on hold).