AMP Capital – 23 September 2016
With central bank announcements from the Bank of Japan (BoJ) and the US Federal Reserve (Fed) out of the way and benign, share markets rose over the last week, bond yields fell, commodity prices rallied and the US dollar fell. US shares rose 1.2%, Eurozone shares gained 3.1%, Japanese shares rose 1.4%, Chinese shares gained 1.1% and Australian shares rose 2.5%. With the US$ down and “risk on” the A$ rose above $US 0.76.
The past week has been all about central banks and the news was clearly far better than feared – certainly nothing to support the “out of bullets” fears of a couple of weeks back.
First up, while the Bank of Japan’s announcement lacked the “shock and awe” seen in the early days of ‘Abenomics’, it dramatically ramped up the effort of getting inflation expectations up, by committing to overshooting on its 2% inflation target and expanding its monetary base (mainly via quantitative easing) until this is achieved. In other words it’s now locked into quantitative easing indefinitely. And in an effort to help Japanese banks, it committed to preventing a flatter yield curve. The BoJ also stressed it’s not out of options for additional action. I remain sceptical that without the adoption of “helicopter money”, the BoJ will continue to struggle to meet its inflation target, particularly with the Yen remaining around 100 to the US$. But the BoJ’s announcement was more aggressive than investors expected and is a long way from the central bank surrender that some had feared.
While the Fed was on hold as expected, perhaps the big surprise was that its comments were only mildly hawkish. On the one hand it judged that the case for a rate hike has “strengthened”, that the risks to the economic outlook are now “roughly balanced” and there were three dissents in favour a rate hike. On the other hand, it is still waiting for more evidence of progress towards its objectives. Chair Janet Yellen repeated that the Fed being able to more effectively respond to rising inflation than to falling inflation is a reason for their caution. The Fed continues to refer to only “gradual” increases in interest rates and their “dot plot” of meeting-participants’ interest rate expectations continues to decline. The dot plot is now showing just one hike this year, only two hikes next year and expectations for the long run natural rate have fallen further to 2.9% (from 3% in June).
Source: US Federal Reserve, Bloomberg, AMP Capital
Our base case remains for the Fed to hike at its December meeting, but this will require more consistently positive economic data from the US over the next three months. For share markets, the Fed remains broadly supportive, although volatility will no doubt increase again as we get closer to the December meeting.
In Australia, new Reserve Bank of Australia (RBA) Governor Philip Lowe and the Treasurer have recommitted to a medium term inflation target of 2-3% by enhancing the flexibility around the target and referencing the importance of guiding expectations. Inflation targeting has been good for Australia and lowering the target, as some have suggested, would have just lowered its credibility. Meanwhile, emphasising the flexibility around the target highlights that the RBA does not have to mechanically keep cutting just because inflation is below target, but by the same token, the reference to ‘guiding expectations’ highlights that inflation needs to come back to target within a reasonable time frame. These two adjustments probably just cancel each other out in terms of what it means for monetary policy in the months ahead. On this front, the minutes from the RBA’s last board meeting and Governor Lowe’s parliamentary testimony were pretty neutral on the outlook for rates. The outlook for low inflation, the upside risks to the Australian dollar as a result of ongoing global monetary stimulus and Fed delays and the need to manage inflation expectations supports our expectation for another rate cut, but the solid economic growth outlook and the risk of financial instability (related in particular to the housing sector) argue against another move. So we continue to regard our outlook for another cut as a close call. With Lowe saying that whether another rate occurs is going to depend amongst other things on “what the next inflation data look like”, the September quarter inflation release in late October will clearly be critical ahead of the RBA’s November meeting. When asked if the RBA is running out of policy options Governor Lowe responded “not at all”. That said I don’t think he will have to ease policy much more anyway.
Finally, the Reserve Bank of New Zealand left official rates unchanged at 2% but retained a clear easing bias and the Bank of Indonesia cut again and remains dovish.
The bottom line is that it’s basically more of the same from central banks. They want higher growth and more inflation. More help from governments is desirable but it will take a while. They don’t want to upset things given uneven and fragile global growth. Global monetary policy is set to remain easy for some time yet. Which means the broad environment (ie beyond short term event risks) remains positive for shares and growth assets.
Major global economic events and implications
It was another mixed week for US data, with falls in the Markit manufacturing conditions PMI, housing starts, existing home sales and the Conference Board’s leading economic indicator but gains in the National Home Builders’ Association housing conditions index and home prices and another fall in jobless claims. It’s worth noting though that the weakness in housing starts was all due to the South and weather related and the weakness in home sales looks supply related.
The Eurozone composite business conditions PMI fell slightly in September but remains consistent with moderate growth.
China’s MNI business conditions indicator rose in September adding to confidence that Chinese growth has stabilised.
Australian economic events and implications
Australia economic releases were largely second order over the last week. ABS data showed a further moderation in home price growth over the year to the June quarter to 4.1%, but June quarter growth was 2% plus (or 8% plus on annualised basis) in Sydney and Melbourne, which indicates these cities remain too hot. A surge in auction clearance rates suggests they may have become even hotter lately. There is not much the RBA can do, but it is an issue for APRA to keep an eye on.
Source: APM/Domain, AMP Capital
Meanwhile Australia’s population surpassed 24 million in the March quarter. While population growth has slowed to 1.4% year on year from a peak of 2.1% in 2008 it appears to have stabilised, remains strong compared to most other advanced countries, will help drive reasonable potential economic growth and continues to underpin long term housing demand.
What to watch over the next week?
Various Fed speeches and in particular Fed Chair Yellen’s Congressional Testimony (Wednesday) and speech (Thursday) will be watched for clues on the interest rate outlook, but may not add much given the proximity to the Fed meeting just held. The main US indicators to watch are consumer confidence (Tuesday) which is expected to show a slight fall, durable goods orders (Wednesday) which is expected to fall after strong gains in July and the August core personal consumption deflator (Friday) which is expected to rise 1.7% yoy. The first presidential debate (Monday) between Clinton and Trump will no doubt boost investment market focus on the coming election, particularly with Trump gaining lately.
In the Eurozone, money supply and bank lending data will be released Tuesday, economic confidence data (Thursday) is expected to hang around levels consistent with moderate economic growth and September core CPI inflation (Friday) is expected to have remained around 0.8% year on year, maintaining pressure on the European Central Bank (ECB) to extend its quantitative easing program beyond its current expiry of March 2017.
In Japan, expect August data to be released on Friday to show that labour market indicators remain strong and industrial production bounced, but that household spending has weakened and inflation remains at -0.5% yoy.
China’s Caixin manufacturing PMI (Friday) and official PMI (Saturday) are expected to show little change.
An OPEC meeting with Russia ((Wednesday) will be watched for any return to supply discipline.
In Australia, expect credit data (Friday) to show moderate growth. Data on job vacancies & new home sales are also due.
Outlook for markets
Despite a short term boost from the Bank of Japan and the Fed, shares remain vulnerable to a further correction or volatility in the next few months. September and October are often rough months seasonally and various event-risks loom in the months ahead, including ongoing debate around the Fed, the Austrian presidential election, Italian banks, the Italian Senate referendum, the US election with support for Trump edging up and global growth generally. However, after any short term weakness, we anticipate shares to trend higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions and continuing moderate global economic growth.
Ultra-low bond yields point to a soft medium term return potential from them, but it’s hard to get too bearish on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors.
Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up.
Cash and bank deposits offer poor returns.
There is a high risk that the A$ will re-test its April high of $US0.78 as the Fed continues to delay, presenting challenges for the RBA. Beyond the short term though we see the longer term downtrend in the A$ ultimately resuming, as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, commodity prices remain low and the A$ sees its usual undershoot of fair value.