While US shares fell slightly over the last week most major share market saw gains.Bond yields fell a bit in the US and Australia but rose elsewhere. Oil prices rose after OPEC left output unchanged, but metal and iron prices fell. The $US rose, particularly as the Euro fell on renewed Italian budget worries, and this saw the $A slip back to around $US0.72.

Although major global share markets performed well in September, defying seasonal weakness, Australian shares fell after reaching a ten year high in August as defensives, consumer stocks, financials and high yield sectors came under pressure not helped by rising bond yields.

The trade threat from the US has not gone away. While markets saw a relief rally in response to the latest tranche of US/China tariffs being less than feared its clear that the issue is far from resolved. The proposed fifth round of US/China trade talks didn’t happen. China has released a defence of its position and is going down its own path on the trade issue by announcing a cut to its average tariff to 7.5% from 9.8% and reducing non-tariff barriers and seeking to offset the impact of US tariff hikes by policy stimulus rather than engaging with the US on its gripes. And tensions between the US and China appear to be rising with the Trump accusing China of interfering in the mid term elections and some low-level signs that military tensions may be rising too. Our view remains that while the tariffs actually implemented so far are relatively small further escalation in the US/China trade conflict is likely with a negotiated solution still a way off. Meanwhile, the risk is rising that Canada will not agree to a revamped NAFTA deal with the US, the US and Japan are now to enter new trade talks with Trump clearly wanting concessions from Japan and French President Macron said he would not agree to a new EU trade deal with the US unless the US commits to the Paris climate agreement. Of course, Trump wants to get US allies on side so he can focus on China but there is still a long way to go on that front too. So, trade will remain a periodic issue for markets.

The US Fed provided no surprises, hiking rates by another 0.25%, describing the economy as strong and indicating that further gradual rate increases are likely. While the Fed is no longer describing monetary policy as “accommodative” its far from tight either and Fed officials’ interest rate expectations (the so-called dot plot) point to rates rising above the Fed’s estimate of the long run neutral rate which is currently at 3%. We expect another hike in December and, like the Fed, three more hikes next year. Market expectations for just over two more hikes over the year ahead remain too dovish. Continuing US rate hikes mean ongoing downwards pressure on the Australian dollar and the risk of more out of cycle rate hikes by Australian banks to the extent global borrowing costs rise. Trump’s criticism of Fed rate hikes are clearly not having any impact though with Powell indicating the Fed’s focus is keeping the economy healthy and that it doesn’t consider politics.

The issues around Brett Kavanaugh’s nomination to the US Supreme Court add to the risk that the Republicans will lose control of the Senate as well as the House. While this will not change our views around Trump and his economic policy – there is a good chance he will get impeached but there still wouldn’t be enough votes in the Senate to remove him from office and Congress won’t change or reverse his economic policies – it will be something that markets will worry about in the run up to and after the November 6 mid-terms.

Italy targeting a higher budget deficit – a negative for the Euro, but nowhere near as bad as feared. News that the Italian coalition Government will target a 2019 budget deficit of 2.4% of GDP has pushed the Euro down and is a negative for Italian shares and bonds. This is not low enough to reduce Italy’s public debt to GDP ratio and will lead to some conflict with the European Commission. However, its far less than had been feared a few months ago and is not high enough to see the rest of Europe pressure Italy too much (particularly as France and Germany don’t want to fuel Italian anti-Euro populist sentiment). Rather the rest of Europe is likely to leave market forces via higher Italian bond yields to discipline Italy. So not good for Italian bonds but no disaster for the Eurozone.

Major global economic events and implications

US data remains strong with a new 18 year high in consumer confidence, strong durable goods orders (although underlying orders were a bit soft) and rising imports. The US housing sector is far from its pre GFC boom though with a soft trend in sales and continued modest growth in home prices – but that is probably a good thing.

Eurozone economic sentiment slipped in September but remains strong and private lending continues to accelerate.

The Japanese labour market remained strong in August, industrial production rose and core inflation in Tokyo edged up to 0.6% yoy. but its still a long way from the BoJs 2% target.

Australian economic events and implications

In Australia, there was good news on the budget, but the risks around house prices appear to be mounting and rising petrol prices pose a threat to consumer spending power.

First the good news from the last week:

• The 2017-18 budget deficit came in at $10bn which is $8bn less than expected in May. While part of this owes to spending delays, the Government has announced more spending ahead and risks remain around wages growth, it nevertheless indicates that the Government has some scope to provide more stimulus ahead of the next election.
• And ABS job vacancy data remains very strong up 16.5% yoy, albeit it did slow down a lot in the 3 months to August.

Against this though:

• The risks around the housing market are continuing to mount with more banks withdrawing from SMSF lending and signs of a crackdown on property investors with multiple mortgages as the banks move to comprehensive credit reporting (ie sharing info on customer debts) and focusing on total debt to income ratios. The latter is significant given estimates that nearly 1.5 million investment properties are held by investors with more than one property.
• Credit growth to property investors remains very weak as tighter lending standards & falling investor demand impact.
  

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Source: RBA, AMP Capital

• Petrol prices over the last week have pushed higher on global oil supply concerns with more upside likely as supply from Iran and potentially Venezuela is cut. The weekly Australian household petrol bill is now running over $10 a week higher than a year ago. So, while higher petrol prices (if sustained) will add to headline inflation, they will also cut into household spending power and dampen spending elsewhere which will keep underlying inflation down.
  

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Source: Bloomberg, AMP Capital

For the RBA, these considerations largely offset each other for now so we see no reason to change our view that it will remain on hold for a lengthy period. I am even tempted to the RBNZ approach that the next move in rates “could be up or down”.

What to watch over the next week?

In the US, it’s back to focussing on jobs and wages with September labour market data due Friday expected to show another strong 190,000 gain in jobs and unemployment falling to 3.8%, but wages growth slipping back to 2.8% year on year, albeit maintaining a gradual rising trend. In other data expect the September ISM manufacturing index (Monday) to fall back to a still strong reading of 60, the non-manufacturing ISM index (Wednesday) to remain around 58 and the trade deficit (Friday) to worsen.

Eurozone unemployment (Monday) is expected to fall to 8.1%.

The Japanese September quarter Tankan business conditions survey (Monday) is expected to remain solid.

In Australia, the RBA will yet again leave interest rates on hold when it meets Tuesday. While recent economic growth and jobs data has been good, we are still waiting for inflation and wages growth to pick up and the slide in home prices risks accelerating as banks tighten lending standards which in turn threatens consumer spending and wider economic growth. As a result it would be dangerous to raise rates and we don’t see the RBA hiking until 2020 at the earliest and still can’t rule out the next move being a cut. Meanwhile, on the data front expect CoreLogic data (Tuesday) to show another fall in home prices for September, August building approvals (Wednesday) to show a 2% bounce, the trade surplus (Thursday) to fall slightly to $1.4bn and retail sales (Friday) to rise 0.2%.

Outlook for markets

We continue to see the trend in shares remaining up as global growth remains solid helping drive good earnings growth and monetary policy remains easy. However, the risk of a correction over the month or so still remains significant given the threats around trade, emerging market contagion, ongoing Fed rate hikes, the Mueller inquiry in the US, the US mid-term elections and Italian budget negotiations. Property price weakness and approaching election uncertainty add to the risks around the Australian share market.

Low yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds.

Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.

National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 10% or so, but Perth and Darwin property prices bottoming out, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.

While the $A is working off very negative short positions it’s still likely to fall to around $US0.70 and maybe into the high $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Being short the $A remains a good hedge against things going wrong in the global economy.