Global share markets fell again over the last week on the back of worries about global growth in the face of the escalating US/China trade war, made worse by Trump’s decision to put a 5% tariff on imports from Mexico rising to 25% by October unless it stops illegal immigration. Australian shares were dragged lower too as post-election euphoria wore off with utilities, property, consumer staples and energy shares hard hit. Chinese shares managed to rise though helped by the prospect of more policy stimulus. Bond yields fell further on the back of safe haven demand, growth fears, weak inflation and increasing expectations of monetary easing. While the iron ore price rose slightly copper and oil remained under pressure. The $A slipped towards $US0.69 as the $US rose.

Trade threat escalating badly. Trade war fears continued to ramp up over the past week with Trump saying he was “not yet ready” to make a deal with China and hints from China that it may stop exports of rare earth minerals to the US highlighting that the dispute is moving beyond tariffs and Trump opening a new tariff front with Mexico. China supplies around 80% of US rare earth imports and they are essential in sectors like defence and electronics. The US could retaliate by banning the sale of semiconductor chips to China. While the tariffs on Mexico are immigration related, imports from Mexico are around 14% of total US imports and will reap havoc with US companies supply chains – particularly in the auto sector. Business will wonder who in their supply chain will be disrupted next. Clearly this ongoing escalation will not be good for business confidence, growth and profits. Share markets are likely to have to fall a lot further to make Trump realise just how great the threat to the US economy and by implication his 2020 re-election prospects are (US President’s don’t get re-elected when unemployment is rising). So shares likely face more short term downside as the trade conflict(s) will likely get worse before it gets better. The “great negotiator” (Trump) surely realises that he won’t look so great if all he has to show for his trade war is rising unemployment.

Back to business as usual after the EU parliamentary elections failed to see a populist/Eurosceptic surge. While the centrist parties lost seats this was not so much to the populist/Eurosceptics who have secured a similar number of seats as in the old parliament but to smaller pro-EU parties like the Greens so pro-EU parties maintain a roughly two thirds majority. So it’s business as usual. One risk with the EU parliamentary elections out of the way and haggling now shifting to Europe’s top bureaucratic jobs is that Germany’s Jen’s Weidmann could succeed Draghi as ECB President. Weidmann is a well-known hawk who opposed much of Draghi’s stimulatory measures so if he were to take over it would likely be taken badly by investment markets – or at least until he shows he will be more pragmatic.

The UK EU parliamentary vote saw the Conservatives and Labour suffer a protest vote for not solving Brexit but its interesting to note that outside of them pro EU parties got 40% of the vote, which was more than Brexit parties did at 35% suggesting more support for Bremain than Brexit! Notwithstanding that, the likely rise of a hard core Brexiteer as Tory leader (Boris Johnson) increases the risk of a no-deal Brexit for the UK.

In Australia, the Victorian budget highlighted the silly dependence Australian states have on the property market with the property downturn causing a slump in stamp duty revenue which in turn prompted Victoria to hike other taxes at a time when growth in state public capital spending is set to slow. This is bonkers and risks accentuating the negative impact of the property downturn on economic growth. It highlights the need to ditch ridiculous state stamp duties and replace them with a more stable revenue streams such as an increased GST or a land tax.

Major global economic events and implications

US consumer confidence rebounded in April and remains solid highlighting that while the trade war is impacting business confidence its not yet having much impact on consumers. In particular, consumer perceptions of the jobs market remain very strong which is consistent with jobless claims remaining ultra-low. Meanwhile, housing data remains mixed with pending home sales down in April and flat on a year ago and house price growth slowing but lower mortgage rates should help.

Meanwhile, US core private consumption deflator inflation has been revised even lower and Fed Vice Chair Clarida has noted that while the US economy is in a “good place” an increase in downside risks to growth and inflation could drive rate cuts. Unless the trade war is resolved soon Fed rate cuts are looking increasingly likely.

Eurozone economic sentiment rose in May with gains in business and consumer confidence and credit growth accelerated in April.

Japanese data for April showed a continuing strong labour market (as the labour force shrinks) and a small bounce in industrial production, albeit its still down 1.5%yoy. Core inflation in Tokyo slipped back to just 0.8%yoy.

China’s composite business conditions PMI was little changed in May at a reasonable 53.3 thanks to resilient non-manufacturing conditions but a fall back in the manufacturing PMI, probably not helped by the renewed trade threat, will maintain pressure for more policy stimulus in China

Australian economic events and implications

Australian data was generally soft over the last week with a further fall in building approvals, broad based declines in business investment and continuing soft credit growth. There was some good news though with rising business investment plans for 2019-20 as the mining investment bust bottoms out and turns up and as non-mining investment continues to head up. Weak demand growth in the economy will probably mean that it won’t be anywhere near as strong as the next chart implies though.

Source: ABS, AMP Capital

The minimum wage to rise 3% from July – but that’s less than last year’s 3.5% rise.So with around 20% of workforce (those on awards) getting the minimum wage rise it actually implies a 0.1% pa fall in overall wages growth over the year ahead (ie from 2.3% year on year down to around 2.2%yoy) all else equal. Expect wages growth to remain soft!

The combination of slower growth in the minimum wage, falling building approvals, soft credit growth, falling March quarter investment and likely only modestly rising capex in 2019-20 leave the RBA on track to cut rates on Tuesday by 0.25% with further cuts to follow.

What to watch over the next week?

In the US, the Markit business conditions PMIs point to softer readings for the May manufacturing and non-manufacturing ISM indexes due Monday and Wednesday respectively, but payroll employment for May (Friday) is expected to show another solid gain of around 190,000 jobs keeping unemployment at 3.6% although with wages growth remaining benign at around 3.2% year on year.

The ECB at its meeting on Thursday is expected to leave monetary policy on hold but remain dovish and biased to providing more stimulus. It may announce that its negative interest rate on bank reserves only applies beyond required reserve levels. On the data front unemployment (Tuesday) is expected to be unchanged in April at 7.7% and core inflation for May (also Tuesday) is expected to remain soft at 1.3%.

China’s Caixin manufacturing and services conditions PMIs for May will be released on Monday and Wednesday respectively.

In Australia, the RBA is expected to cut the cash rate to an historic low of 1.25% at its board meeting on Tuesday. This will be the 13th rate cut in the easing cycle that started way back in November 2011. The RBA has revised down its growth and inflation forecasts sharply and now accepts that it needs lower unemployment to get inflation back to target. The problem is that recent signs point to rising unemployment. And Governor Lowe strongly hinted at an imminent rate cut saying that “the case for lower interest rates” would be considered at Tuesday’s meeting. So the RBA has now fully prepared the market for a cut and of course the election is out of the way. With the recent reduction in bank funding costs and nearly 90% of bank deposits on interest rates above 0.5% (and hence able to be cut if the RBA cuts) we expect all of the RBA’s cut to be passed on to customers. While rate cuts may not have the same bang for the buck as they did a few years ago now that debt is much higher and lending standards much tighter (so don’t expect a quick return to the house price boom) they will help households that already have a mortgage (to pay down their debt faster and maintain their spending) and keep the $A lower which in turn should help Australian businesses. They should also be seen as part of a package with fiscal stimulus on the way as indicated in the April Budget (with scope for more given the tax revenue boost from higher iron ore prices).

Beyond Tuesday’s likely cut we expect the RBA to cut by another 0.25% in August and we now expect the RBA to take the cash rate down to 0.5% by mid next year. The basic problem for the RBA is that it needs to get unemployment down but the slowing economy and jobs market points to a further rise in unemployment which we expect to reach 5.5% by year end. As a result, we now expect that the RBA will have to take the cash rate below 1%, which will see an increasing debate about whether it should use quantitative easing. QE is not our base – as we don’t think things are that bad and if they were fiscal policy should really take over – but as has been the case at other major central banks the RBA is likely to prefer exhausting cash rate cuts before considering QE and this is unlikely until it gets the cash rate down to 0.5%, which we expect to be reached by mid next year.

On the data front in Australia the focus is likely to be March quarter GDP data due to be released Wednesday which is expected to show continuing weak growth of 0.5% quarter on quarter or 1.8% year on year thanks to weak consumer spending and investment and falling housing construction. In other data, expect to see a further moderation in monthly house prices falls to -0.3% month on month in CoreLogic data for May (Monday) helped by a post-election bounce as property tax uncertainty was removed, a constrained 0.2% rise in April retail sales and a +0.1 percentage points contribution to March quarter GDP growth from net exports (both due Tuesday), a continuing strong trade surplus of around $5.1bn in April (Thursday) and flat housing finance for April (Friday).

Outlook for investment markets

Share markets are likely to see a further pull back in the short term on the back of uncertainty about trade and mixed economic data. But valuations are okay, global growth is expected to improve into the second half if the trade issue is resolved and monetary and fiscal policy has become more supportive of markets all of which should support decent gains for share markets through 2019 as a whole.

Low yields are likely to see low returns from bonds, but government bonds remain excellent portfolio diversifiers.

Unlisted commercial property and infrastructure are likely to see a further slowing in returns. This is particularly the case for Australian retail property. However, lower for even longer bond yields will help underpin unlisted asset valuations.

National average capital city house prices are likely to remain under pressure from tight credit, record supply and reduced foreign demand. However, the combination of imminent rate cuts, support for first home buyers via the First Home Loan Deposit Scheme, the relaxation of the 7% mortgage rate serviceability test and the removal of the threat to negative gearing and the capital gains tax discount point to house prices bottoming out by year end and higher than we had been expecting. We now look for a 12% top to bottom fall in national capital city average prices, up from 15%. Next year is likely to see broadly flat prices as rising unemployment acts as a bit of a constraint.

Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by year end.

The $A is likely to fall further to around $US0.65 this year as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Excessive $A short positions and high commodity prices may help drive a short-term bounce though before the downtrend resumes and will likely prevent an $A crash.