Global share markets fell again over the last week on the back of increasing concerns about US and global growth after another fall in the US manufacturing conditions ISM index. Global growth fears also weighed on the Australian share market with all sectors in the red but particularly financials which were also hit by the latest RBA rate cut, tech stocks and resources. Bond yields generally fell reflecting safe haven demand and expectations for further monetary easing. Oil, metal and iron ore prices also fell but gold rose on safe haven demand. The $A was little changed as the $US slipped.
US/global recession risks on the rise, although the indicators aren’t all bad and its still not our base case. An unexpected fall in the US ISM manufacturing conditions index to its lowest level since 2009 and weak US auto sales coming on the back of falls in Eurozone and Japanese business conditions PMIs reported a week ago indicate that the risk of global recession is still rising. In the US, the concern is that the slump in business confidence since President Trump started ramping up the trade war from mid last year will move on from depressing business investment to depressing employment and hence consumer spending. However, the indicators aren’t all bad. First the fall in the ISM manufacturing index to a level of 47.8 has been quite precipitous but its only just below its 2016 low and still way above levels associated with past major recessions of around 35 to 40. Secondly, the Markit manufacturing conditions PMI, which has a bigger sample of companies, has been far more stable lately than the ISM and has recently shown signs of improvement. See the next chart. Thirdly, services sector conditions PMIs have been holding up a bit better. Finally, Chinese manufacturing conditions actually improved slightly in September. Given these considerations, a lack of the sort of excess that normally precede recessions and ramping up monetary easing globally we remain of the view that recession will be avoided but the risks are rising and significant. Resolving or at least de-escalating the trade war is now critical. This still looks like it will require a much deeper share market fall to make Trump more fearful, as the experience over the last year indicates that steep share market falls do make him more cooperative on trade.
Source: Bloomberg, AMP Capital
News that the US is about to put a bunch of tariffs on the EU doesn’t help. To be sure this was authorised by the WTO in response to illegal government aid to Airbus, was the result of a multi year litigation and the $US7.5bn of goods involved is small compared to the tariffs put on around $US550bn of imports from China. But it still adds to fears flowing from US trade wars.
The RBA has cut rates to a new record low of 0.75%, but even more easing looks necessary to achieve “full employment” with quantitative easing looking likely. The reasons for the latest cut are well known: downside risks to the global outlook; weak Australian growth; a likely slowing in employment; and subdued wage growth and inflation. And as Governor Lowe points out there is a global excess of saving over investment fundamentally driving low rates. The interest rate and tax cuts seen to date will provide some help but the problem of excess savings will likely be with us for some time yet and its hard to see growth picking up enough in Australia to attain “full employment” which the RBA is now referring to as an objective in its post meeting statement. Its hard to get a precise handle on what exactly the full employment level is in terms of where wages growth and inflation would start to accelerate. But based on recent Australian and global experience it probably means unemployment of around 3.5-4% and underemployment around something similar which means labour market underutilisation of around 7-8%. So, at just below 14% currently we have a long way to go. As a result, we see the RBA cutting the cash rate again next month to 0.5% and then to 0.25% early next year. But with the big banks passing less and less of RBA cuts through to home borrowers – the average pass through after the June cut was 0.22%, July was 0.21% and this months cut was just 0.14% as they won’t cut their deposit rates below zero – rate cuts are becoming less and less effective and there will be no point in going to zero or negative (which would just scare people). As a result, its now likely that the RBA will have to undertake quantitative easing next year. Ideally, we need more help from fiscal stimulus and structural reforms but this looks like it will take a while to come through so the pressure will remain on the RBA.
Australian petrol prices still higher than justified. They may be off some of the highs like 173.9 cents a litre seen across many Sydney service stations a week ago but many in Sydney are still in the mid-160s and the capital city average around 154 cents is way above would could be justified by world oil prices and the level of the $A even allowing for a lagged flow through of the brief oil price spike that occurred after the attacks on Saudi Arabia. In fact, oil prices are now below where they were before the attacks. Either refiners or retailers or both must be making a bit of extra profit here under cover of the attacks, school holidays and the long weekend in four states and territories. Barring another flare up in the Middle East, expect petrol prices to fall back over the week ahead.
Source: Bloomberg, Motor Mouth, AMP Capital
Major global economic events and implications
US data was weak with a further fall in the ISM manufacturing and non-manufacturing conditions indexes, soft construction spending, weak auto sales and mixed jobs data. Our view remains that the Fed will cut rates again later this month with another cut now also looking likely in December.
Eurozone unemployment fell to a 7.4% in August (which is low for them!) but core inflation remained weak around 1%yoy, which is well below target and consistent with the ECB’s decision to ramp up monetary stimulus.
The Japanese labour market remained tight in August (helped by its falling labour force), but consumer confidence fell not helped by the rise in the consumption tax rate from 8% to 10%, industrial production was weaker than expected and the Tankan business survey showed some softening in conditions for manufacturers but with non-manufacturing conditions holding up pretty well.
Chinese business conditions PMIs surprisingly improved a bit in September, particularly for manufacturers as measured by the Caixin survey. Its unlikely to be enough to take pressure of policy makers for further stimulus measures though given the ongoing trade threat.
Australian economic events and implications
Australian retail sales saw a bit of a bounce in August with good gains in clothing and department stores providing evidence that some of the tax and rate cuts are being spent. However, with overall sales up just 0.4% month on month, it was less than expected and consistent with various business surveys and anecdotes suggesting that there has not been a big boost. But there is likely more to come in September and it should help keep September and December quarterly GDP growth in at least positive territory. Meanwhile, building approvals continued to slide in August, credit growth slowed further with record low growth in housing credit (albeit it should start to stabilise soon as housing finance commitments are improving) and the trade surplus fell in August on the back of the decline in the iron ore price from crazy high levels.
Home prices saw another solid rise in September according to CoreLogic on the back of continuing strong gains in Sydney and Melbourne as the boost from the election, rate cuts and regulatory easing continues to impact. After the initial bounce prices will likely be constrained though by past standards as a result of tighter lending standards, strong unit supply in Sydney and to a lesser degree Melbourne and weak economic conditions. If we are wrong and its back to boom time another round of regulatory tightening will be required as the RBA won’t be able to tighten monetary policy.
The RBA’s bi-annual Financial Stability Review noted a range of risks – around external shocks, high household debt and risks in housing markets – but indicates that the RBA is sanguine about the financial system’s resilience. In particular, the risk from falling house prices has fallen, lending standards have strengthened, housing loans in negative equity remain low as are mortgage arrears and the household sector has built up repayment buffers. So, for now the RBA is pretty relaxed about household finances, but this would change if economic conditions deteriorate driving much higher unemployment and job instability which in turn would threaten consumer spending which is partly why the RBA is now trying so hard to support growth. The RBA also noted that the pressure on bank profit margins from falling interest rates may not be as great as seen in other countries because most deposits in Australia currently pay interest well above zero. This, of course, implies that banks can cut those deposit rates which is not so good for depositors.
What to watch over the next week?
The big focus in the week ahead will be on renewed face to face trade talks between the US and China on Thursday with senior Chinese negotiators travelling to the US. Both sides have offered a few goodwill concessions going into these talks notably with China not retaliating to the latest US tariff hikes and the US delaying some tariff increases, but constant threats from the US side have not helped. A full resolution of the dispute may be wishful thinking at this point, but the pressure on both the US and China is now intense with the trade war dragging on both economies and the US economy at increasing risk of recession which would be disastrous for President Trump’s re-election prospects. As such there is a reasonable chance of some sort of interim deal that involves China making some commitments around IP, knowledge transfer and the purchase of US agricultural products and the US freezing tariffs at current levels. If so, this would take some pressure of the global economy and would come as a relief to investors, but is unlikely to see big rebound as the uncertainty will remain.
In the US, expect a small fall in small business optimism (Tuesday), the minutes from the Fed’s last meeting (Wednesday) to leave the door open for more easing and core CPI inflation (Thursday) to remain around 2.4% year on year in September. The latter translates to around 1.8% for core private consumption deflator inflation. Data on hiring and job openings will also be released Wednesday.
In Australia, expect the September NAB business survey (Tuesday) to show business conditions and confidence around average levels, consumer confidence (Wednesday) for October to also remain around average but housing finance commitments (Thursday) for August to show a further 3% rise.
Outlook for investment markets
Share markets remain at risk of further falls and volatility in the months ahead given unresolved issues around trade and Iran, impeachment noise and weak global economic data. But valuations are okay – particularly against low bond yields, global growth indicators are expected to improve by next year and monetary and fiscal policy are becoming more supportive all of which should support decent gains for share markets on a 6-12 month horizon.
Low yields are likely to see low returns from bonds once their yields bottom out, but government bonds remain excellent portfolio diversifiers.
Unlisted commercial property and infrastructure are likely to see reasonable returns. Although retail property is weak, lower for longer bond yields will help underpin unlisted asset valuations.
The election outcome, rate cuts, tax cuts and the removal of the 7% mortgage rate test are driving a rise in national average capital city home prices led by Sydney and Melbourne. But beyond an initial bounce, home price gains are likely to be constrained through next year as lending standards remain tight, the record supply of units continues to impact and rising unemployment acts as a constraint.
Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 0.25% by early next year.
The $A is likely to fall further to around $US0.65 as the RBA cuts rates further. Excessive $A short positions, still high iron ore prices and Fed easing will provide some support though with occasional bounces and will likely prevent an $A crash.
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