Another Taper Tantrum But Global Growth Looking Ok

Investment markets and key developments over the past week

• Shares rose over the last week helped by a combination of good economic data and a further rise in oil prices. Bond yields rebounded on ECB taper talk and increasing expectations for a December Fed rate hike. As a result of the latter the $US rose and appears to be breaking higher which pushed the $A lower. This was despite a further rise in the oil price on the back of falling US crude stockpiles and worries about the impact of Hurricane Matthew.

• Another taper tantrum? ECB tapering its quantitative easing program is inevitable but it’s likely to be extended first. The past week saw global bond yields pushed higher by more talk that the ECB will taper (or gradually slow) its bond purchases once its quantitative easing (QE) program ends. ECB tapering is inevitable but it’s more likely to extend QE beyond March 2017 at the current rate of €80bn a month first given that growth is still fragile, inflation below target and political risk high. Taper talk and volatility will likely continue though and global bond yields are poor value regardless of whether the ECB tapers sooner or later. The risk is that a 2013 style taper tantrum - if it causes a sharp rise in peripheral Eurozone bond yields - will actually result in QE for longer.

• Global business conditions PMIs point to okay global growth. The much watched global manufacturing PMI rose in September – with notable gains in Brazil, Japan, Europe, the UK, the US and even Australia - continuing a mild rising trend seen over the last six months.

• Consistent with this, the IMF’s global growth forecasts have stabilised. After the usual downwards revisions to the IMF’s 2016 and 2017 global growth forecasts they have now stabilised relative to the IMF’s last update in July at 3.1% and 3.4% respectively. The IMF’s 2016 growth forecast has followed the same pattern of the last few years – starting towards 4% and then ending around 3%. The 2017 forecast may have a bit more downside to go though. 3% global growth is okay for investors as it’s enough to support modest profit growth, but not so strong as to invite aggressive monetary tightening.

• While Hilary Clinton enjoyed a bit of a poll boost post the first presidential debate taking her lead to around 3-4%, the vice-presidential debate looks to have been won by Mike Pence, albeit its impact is usually minor, and the election outcome remains close. The focus now shifts to the next presidential election debate on Sunday. Our view remains that a November 8 victory by Clinton would simply mean more of the same in the US as Democrats would not control Congress but a Trump victory (or anticipation of it) would be initially negative for shares on policy uncertainty & trade war worries, push up bond yields as the US budget deficit is likely to widen and US interest rates move higher and therefore positive for the $US. After an initial negative reaction shares are likely to rebound if Trump’s Reaganesque policies (tax cuts, increased infrastructure & defence spending, and deregulation) predominate over his protectionist policies. For Australian assets a Trump victory would mean an initial share sell-off followed by a rebound, potentially higher bond yields and a lower $A.\

• RBA on hold and neutral - we still see another rate cut but it’s a very close call. With no major economic developments in the last month, September quarter inflation due later this month and new Governor Philip Lowe presumably wanting to demonstrate a degree of policy continuity it was no surprise to see the Reserve Bank of Australia leave rates on hold at 1.5% at its October meeting. We remain of the view that the RBA will cut rates again at its November meeting when it reviews its economic forecasts after the release of the September quarter inflation data in late October, particularly with the $A remaining too high. However, with economic growth holding up very well, commodity prices and national income looking like they have bottomed and the new Governor perhaps preferring a period of stability, this is a close call and is critically dependent on seeing a lower than expected September quarter inflation result.

• Perhaps of more interest was the RBA’s view on the housing market. While it remains relatively sanguine it has acknowledged a strengthening in some markets recently, suggesting that it may be becoming a bit less relaxed. The RBA seems to remain comfortable in waiting for the surge in apartment supply to cool property prices. But given the recent rebound in auction clearance rates, Sydney and Melbourne property prices continuing to grow solidly and the risk that the apartment building boom will go way beyond the point of being healthy, my view remains that the RBA is a bit too relaxed about home prices and at least a bit of “jawboning” would be appropriate at present if not a further tightening by APRA.

Major global economic events and implication

• US economic data was mostly good leaving the Fed on track for a December rate hike. The ISM business conditions indexes rebounded in September to reasonable levels, particularly for non-manufacturing which is strong, durable goods orders were revised up and employment indicators were generally good (with better employment readings in the ISM surveys and lower jobless claims offsetting a slightly slower ADP employment survey). The trade deficit widened in August though.

• Japanese data was mixed with lacklustre conditions according to the Bank of Japan Tankan’s survey, a slight improvement in September’s manufacturing conditions PMI but a worsening in the services PMI and stronger consumer confidence.

• The Reserve Bank of India surprised with a 0.25% rate cut highlighting that global monetary conditions are still easing.

Australian economic events and implications

• Australian economic data was mostly solid with a stronger than expected gain in August retail sales after three soft months, building approvals remaining around record levels pointing to a stronger for longer housing construction cycle, a rebound in September business conditions PMIs albeit to still soft levels and a further decline in Australia’s trade deficit (which now looks to have seen the worst). Home prices continued to rise solidly in September with Sydney and Melbourne remaining uncomfortably strong (particularly with the supply of units surging). Finally, the Melbourne Institute’s Inflation Gauge rose solidly in September but has been soft in the quarter as a whole with the trimmed mean measure of underlying inflation falling to just 0.8% yoy.

What to watch over the next week?

• In the US, expect the minutes from the Fed’s last meeting (Wednesday) and a speech by Fed Chair Yellen (Friday) to repeat the message that the Fed will remain gradual in raising rates and expects to hike rates again at its December meeting. On this front, an expected 0.4% month on month gain in September retail sales after two weak months will be important in indicating whether the Fed is on track or not. Data on job openings (Tuesday), small business optimism (Wednesday) and producer prices (Friday) is also due.

• The US third quarter earnings reporting season will also kick off with Alcoa (NYSE:AA) reporting Monday. While total earnings for S&P 500 companies are expected to be down 1.5% from a year ago, they are expected to be up slightly on the June quarter continuing an earnings recovery that has been helped by a stabilisation in the US dollar and rising trend in the oil price.

• In China, expect September export growth to remain negative but import growth to slow slightly (Thursday), consumer price inflation to remain low at around 1.6% yoy, producer price deflation to continue to fade (both Friday) and total credit to slow after the August surge.

• In Australia, expect the NAB business survey (Tuesday) to show business confidence and conditions remaining above long term average levels, housing finance (also Tuesday) to bounce back after a fall in July and the Westpac/MI survey (Wednesday) to show that consumer confidence remains around average levels. The RBA’s six monthly Financial Stability Review (Friday) will be watched mostly for more colour around the state of the housing market.

Outlook for markets

• While the period for seasonal share market weakness (August to October) so far has passed without a major mishap, we remain cautious on shares in the short term as event risk remains high for the months ahead including ongoing debate around the Fed and ECB, issues around Eurozone banks, the US election on November 8 and the Italian Senate referendum & Austrian presidential election re-run (both on December 4). 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 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.

• Increasing confidence that the Fed will hike rates again by year end has taken some pressure off the $A in the short term and we continue to see the longer term trend remaining down as the interest rate differential in favour of Australia narrows as the RBA continues cutting rates and the Fed eventually resumes hiking, commodity prices remain low and the $A sees its usual undershoot of fair value.

Originally published by AMP Capital