Better News On Trade But Investors Still Nervous

• The British always do good comedy and Brexit keeps getting funnier with PM May delaying a vote on her deal to avoid certain defeat before then facing a confidence vote from her party. While she survived the vote more than one third of her party voted against her leaving her weakened and she is now a bit of a lame duck as she won’t be leading into the next election. She still faces an uphill battle to improve her deal with the EU and then win parliamentary support. All of which is leading to an increased risk of a new election and a no deal Brexit in March (which risks plunging the UK into recession). As Lance Corporal Jack Jones kept saying in Dad’s Army “don’t panic! don’t panic!”. This is all bad news for the UK and UK assets with the British pound taking most of the hit, but despite reports to the contrary it remains a second order issue for global markets.

• US data releases over the last week were strong. Job openings and hiring remain robust, small business confidence fell in November but remains very high and jobless claims fell sharply back to their lows after several weeks of increases. Meanwhile, November headline CPI inflation fell back to 2.2% year on year helped by lower energy prices with more to go this month and core inflation rose to 2.2%yoy but short-term momentum in inflation is running around 2%. The November CPI is consistent with the core private final consumption deflator at 1.9%yoy. Core inflation stabilising around 2% gives scope for the Fed to pause/go slower next year after it hikes in the week ahead.

• The European Central Bank remains dovish. While it confirmed that its quantitative easing program will end this month, it was really a dovish tightening with Draghi seeing the economic risks as “broadly balanced” but “moving to the downside” consistent with downwards revisions to the ECB’s growth and inflation forecasts, a hint of more cheap financing (or LTRO) for banks, a continued reference to rates being on hold through summer 2019 (we can’t see a hike until 2020 at the earliest) and a commitment to continue reinvesting maturing bonds for an extended period. Next to watch will be another round of cheap bank financing early next year.

• The further downwards revision to Japanese September quarter GDP growth to -0.6%qoq was bad news, but various business surveys seem to be holding up at reasonable levels including the Tankan business survey and machine orders rose in October.

• Chinese economic data for November was on balance soft with weaker growth in imports, exports, industrial production and retail sales, but a slight pick-up in investment growth, stronger than expected growth in lending and credit and lower jobless. The overall impression is that growth is continuing to slow, which will likely drive more decisive policy stimulus in the months ahead.

• Australian economic data releases over last week were nothing to get excited about. The ABS reported that house prices fell 1.5% in the September quarter, but this just confirmed declines already reported by private sector surveys which show an intensification over the last two months. Housing finance rose in October, but this could just be a statistical bounce after several weak months. Consumer confidence was little changed in December, but business confidence continued to slip below consumer confidence after running above it since the 2013 election. The problem is that neither are particularly strong and with house prices falling and wages growth likely to remain weak its hard to see consumer confidence rising much and a continuing slide in business confidence may threaten business investment. Finally, the CBA’s December business conditions PMIs slowed slightly.

• In the US, the focus is likely to be on the Fed on Wednesday which is expected to raise the Fed funds rate by another 0.25% to a range of 2.25-2.5% but its likely to be a “dovish hike” with the Fed dropping the reference to further “gradual” rate hikes and replacing it with language that signals a greater data dependency. Basically, with the Fed Funds rates getting close to neutral, US core inflation stabilising around the 2% target, interest sensitive sectors like housing and auto demand slowing and various headwinds to the US economy next year the Fed is likely to signal that its open to a pause on interest rates or at least moving more slowly in raising them. Our base case is that the Fed will hold the Fed Funds rate flat during the first half of next year and only raise rates once or twice in the second half.

• On the data front in the US expect flat to softish readings for the NAHB home builders’ conditions index (Monday), housing starts (Tuesday) and existing home sales (Wednesday) and Friday data to show a rise in durable goods orders, solid growth in personal spending and a rise in inflation as measured by the core private consumption deflator of 1.9% year on year.

• The Bank of Japan is not expected to make any changes to monetary policy when it meets Thursday, with core CPI inflation (Friday) likely to remain stuck around 0.4% yoy and providing one reason why this is likely to remain the case for a long while yet.

• The Bank of England is also expected to leave its cash rate at 0.75% when it meets Thursday with Brexit uncertainty likely to weigh heavily on its thinking.

• In Australia, the Mid-Year Economic and Fiscal Outlook to be released on Monday is likely to show that the Federal budget is running around $9bn per annum better than expected – thanks to higher than expected commodity prices and employment driving stronger tax revenue only partly offset by fiscal easing measures. This year’s budget deficit projection is likely to fall to around -$6bn (from a projection of -$14.5bn in the May Budget) and the 2019-20 surplus on unchanged policies will be projected to be around +$11bn (up from $2.2bn in May) with future surpluses looking even stronger. This is likely to enable the Government to announce around $9bn in income tax cuts and other pre-election goodies ahead of next May’s election and still maintain a surplus projection for 2019-20. The big risk of course is that the revenue windfall is not sustained as slower Chinese growth weighs on commodity prices, jobs growth slows, and wages growth remains weak. The Government’s growth forecast for this financial year of 3% is expected to remain unchanged but it may lower forecasts for 2.25% inflation and 2.75% wages growth as both look too optimistic.

• The minutes from the RBA’s last meeting (Tuesday) will likely repeat the mantra that it expects the next move in rates to be up although there is no strong case for a near term move, but investor interest is likely to be on what the Bank has to say about the housing market and credit conditions with recent speeches suggesting that it may be getting a bit more concerned about the risks. On the data front expect November labour force data (Thursday) to show a 10,000 gain in jobs and unemployment remaining at 5%. June quarter population data (also Thursday) will likely show some slowing in population growth to around a still strong 1.5%yoy.

• Shares remain at high risk of further short-term weakness (notwithstanding any Santa rally), but 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.

• Low yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds as the RBA holds and the Fed continues to hike (albeit at a slower rate next year).

• Unlisted commercial property and infrastructure are likely to see some slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.

• National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 10% or so in 2019, but Perth and Darwin property prices at or close to bottoming, 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%.

• Beyond any further near-term bounce as the Fed moves towards a pause on rate hikes next year, the Australian dollar likely still has more downside into the $US0.60s 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. Being short the Australian dollar remains a good hedge against things going wrong globally.

I hope your weekend is like a dog with two tails.

Written By: Shane Oliver