Tag Archives: Economic Update
Economic and market commentary
By Robert Wright /November 17,2021/
Investors remained focused on rising inflation and the possibility of policy settings being tightened worldwide.
Bond yields continued to rise – particularly in Australia – as investors brought forward their expectations for interest rate hikes. This hampered returns from fixed income markets.
Equity markets performed much more strongly, aided by the release of pleasing corporate results for the September quarter.
Australia:
The latest surveys indicate conditions have improved modestly for both manufacturers and services companies, although backward-looking economic data were largely ignored given recent restrictions in NSW and Victoria. Instead, like elsewhere, the main focus was on potential changes to central bank policy.
In early October the Reserve Bank of Australia reiterated its yield target of 0.1% on 3-year government bonds. Later in the month, market movements had pushed the yield on these securities above 1.0%, seemingly with limited effort from the Reserve Bank to defend the target. This prompted investors to question whether officials were changing their stance on policy settings.
At an annual rate of 3.0%, headline inflation for the September quarter printed in line with consensus forecasts. The Reserve Bank’s preferred measure of inflation – the trimmed mean – rose at a more modest 2.1% over the year. Official interest rates are unlikely to be changed for the foreseeable future.
New Zealand:
As had been widely anticipated, official interest rates were raised by 0.25%, to 0.50% in October.
Reserve Bank of New Zealand officials appear to be concerned about quickening inflation – consumer prices rose by more than 2% in the September quarter alone, and are nearly 5% higher on a rolling 12-month measure.
As a result, some commentators are suggesting interest rates could be raised by a further 0.75% at the Bank’s next meeting in late November.
US:
At an annual pace of 2.0%, growth in the world’s largest economy fell short of expectations for the September quarter.
Pandemic-related supply shortages and bottlenecks continued to hamper manufacturers. Car production fell around 7% in September, for example, due to a shortage of semiconductors.
Services sectors are enjoying better operating conditions, as consumers continue to increase spending following months of lockdowns and disruptions.
There were mixed signals of the jobs front – new payrolls were lower than expected, but the unemployment rate dropped 0.4%, to 4.8%.
All of these data releases were overwhelmed by comments from Federal Reserve officials on the outlook for inflation and, in turn, potential changes to interest rate policy. The Federal Reserve is still expected to start tapering its quantitative easing program during November, likely reducing its monthly purchases of Treasuries and mortgage-backed securities.
Afterwards, attention is expected to increasingly shift to the likely timing of interest rate hikes. Inflation remains very high and whilst officials continue to suggest this will prove temporary, pricing pressures owing to supply disruptions seem likely to persist into 2022 and longer-term inflation expectations are rising due to elevated energy prices.
Consequently, some investors are now anticipating two interest rate hikes in the US before the end of next year.
Europe:
The latest GDP data in the Eurozone beat expectations. The region’s economy grew by 2.2% in the September quarter, meaning overall activity levels have rebounded to 99.5% of pre-Covid levels. The upturn has been attributed to an encouraging recovery in services sectors.
The increase in discretionary spending is being reflected in higher inflation; consumer prices rose 0.8% in October alone. Like elsewhere, this prompted suggestions that the European Central Bank might have to raise official interest rates.
Less encouragingly, the latest data highlighted a slowdown in industrial production in Germany; Europe’s largest economy. Moreover, ongoing reports of supply shortages suggest weakness in the manufacturing sector could persist through the December quarter and, potentially, into next year.
Asia:
In China, large property developer Evergrande Group avoided a bond default following a last-minute coupon payment. This failed to calm investors’ nerves, however; high yield credit spreads in Asia widened sharply over the month, resulting in disappointing returns from the region’s credit markets.
In Japan, there was an unexpected upward revision to economic growth forecasts for 2022. Officials expect growth to rebound back towards pre-pandemic levels in the next 12 months or so.
Australian dollar
The dollar reversed its recent weakness and strengthened by 4.0% against the US dollar. The ‘Aussie’ appreciated similarly against a trade-weighted basket of international currencies.
Performance relative to the Japanese yen was particularly impressive. At the end of October the Australian dollar bought nearly ¥86, an increase of 6.6% over the month.
The dollar was buoyed by rising commodity prices – coal and oil increased, which offset slightly lower iron ore prices.
Australian equities
The local share market started October on the back foot, as concerns about rising inflation drove the S&P/ASX 200 Index more than 2% lower on the first day of the month.
Equities quickly recovered and had moved nearly 2% higher towards the end of the month thanks to positive trading updates from the start of the AGM season. A sudden jump in bond yields on the last day of the month saw these gains reverse, however, and caused the Index to finish the month close to where it started, with a total return of -0.1%.
The Energy sector fell 2.7%, despite higher oil prices (Brent oil rose 7.5%). Energy companies struggled late in the month as news releases indicated oil supplies could soon increase, given a surprising jump in US inventories and the possibility of a resumption in Iranian oil exports.
Weakness among iron ore miners drove Materials stocks -0.5% lower. Iron ore prices fell around 5% due to Chinese steel production restrictions and weakening demand expectations.
In contrast, Materials stocks helped drive the S&P/ASX Small Ordinaries Index 0.9% higher thanks to strong performances from several gold and rare earth mining companies.
Listed property
Global property stocks fared well, with the FTSE EPRA/NAREIT Developed Index increasing by 1.9% in Australian dollar terms.
The best performing regions included Sweden (+14.0%), USA (+7.8%) and Hong Kong (+6.1%), while laggards included Germany (-0.3%), Japan (-0.3%) and Australia (+0.4%).
Global equities
Several major share markets enjoyed their strongest month of performance of the year. The S&P 500 Index in the US closed October 7.0% higher, for example. Technology stocks continued their good form, enabling the NASDAQ to perform even better; up 7.3%.
In Europe the Stoxx 50 added 5.0%, while in Asia Hong Kong’s Hang Seng and Singapore’s Straits Times rose 3.3% and 3.6%, respectively. Japan was the only major market not to participate in the rally, with the Nikkei closing the month 1.9% lower.
Returns from all major markets were diluted for Australian investors due to the strength of the dollar. Nonetheless, global shares made a positive contribution to diversified portfolios over the month.
Global and Australian Fixed Income
Bond yields rose in most major regions, as investors continued to focus on high inflation and the possibility that interest rates could be raised earlier than previously thought.
The yield on 10-year Treasuries rose 6 bps over the month, to 1.55%. Similar moves were seen on 10-year yields in other countries (Germany +9 bps, Japan +3 bps and the UK +1 bp).
The most significant yield movements were seen in Australia, where 10-year yields skyrocketed by 60 bps and closed the month above 2% for the first time in more than two years; well before the Covid pandemic began.
Global credit
Spreads on investment grade and high yield credit were little changed in October, at least in the US and Europe. Asian markets were a little weaker, partly reflecting ongoing concern about high leverage in the Chinese property sector. Consequently, returns from global credit markets were broadly neutral over the month.
Source: Colonial First State
Unintended consequences of Government COVID-19 Policies
By visual /May 13,2020/
For every action there is a reaction. And while we’re not criticising the government’s policy response to COVID-19, we recognise that such intervention often has unintended consequences.
Take lower interest rates for instance. Central banks intended to make the cost of investment cheaper and be stimulatory. Instead, Australian households borrowed more money to buy bigger and better houses and US corporates levered up to buy back shares. Both actions have contributed to the economy’s current precarious situation.
One needs to think laterally when considering unintended consequences, something we apply our collective minds to. Why? Unintended consequences can impact the long-term prospects of companies and industries, both positively and negatively.
A costly decision
Providing a payment holiday seems like the right thing for banks to do given the unique circumstances. However, is it simply delaying the inevitable?
While a payment holiday means you don’t have to pay principal or interest over a six-month period, interest still accrues. In other words, after the payment holiday you have more debt. Imagine if the asset against that debt, maybe your family home or investment property, is worth less in six-12 months’ time. That leaves you with a higher liability and lower asset value.
If the servicer of the loan cannot find a job and is forced to sell in a depressed market, this becomes permanent financial damage. The unintended consequence of a payment holiday for SMEs and households could be a bigger problem down the track.
Credit rationing
Banks are experiencing significant demand for credit from existing customers. SMEs and households are getting payment holidays and larger corporates are drawing down any credit line they can. This is extremely capital consumptive for banks.
While the RBA is providing adequate liquidity and the government is providing motivation to extend credit to SMEs, there’s little motivation for banks to take on new customers, either consumers or SMEs. We believe credit rationing for new customers is likely, with non-bank lenders pulling back at the same time. This will provide a headwind for the economy, with a reduced number of business start-ups in the short to medium term.
Commercial property
SMEs are most likely to use retail and office properties. To keep SMEs afloat, the government is addressing the two biggest costs, one of which is rent. The government has set up rules for a Mandatory Code of Conduct which helps tenants with turnover up to $50m. Essentially, the commercial landlord must take the same revenue hit as the tenant. At least half of this rent is waived completely, and the rest is deferred.
This is a smart move politically because there’s a perception that commercial landlords are rich, so there’s little sympathy from the public. However, unintended consequences are likely.
Commercial property is an attractive investment for two reasons; the stability of cashflows and the ability to borrow large sums of money against the asset. Landlords generally don’t get to participate in the upside when a tenant’s sales are going through the roof, but on the flip side, when the going’s not so good, they still get paid or can replace the tenant.
Banks traditionally liked lending to commercial property owners because of stable cashflows, the security of a hard asset and there wasn’t that operating leverage as is the case in most businesses. A precedent has now been now been set.
Commercial landlords now must cop the downside being felt by their tenants. There is even a six-month moratorium on evictions; so this asset, which was generating cash and servicing a debt, is generating no cash and there is nothing the landlord can do about it.
When the dust settles, banks are going to want more collateral and will likely lower loan to value ratios at a time when values could be under pressure. Given the importance of debt finance for most commercial property investors, this is likely to negatively impact valuations in the medium term.
The unintended consequences could include landlords hiking rents to take this new risk into consideration. If unable to increase rents, the result could be an accelerated downcycle in commercial property valuations, which would provide a further headwind for credit providers, which in turn could lead to further credit rationing.
Policies being implemented today have numerous unintended consequences that may impact the long-term prospects of many industries. This includes changes to supply chains from global just-in-time inventory systems to relying more on domestic supply chains. Immigration may slow to a trickle which, in turn, will impact economic growth.
Source: Perpetual
Geopolitical risks for the economy and investments
By visual /May 13,2020/
The world has always been challenged by the dynamics of geopolitics. The nature and magnitude of associated conflicts may transition and manifest across varying contexts but, broadly speaking, geopolitical risk is ever present.
The fierce competition between the powerhouses of the East and West has been watched closely by many. The trade war between the US and China, characterised by tit-for-tat tariffs, continues to disrupt major global supply chains with greater levels of exposure to the two while threatening to hinder global economic growth, albeit the extent to which is difficult to determine.
Numerous attempts to assess the impact and cost of the trade war between the US and China have been undertaken and recent research by the International Monetary Fund estimated the combined effect of the tariffs announced in 2018 and the recently announced tariffs this year could lower global GDP by 0.5% in 2020.
However, not all market participants are worse off as a result of the disputes between the US and China. While the impact of the trade war has affected the financial markets, primarily through its effect on investor sentiment, more broadly there could be opportunities for some nations to benefit from a potential diversion of trade, particularly for economies who have the competitive capacity to replace US and Chinese firms .
The open rivalry and strategic competition comes as China makes progress towards achieving its major long- term goal in becoming a “moderately prosperous country” by 2020. As part of this strategy, China aims to become a “global innovation power in science and technology” along with several other goals relating to sustainability of its growth.
Some of the actions China is alleged to have taken to achieve this, including allegations of inappropriate transfer of IP and technology, have raised concerns over national security for the US. This issue has been a driving force behind the protracted trade negotiations between the two countries with negotiations stalling on matters related to restrictions placed on some of China’s largest players in the tech industry. The tensions between the two nations are likely to remain while the possibility of a trade deal is still unknown.
Recently the People’s Bank of China (PBoC) let the yuan depreciate in its daily rate fixing, to be above the key USD/CNY 7 mark. Key reasons for the RMB depreciation is suggested to be in support of growth in light of the impact of US tariffs on China. Recent measures by China to combat US tariffs through a devalued yuan has soured the outlook for a trade deal.
While China is caught in a challenging set of negotiations with the US, it is facing unrest within its own country. In 1997, when the UK handed Hong Kong over to China, a One Country, Two Systems Framework was established which set out civic freedoms and a high level of autonomy, including judicial independence.
Recently proposed amendments to Hong Kong’s Fugitives Bill to allow extradition of fugitives not only to China, but to any jurisdiction in the world with which the territory has no existing formal agreement, has led to protests in the streets of Hong Kong over concerns and fears that the law could be abused by China for political or commercial reasons.
What began as a peaceful protest against an amendment to Hong Kong’s Fugitive Bill has now turned into the revival of a deeper-rooted issue reminiscent of the 2014 Umbrella Movement. While it is an example of China’s assertion of power within its own borders, it too is a demonstration of a clash of political ideology and symbolic of the gradual reclaim of power that has long been vested in the West.
Changing geopolitical relationships is also clear in the pending UK exit from the European Union (EU). The outcome remains more uncertain yet following the resignation of May only months before the Brexit deadline. Oxford Economics’ modelling of the economic implications assumes the base case as the UK continuing its EU membership.
In this model, all scenarios show a degree of trade destruction in which UK trade volumes decline as a share of GDP, reflecting the increased cost of trade between the regions, encouraging consumption of domestically produced goods instead. In the worst case scenario, compared to the base case, exports fall by as much as 8.8% and imports by up to 9.4%. The loss contributes to a 3.9% loss of GDP when factoring in events, such as a drop in labour productivity and foreign direct investment.
The rise of widespread geopolitical issues comes at a time when the world economy is slowing. The uncertain impact of potential US tariffs and the course of the UK’s pending divorce from the EU continues to introduce greater levels of volatility into the markets.
Source: BT
Economic Update
By visual /May 13,2020/
Market and Economic overview
Australia
The coronavirus ‘curve’ of known cases has flattened out, suggesting social distancing measures have been successful in slowing the spread of the disease.
The focus is now on a gradual easing of restrictions – people will gradually start returning to work as non-essential areas of the economy start to function again.
It will take time for conditions to normalise completely – borders remain closed to overseas visitors, for example, so tourism-related areas of the economy will continue to struggle.
It remains too early to say how significant the slowdown will be, but some observers have suggested the Australian economy could contract by approximately 5% in 2020. At the same time, consensus expectations suggest unemployment could double, from around 5% in February to perhaps 10% during the course of this year.
Job security is low and house prices appear likely to fall, which could further dampen sentiment. For now, credit card spending is running nearly -20% below the corresponding period a year ago, highlighting the current weakness in consumer confidence.
United States
By the end of April, more than 1 million people in the USA had been diagnosed with coronavirus.
Like other countries, the US had implemented various closures and restrictions. The ‘30 Days to Slow the Spread’ expired on 1 May 2020 and President Trump has suggested social distancing restrictions will not be extended.
Trump appears determined to reopen the economy as soon as possible, against the recommendations of some medical professionals. Ultimately, he wants the economy firing again in the run-up to the Presidential election in November.
The latest data showed the world’s largest economy shrank at an annual rate of -4.8% in the March quarter, even worse than consensus forecasts.
The downturn was due to economic disruptions in March. Data for the June quarter is expected to be worse still given more extensive closures during April, at least.
Europe
Much of Europe remains in lockdown, although numbers of cases vary quite markedly across the region. Germany – the largest economy in Europe – has much fewer cases than some other countries such as France, Italy, Spain and the UK. The economic impact might therefore differ between countries but will undoubtedly be significant overall.
Euro Area GDP growth declined at an annual rate of -3.3% in the March quarter and is expected to fall further in the June quarter.
Annual growth rates were lower still in some of the region’s major economies: France -5.4%; Italy -4.8%; and Spain -4.1%.
New Zealand
Restrictions have been eased in New Zealand; ‘Level 3’ measures are now in place – similar to those in Australia – after the more stringent ‘Level 4’ lockdown was no longer deemed necessary.
The Reserve Bank of New Zealand remains very active with its recently introduced asset purchase program. The Bank is buying large amounts of government and local authority bonds to ensure the smooth operation of the local fixed income market.
Asia
China’s economy shrank at an annual rate of -6.8% in the March quarter; a sharp slowdown from the 6.0% year-on-year growth seen in the December quarter of 2019.
The industrial sector was hardest hit by the near two-month shutdown of non-essential parts of the economy.
Whilst alarming, the short-term contraction will not impede China’s long-term growth trajectory, according to officials. That said, conditions could remain subdued in the foreseeable future.
Australian dollar
The Australian dollar clawed back all of its lost ground from March. The currency gained 7.0% against the US dollar, closing April at 65.5 US cents. Similar strength was seen against other currencies too.
Commodities
Most commodity prices finished the month of April stronger as demand uncertainty eased. Following sharp falls in March, copper (8.0%), nickel (8.0%) and zinc (3.4%) posted solid gains, although not enough to recover previous losses.
Iron ore (1.4%) reversed its downward trend on signs of a turnaround in Chinese manufacturing activity and reflecting China’s economic stimulus plans.
Oil prices (WTI Crude -26.6%) continued to fall, although stemmed losses towards month end on evidence of falling production.
The gold price (7.6%) again proved resilient against a backdrop of ongoing market uncertainty, while platinum (9.8%) and silver (10.1%) bounced back after March’s sharp falls.
Australian equities
The equity market recovery in the last week of March continued throughout April. The S&P/ASX 100 Accumulation Index rose 8.4%, registering its strongest monthly return since 1988.
Confidence was initially supported by the huge monetary and fiscal responses to the pandemic and later by encouragement that social distancing restrictions were proving effective.
The full impact of the virus remains unknown, however, and the shock to company earnings and balance sheets has placed additional pressure on dividend policies. At the same time, most companies have withdrawn earnings guidance.
Australia’s banks continued to underperform, as delays to mortgage payments and decreased property activity threaten earnings. The growing prospect of dividend cuts and the view that the banks will play a key role in supporting the economy has further dragged on investor sentiment.
Listed property
After plunging dramatically in March, global listed property markets rebounded in April. The COVID-19 situation continues to be the dominant driver of property securities. Due to virus containment measures globally, including widespread lockdowns, there are rising expectations for sweeping rent abatements across the sector, particularly in the most heavily hit sub-sectors such as discretionary retail. Many listed property securities globally have now withdrawn their earnings and dividend guidance due to the uncertainty.
Global equities
Unprecedented levels of monetary and fiscal support helped global markets stage a remarkable recovery. The MSCI World Index bounced 10.6% in local currency returns in April – its strongest month since 1975. The appreciation of the Australian currency tempered global equity returns for domestic investors, with the MSCI World Index rising ‘only’ 3.7% in Australian dollar terms.
UK equities were the weakest performers in April, with oil giant Shell announcing a cut in its dividend. Financial stocks also weakened after Lloyds revealed a large drop in profits. Disappointing returns from energy and financials stocks have contributed to the underperformance of the MSCI World Value Index in recent months.
Global and Australian Fixed Income
Bond markets were substantially calmer in April compared to March as central bank support programs appeared to be having their desired effect.
The Reserve Bank of Australia, for example, has bought around $50 billion of government and state government bonds in the past few weeks. This has materially improved liquidity and helped steady the local bond market.
Benchmark 10-year US Treasury yields closed April just 0.03 percentage points lower, at 0.64%. Yields also declined in the UK, Germany and Japan, by 13 bps, 12 bps and 5 bps, respectively.
Australian yields moved in the opposite direction, though not significantly. The yield on 10-year Commonwealth Government bonds closed the month 13 bps higher, at 0.89%. This resulted in a modest negative return from the domestic bond market.
Global credit
Like shares, corporate bonds were buoyed by an improvement in risk appetite globally. Credit spreads – the difference in yield between corporate bonds and comparable high-quality government bonds – narrowed substantially.
Companies looked to take advantage of improving risk appetite and strong inflows into the asset class by offering a substantial amount of new bonds. In some cases, this was to bolster their balance sheets to help cushion the impact of a more prolonged period of lower profitability.
Source: Colonial First State