Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
Global share markets rebounded over the past week with US shares rising 2.7% to a new record high helped by calming words from the Fed. Eurozone shares rose 1.2%, Japanese shares gained 0.4% and Chinese shares rose 2.7%. However, Australian shares fell 0.8% partly in delayed reaction to the previous week’s falls in the US and not helped by talk of earlier rate hikes in Australia and coronavirus concerns, with IT and materials up but falls led by health and financial stocks. Bond yields rose in the US and Europe but fell in Japan and Australia. Commodity prices rose as reflation trades came back into favour and the US dollar fell, which helped the A$ recover from some of its recent decline.
The central bank and coronavirus soap opera rolls on unfortunately but, I thought I would reverse the order this week. There is a great new biopic called The Glorias about American feminist writer and activist Gloria Steinem. Towards the end of the film in a rally after the US 2016 election she said that one of the benefits of being old is that she can remember a time when things (for women) were worse. And it does seem that there has been significant progress in terms of gender equality since the 1960s. But there is a long way to go. Recognising this a few years ago Bianca Hartge-Hazelman put together the Financy Women’s Index to track the financial progress of women and the timeframe to reach gender economic equality. The latest issue has just been released and while the trend is up there is many years, in some areas decades, to go to achieve financial equality for women.
Business conditions PMIs in major developed countries remained strong in June – down but still very strong in the US and UK, up and now very strong in Europe and down and weak in Japan. Overall, its consistent with ongoing strong global growth – but with momentum shifting from the now mostly open US to reopening Europe.
The sting in the tail is that price pressures remain significant as evident in strong input and output price readings, but there may be some relief as the ratio of new orders to inventories is showing signs of rolling over suggesting that production and hence inventories are catching up to demand. This is evident in various other things with US auto makers production plans surging and US lumber prices down nearly 50% from this year’s high.
Congressional testimony by Fed Chair helped calm market fears about a hawkish lurch by the Fed. While Fed hawks continue to make the case for an earlier taper and rate hike (7 of the 22 officials see the first rate hike being in 2022) Fed Chair Powell and New York Fed President Williams reiterated that the inflation spike is likely to be temporary and that there is still a long way to go on employment. Our view is unchanged with the Fed expected to start formally talking about tapering soon, ahead of a taper from later this year or early next with the first rate hike in 2023.
Meanwhile the Biden Administration has made more progress in getting its program passed through Congress with a bipartisan deal on infrastructure spending. This amounts to only US$579bn meaning that the Democrats will resort to budget reconciliation in passing the remainder of their US$4trn or so in total spending plans (and tax hikes). Tying the bipartisan deal together with the passage of a reconciliation bill adds to the uncertain passage of the former and so there remains a long way to go on both and the outcome is likely to be lower spending than in the original plans and note also that it will be spread over 8 years or so. This means there will be a significant fiscal cliff next year – which should be manageable though if the economy continues to reopen. The odds of a corporate tax hike will also start to go up again, albeit a 28% rate is still unlikely.
In Australia, our view on the RBA’s exit path from easy money remains as follows: ending the Term Funding Facility for banks this month; leaving the bond yield target focussed on the April 2024 bond; tapering the bond buying program from September; and possibly ending the bond yield target next year; ahead of a first rate hike in 2023 (or maybe, covid permitting, in late 2022). 2023 for the first rate hike now seems to have become consensus amongst economists. Reflecting the continuing stronger than expected recovery and in order to provide more flexibility RBA Governor Lowe is likely to also use the July meeting to formally drop the reference to the conditions for a rate hike as being “unlikely to be met until 2024 at the earliest” with the more flexible wording that the conditions “still seem some way off” that he used in his 17th June speech in Toowoomba. The latest coronavirus related lockdowns and a weaker inflation spike in Australia will likely keep the RBA relatively cautious in July though.
It was more of the same on the coronavirus front over the last week. The global downtrend in new cases continues led by developed countries and with India remaining in steep decline. However, the downtrend in new cases globally is showing tentative signs of bottoming out as many countries continue to see a rising trend in new cases including South Africa, South Korea, Indonesia, Russia, Brazil and Columbia.
The UK is also continuing to see a rising trend in new cases and there has also been a pick-up in Israel (albeit from a low base) – with both due to the Delta variant affecting mainly unvaccinated people. While vaccines are not completely effective against infection particularly against the Delta variant, they are highly effective against hospitalisation and death which is what will be key in term of allowing a continuing reopening. So far so good with deaths and hospitalisations remaining low in the UK despite the rise in new cases – and this will be the key to watch going forward. The problem though is that even in the UK there is still a big part of the population that has not been vaccinated, let alone fully vaccinated posing a threat to the recovery until higher levels of full vaccination are reached and this is also a risk in other countries including the US and Europe.
In Australia, while the number of new cases remains low by global standards, the expanding cluster of Delta variant cases in Sydney is a big concern, with Greater Sydney, the Blue Mountains, Wollongong and the Central Coast – along with anyone who has been in Greater Sydney since June 21 – now in a two-week lockdown. Ideally the lockdown should have started a few days earlier when the flow of new cases was lower. But at around 20 a day its still relatively low – compared to say last July when the Melbourne hotspot lockdown started when new cases were already spiralling at over 60 a day or the over 600 a day when the full Victorian lockdown started in August – providing some confidence the lockdown will quickly work in controlling the spread of new cases and so can be limited to two weeks or so.
Our rough estimate is that the two-week Greater Sydney and surrounds lockdown will cost the economy around $2bn, although much of the lost economic activity will hopefully be quickly recouped upon reopening. Australia has had several snap lockdowns since November last year and the evidence strongly suggests that if applied early, they head off a bigger problem with coronavirus and hence a much longer and far more economically damaging lockdown (in the absence of course of most being vaccinated). “A stitch in time saves nine” as the old saying goes! Providing they are short, then the economic impact is relatively “minor” (although still horrible for those impacted) as people and businesses delay spending and economic activity which then bounces back quickly once the lockdown ends. This is evident in our weekly Australian Economic Activity Tracker (see the next chart), which shows a rising trend in economic activity through the period of snap lockdowns since last November, including a rebound recently after Victoria’s snap lockdown ended. With Greater Sydney, the Blue Mountains, Wollongong and the Central Coast having around 6.6 million people and covering about 25% of Australian GDP we estimate a hit to economic activity from the lockdown of about $2 billion if its contained to two weeks with much of that likely to be recouped upon reopening. Fortunately, as noted above the lockdown is starting relatively early, providing some confidence that it can be contained to two weeks. Of course, the risk is greater now that we are dealing with the more virulent Delta variant, but so too was Victoria in late May.
So far 23% of people globally and 48% in developed countries have had at least one dose of vaccine. Canada is now at 68%, the UK at 65%, the US at 54%, Europe at 48% and Australia is at 27%. The success of the vaccines continues to be evident in low new cases, hospitalisations and deaths in countries with high levels of vaccination although as noted earlier the UK has had some problems.
Australia’s daily vaccination rate remains low at 0.4% of the population. However, with global vaccine production ramping up and more Pfizer and then Moderna vaccines scheduled to arrive in Australia, the latest Federal Government plan sees enough vaccines for two doses for all adults by October. Fingers crossed!
Our Australian Economic Activity Tracker recovered further over the last week after the hit from Victoria’s snap lockdown. However, another dip is likely in the weeks ahead reflecting the lockdown in Sydney and surrounds. Our US Tracker has now just ticked above its pre-coronavirus level, but the recovery in our European Tracker stalled in the last week.
Major global economic events and implications
As noted earlier US business conditions PMI’s fell in June led by services after a reopening bounce, but remain very strong. Meanwhile, durable goods orders particularly for capital spending continue to trend up and jobless claims fell but home sales fell but remain high. Personal income fell 2% in May as stimulus payments wound down but growth in wages income was strong. Personal spending was flat as spending rotated from goods to services, but real consumer spending is on track for annualised growth of around 11% this quarter and the outlook is solid thanks to strong wage income growth, a still high saving rate of 12.4% and more than $2 trillion in excess savings built up through the pandemic.
Consistent with the CPI, US May core private consumption inflation rose 0.5%mom or 3.4%yoy but again it was narrowly based with just six pandemic impacted categories having a weight of just 12% in the core index accounting for 60% of its monthly rise (notably car rental up 12% and vehicles up 2.8%) with the remaining 88% of the core index rising an average 0.2%mom. This is consistent with the Fed’s assessment that the inflation spike will be transitory.
Eurozone business conditions PMIs rose further in June, business confidence rose in Germany and France and consumer sentiment rose to the top of its normal range.
The Bank of England left monetary policy on hold despite a more positive outlook, with only one dissenter in favour of slowing asset purchases.
Japan’s PMIs fell but are due a bounce as reopening starts.
Australian economic events and implications
Australian retail sales rose a less than expected 0.1% in May and the composite business conditions PMI fell 1.9 points in June. However, both were likely affected by the latest coronavirus scares. Retail sales saw the sharpest fall in lockdown affected Victoria but it’s still 8% above its pre-covid trend and likely to suffer as spending on services recovers.
Despite the covid related dip, June business conditions PMI’s remain strong and consistent with good growth. Meanwhile, preliminary trade data for May showed a record trade surplus reflecting booming iron ore exports.
Reflecting the rebound in asset prices particularly for the property market household wealth surged 4.3% in the March quarter and by 15.3% over the year to the March quarter. The rise in debt or liabilities was trivial by comparison resulting in a similarly strong surge in net wealth. See the chart below. While the low base in the March quarter a year ago boosted the annual rise its still very strong providing a positive wealth effect for consumer spending. It would be nice (and fairer) if it was bit less reliant on housing though!
Temporary help for wages? The ABS’s June business survey found that 19% have insufficient employees and 27% are having difficulty finding suitable staff, particularly in the hospitality sector. This should help boost wages growth in the near term – but I would caution that it may just be another temporary pandemic distortion that will correct once borders reopen and back packers return.
What to watch over the next week?
In the US, the main focus is likely to be on June jobs data (Friday) which is expected to show a 690,000 rise in payrolls and a fall in unemployment to 5.7% from 5.8%. Meanwhile, expect gains in consumer confidence and home prices (both Tuesday), a slight fall in pending home sales (Wednesday) and further gains in construction and a slight fall but still strong manufacturing conditions ISM for June (both Thursday).
Expect Eurozone data to show a further rise in economic confidence for June (Tuesday), core inflation remaining subdued at around 1% year on year (Wednesday) and unemployment unchanged at 8% (Thursday).
Japanese jobs data will be released Tuesday, May industrial production data (Wednesday) is expected to show a fall and the June quarter Tankan business survey will be released Thursday.
Chinese business conditions PMIs for June (Wednesday and Thursday) are expected to be little changed.
In Australia, the Federal Government’s Intergenerational Report (Monday) is likely to project a smaller economy than previously expected reflecting the hit to immigration and hence population but the key to per capita GDP will be what happens to productivity growth. Unfortunately, in the absence of major economic reforms productivity growth is likely to remain relatively subdued. On the data front, expect a pick-up in May housing credit growth (Wednesday) reflecting record housing finance commitments, CoreLogic data for June (Thursday) to show a continuing boom in home prices with another gain of 1.9% based on daily data so far this month, strong ABS job vacancy data for May and a near record trade surplus of around $10bn (all due Thursday) and housing finance data for May (Friday) to remain around record highs.
Outlook for investment markets
Shares remain vulnerable to a short-term correction with possible triggers being the inflation scare and rising bond yields, US taper talk and the wider pull back from monetary stimulus, coronavirus related setbacks and geopolitical risks. But looking through the inevitable short-term noise, the combination of improving global growth and earnings helped by more stimulus, vaccines and still low interest rates augurs well for shares over the next 12 months.
Still ultra-low yields and a capital loss from rising bond yields are likely to result in negative returns from bonds over the next 12 months.
Unlisted commercial property and infrastructure are ultimately likely to benefit from a resumption of the search for yield but the hit to space demand and hence rents from the virus will continue to weigh on near term returns.
Australian home prices are on track to rise around 18% this year before slowing to around 5% next year, being boosted by ultra-low mortgage rates, economic recovery and FOMO, but expect a progressive slowing in the pace of gains as government home buyer incentives are cut back, fixed mortgage rates rise, macro prudential tightening kicks in and immigration remains down relative to normal.
Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%. We remain of the view that the RBA won’t start raising rates until 2023, although it could now come in late 2022.
Although the A$ is vulnerable to bouts of uncertainty and RBA bond buying and China tensions will keep it lower than otherwise, a rising trend is likely to remain over the next 12 months helped by strong commodity prices and a cyclical decline in the US dollar, probably taking the A$ up to around US$0.85 over the next 12 months.
While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.