Investment markets and key developments over the past week Global share markets fell over the past week with concerns about inflation and monetary tightening continuing to weigh. For the holiday shortened week US shares fell 2.1% and Eurozone shares fell 0.2%. Chinese shares remained under pressure from concerns about covid related lockdowns. Australian shares rose 0.6% though with strong gains in utilities, resources and consumer staples. Bond yields continued to rise. Oil and iron prices rose, but metal prices fell slightly. The $A fell back to nearer $US0.74 as the $US rose.
Shares remain at risk in the short term, but providing US, global and Australian recession can be avoided a deep bear market should be averted enabling them to be higher on a 12-month horizon. Increasingly hawkish central banks in the face of high inflation, high bond yields, continuing uncertainty around the war in Ukraine, the risk (albeit less than 50%) of a Le Pen win in the French election and the return of possible tax hikes in the US to fund a slimmed down Build Back Better program ahead of the US mid-terms all risk making for a volatility short term ride in share markets, However, past experience tells us that if recession is avoided falls in shares should be limited and the broad trend will remain up. While Europe is most at risk of recession so far our European Economic Activity Tracker – see below – is still rising. In the US the 10yr/2yr bond yield curve has steepened again and even if it does go back to being inverted and other versions of the yield curve invert the lag to recession in the US from such an inversion has historically averaged around 18 months which takes us to late next year which is too far away for share markets to get too worried about just yet. And in Australia there is no sign of recession.
US CPI inflation may have peaked. Inflation rose to a new 40 year high in March of 8.5%yoy with core (ex food and energy) inflation rising to 6.5%. This was in line with expectations for the headline and slightly less than expected for core. What’s more base effects (where very high monthly CPI increases starting in April last year will start to drop out of year-on-year calculations), a rolling over in petrol prices (Russia/Ukraine war dependent though), easing shipping costs and used car prices and rising inventory levels suggest we may have seen the peak in year-on-year inflation in the US. Source: Bloomberg, AMP This is also consistent with our US Pipeline Inflation Indicator which is showing signs of having peaked despite recent (Russian invasion of Ukraine driven) volatility. Source: Macrobond, AMP However, while US inflation may be at or close to peaking its likely to remain uncomfortably high and well above Fed forecasts for a while yet. The rise in inflation continues to broaden out with median inflation showing another strong monthly gain of 0.5%mom in March. And while goods inflation may be slowing, services inflation is continuing to pick up particularly in areas like shelter and public transport. And the setback to economic activity in China on the back of its zero covid policy along with the war in Ukraine threaten ongoing disruption to supply chains and continuing high commodity prices. So high inflation will continue to maintain pressure on central banks. The longer inflation stays high the more it will be built into higher inflation expectations and risk becoming self-perpetuating. Hence central bank tightening is increasingly about keeping inflation expectations down and looks to be becoming more aggressive: - Fed speakers remained bearish over the last week with more supporting 0.5% hikes at the May meeting, Fed vice chair Brainard referring to a return to a “neutral” Fed Funds rate (which according to the Fed is around 2.5%) by year end and Fed President Bullard saying the Fed needs to raise rates faster or risk losing credibility. - The Bank of Canada raised its official interest rate by 0.5% taking it to 1% and announcing that it will start quantitative tightening on 25th April by not replacing maturing bonds. It cited “an increasing risk that expectations of elevated inflation could become entrenched” and noted that “rates will need to rise further.” - The Reserve Bank of New Zealand raised its official cash rate by 0.5% taking it to 1.5%. This was more aggressive than market expectations which centred on a 0.25% hike with the RBNZ noting it was consistent with its “least regrets” approach and is aimed “to head off rising inflation expectations…” This in turn is now seeing expectations push up to another 0.5% hike in May, although its likely that with such rapid tightening the NZ economy will slow, with home prices already falling, taking pressure of the RBNZ later this year. - The Bank of Korea raised its cash rate by another 0.25% for the fourth time in this tightening cycle taking it to 1.5% citing upside risks to inflation. - While the Ukraine war poses downside risks to Eurozone growth, the ECB is putting more emphasis on inflation with President Lagarde uneasy about indications inflation expectations might be moving too high. The ECB indicated that it’s on track to end quantitative easing in the September quarter which would then clear the way for higher interest rates. It also flagged a readiness to deploy a new tool to protect against yield spreads widening across member countries, to make sure that this does not interfere with monetary tightening.
Should the RBA follow the RBNZ, the BoC and the Fed with a more aggressive first-rate hike? Our base case remains that the first RBA rate hike will be 0.15% (in order to take the cash rate from 0.1% up to 0.25%) and come in June as the RBA will prefer to avoid hiking in the election campaign and wants to see March quarter wages data due on 18th May. But with Australia facing the same risks as in various other countries that inflation expectations will get out of control locking in higher than target inflation, there is a strong case that a blowout March quarter inflation report (due 27th April) should be met with a rate hike in May and that the first hike should be 0.4% (taking the cash rates to 0.5%) as 0.15% won’t send a particularly strong signal in terms of its anti-inflation resolve. The latest NAB business survey for March showed a further sharp acceleration in wage and inflation pressures pointing to March quarter headline and underlying inflation coming in well above implied RBA expectations for a 0.7-0.8%qoq rise in both. We are expecting a 1.7%qoq rise in the CPI and a 1.1%qoq rise in the trimmed mean. Meanwhile, March jobs data remained strong with unemployment effectively at levels consistent with full employment and likely to fall to 3.75% by mid-year all suggesting that it’s only a matter of time before official wages growth data accelerates. Waiting till June to move is already looking risky and just doing 0.15% for the first hike will add to that risk.
The race to the Australian election on 21 May is now underway. Polling still has the ALP ahead of the Government by 55/45 but it was not a good guide in 2019 and its less clear in marginal seats. The key point for markets remains that unlike in 2019 the policy platforms are not that different this time around. Both sides are seeking to repair the budget through economic growth rather than austerity and the ALP’s priority areas of energy, skills, the digital economy, childcare and manufacturing have a significant overlap with the Government’s priorities. Neither side is proposing a significant reform agenda in key areas like tax, education, industrial relations and housing affordability. With the exception of climate policy where the ALP is more aggressive, its hard to see a big impact on markets. Interestingly whether the RBA hikes in May or waits till after the election in June, interest rates will likely be a hot topic through the election campaign with inflation data at the end of April and then wages data on 18th May likely to just ramp up the rate hike talk.
Talking of elections – the first round of the French presidential election brought no major surprises. Both President Macron and Marine Le Pen came in slightly stronger than polls suggested at 28% and 23% and will go to the final round on 24th April. Compared to the 2017 first round the centre-right performed far worse which partly benefitted the far right (which got around 32% of the vote) but Macron and the left also performed better. Centre-left and centre-right candidates endorsed Macron and the far-left candidate Jean-Luc Melenchon with 22% of the vote called on his supporters to not support Le Pen. Given the absence of large polling errors in the first round and endorsements for Macron from now eliminated candidates he remains the favourite, but a Le Pen victory remains a significant risk. Second round polling still has Macron ahead of Le Pen at 53% to 47%. A Macron victory would likely see him continue to take on the role of leading Europe (after Merkel’s departure) and a continuation of his economic reform program. By contrast a Le Pen win would come as a shock to investment markets and her policies would threaten European unity in terms of economic policy and against Russia and would be bad for the Euro and French shares.
The French election made me think of Serge Gainsbourg and Jane Birken, so here they are with Jane B and Initials BB.
Coronavirus update New global Covid cases are continuing to fall with declines in Europe, the UK and Asia (excluding China). US cases remain low but may be starting to edge up. Source: ourworldindata.org, AMP China is continuing to have problems managing the Omicron wave resulting in lockdowns under its “zero covid” policy (albeit its looking at softening some of its approach) threatening Chinese growth and contributing to further supply disruptions globally. China is continuing to indicate that it will use stimulative policy measures, including hints of another PBOC cut to banks’ required reserve ratios, to boost growth. Source: ourworldindata.org, AMP New cases in Australia have declined over the last week or so. While hospitalisations and deaths have edged up recently, they lag new cases by a few weeks and remain relatively subdued compared to new cases compared to the waves prior to Omicron. Source: ourworldindata.org, AMP So far hospitalisation and death rates remain low across various major countries, with vaccines and prior exposure providing protection against serious illness, better treatments and the Omicron variants being less harmful albeit more transmissible than prior covid variants. The main risk remains the mutation of a more contagious and more harmful variant in lowly vaccinated poor countries. Economic activity trackers Our Australian Economic Activity Tracker rose over the last week suggesting the economy is continuing to grow at a solid pace. Our European Tracker also rose again suggesting surprisingly little impact from the war despite a hit to confidence. Our US Tracker rose but remains surprisingly subdued. Based on weekly data for eg job ads, restaurant bookings, confidence, mobility, credit & debit card transactions, retail foot traffic, hotel bookings. Source: AMP Major global economic events and implications US CPI and producer price inflation rose to new highs of 8.5%yoy and 11.2%yoy respectively. Base effects, a possible rolling over in oil prices and some easing in supply indicators suggests we may have reached the peak but its likely to stay high for a while yet. Meanwhile, small business confidence fell in March, but consumer sentiment rose in April and March retail sales rose slightly but with February revised up. Real retail sales are falling but this is likely being offset by a rotation back to services. Jobless claims rose but this could be related to normal volatility around Easter. UK CPI inflation rose more than expected to 7%yoy in March with producer price inflation rising to 11.9%yoy locking in more Bank of England rate hikes. Japanese producer price inflation fell slightly in March but remains very high at 9.5%yoy. Indian CPI inflation rose to 7%yoy in March. Chinese high frequency economic data for traffic, subway use and property transactions is running well below 2021 levels reflecting covid related restrictions. Consistent with this, import growth slowed more than expected to zero. Meanwhile, the State Council flagged more policy stimulus with hints of an imminent cut to banks’ required reserve ratios which would enable them to lend more. Credit growth picked up further in March but only a bit. CPI inflation rose but only to 1.5%yoy, with core inflation remaining just 1.1%yoy, suggesting little constraint here to stepping up policy stimulus. Australian economic events and implications Unemployment held at 4% in March but the jobs market remains very strong. Hours worked fell due to Omicron and flood disruptions. But jobs growth at 17,900 was strong, particularly after the 77,400 rise in February, it was all in full time jobs, underemployment fell again taking underutilisation to 10.3% its lowest since 2008 and for the nerds unemployment expressed to two decimal places fell to 3.95% from 4.04% which is its lowest since 1974. Our Jobs Leading Indicator (which is a composite of various job vacancy measures) points to continuing strong employment growth ahead and we continue to see unemployment falling to 3.75% by June and 3.5% by year end. Source: ABS, AMP Consumers feeling under pressure, but businesses are upbeat. Despite the strong jobs market, consumers are more focussed on cost of living pressures and this is weighing on consumer confidence which fell again in April with worries about family finances. Unfortunately for the Government consumer confidence is below where it was at the time of the 2016 and 2019 elections. By contrast the NAB survey shows strong business conditions and confidence – with the big dampener being that things are so good they are coinciding with very high readings for purchase costs, labour costs and selling prices. Source: NAB, Westpac/MI, AMP What to watch over the next week? In the US, April business conditions PMIs (Friday) will likely be the key to watch. Business conditions are likely to remain strong but hopefully we will see some lessening in price pressures. Meanwhile, home builder conditions (Monday) are likely to ease a bit but remain strong, housing starts (Tuesday) are expected to fall slightly after a very strong rise in February and the April Phily Fed manufacturing conditions index (Thursday) is likely to fall back a bit after a strong reading in March. The March quarter earnings reporting season will also ramp up. Consensus expectations are for just a 4.3%yoy rise in earnings but its likely to come in at around 10%yoy, with the main focus likely to be on cost and margin pressure. Eurozone business conditions PMIs (Friday) are likely to fall a bit reflecting the impact of the war in Ukraine. Japanese business conditions PMIs for April are also released Friday and core inflation for March is likely to rise but only to -0.8%yoy. Chinese March quarter GDP growth (Monday) is likely to have slowed to 0.7%qoq (or 4.2%yoy) from 1.6%qoq in the December quarter reflecting the impact of covid restrictions. March data also due Monday for retail sales, industrial production and investment will likely also show a slowdown. Australian business conditions PMIs for April (Friday) are likely to remain strong at around 55. Outlook for investment markets Shares are likely to see continued volatility as the Ukraine crisis continues to unfold and inflation, monetary tightening, the US mid-term elections and geopolitical tensions with China and maybe Iran impact. However, we see shares providing upper single digit returns on a 6-12 month horizon as global recovery continues, profit growth slows but remains solid and interest rates rise but not to onerous levels at least for the next year. Still low yields & a capital loss from a further rise in yields are likely to result in negative returns from bonds. Unlisted commercial property may see some weakness in retail and office returns (as online retail activity remains well above pre-covid levels and office occupancy remains well below pre-covid levels), but industrial property is likely to be strong. Unlisted infrastructure is expected to see solid returns. Australian home price gains are likely to slow further with average prices falling from mid-year as poor affordability, rising mortgage rates, reduced home buyer incentives and rising listings impact. Expect a 10 to 15% top to bottom fall in prices from mid-year year into 2024 but with large variation between regions. Sydney and Melbourne prices may have already peaked. Cash and bank deposits are likely to provide poor returns, given the ultra-low cash rate of just 0.1% at present but rising through the second half of the year as the RBA raises interest rates. A rising trend in the $A is likely over the next 12 months helped by strong commodity prices, probably taking it to around $US0.80.
Shane Oliver, Head of Investment Strategy & Chief Economist AMP Captial
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