The Week in Review: January 26, 2018

US markets reached record highs again, but elsewhere it was a different story.

Investment markets and key developments over the past week

Share markets were mixed over the last week with the US share market reaching record highs helped by good earnings news and gains Chinese and Australian shares, but European shares fell on a further rise in the Euro and Japanese shares were flat.

Bond yields were little changed but the big development was a further plunge in the US dollar partly as investors interpreted comments by US Treasury Secretary Mnuchin, who highlighted that a weaker US dollar is good for the US, as indicating a weakening in the US Government's traditional “strong dollar” policy. The falling US dollar contributed to gains in commodity prices with oil also boosted by falling US oil stockpiles and a rise in the Australian dollar back above $US0.80c.

Collapsing US dollar creating consternation but should be self-limiting.

The plunge in the US dollar (down 13 per cent per cent since the start of 2017) is basically a monetary easing for the US and will further boost US growth, profits and the US share market. It's also good news for emerging countries with US dollar debts. The flipside though is that it is working against Fed tightening and so may see the Fed tighten faster and US tariff hikes risk driving a stronger, not weaker, US dollar. For Europe, Japan and Australia, the falling US dollar is a de facto monetary tightening which could delay eventual rate hikes. Taken together, this should help limit downside in the US dollar. At least a falling US dollar is nowhere near the concern that a surging US dollar posed going into 2016.

Global growth forecasts still being revised up. In its latest global economic review, the IMF revised up its growth forecasts yet again, with broad based increases. The pattern of IMF revisions is basically the same as for private sector forecasters and as the next chart highlights years of growth downgrades have given way to upgrades as the post GFC hangover has given finally given way to more self-sustaining growth. Just as the growth downgrades were associated with falling inflation, ongoing monetary easing and falling bond yields the upgrades are likely to eventually give way to rising inflation, gradual monetary tightening and further increases in bond yields.

Source: Bloomberg, AMP Capital

US shutdown ended after three days, with Congress extending funding out to February 8.

Agreeing a solution for “Dreamers” (children of illegal immigrants) remains a big political issue and so another brief shutdown is possible after February 8th. However, the economic impact is likely to remain trivial - the Democrats are wary of the political risk of being seen to blame for a shutdown and so any further shutdown is likely to be brief. From the perspective of economists as long as the flow of US economic stats is not disrupted it's definitely trivial! The US Government's debt ceiling will also start to become an issue next month (with the ceiling likely to be reached in March or early April) – but expect another last minute solution as neither side of politics wants to risk default.

Meanwhile, President Trump's decision to impose tariffs on imported solar panels and washing machines (that will mostly affect China and South Korea) confirms that he is turning to trade to boost his popularity in an election year.

Expect more moves this year as Trump tries to push his America First agenda which could cause moments of angst investment markets. An all-out trade war with China is a risk worth watching, but is unlikely though – as Trump won't want to risk big increases in consumer prices hitting his base and China will likely react calmly. In fact, comments by Liu He, a senior adviser to President Xi, foreshadowing policies to further open its economy, boost imports and cut tariffs suggest China is actually going in the opposite direction. And news that the Trans Pacific Partnership is now going ahead without the US is good news in highlighting that the US is isolated in adopting protectionism.

Major global economic events and implications

US economic data over the last week was mixed with a fall in existing home sales, although this may be due to weak supply, but a solid reading for business conditions PMIs in January and continued gains in home prices. The December quarter US earnings reporting season is off to a strong start. Of the 100 S&P 500 companies to have reported so far 82 per cent have beaten earnings expectations and 83 per cent have beaten on sales.

Eurozone business conditions PMIs and consumer confidence rose even further in January to very strong levels and are consistent with a further acceleration in economic growth.

The ECB's December bank lending survey also showed stable or easing lending standards and rising credit demand. Germany also moved a step closer to stable government with the Social Democrats voting to support formal coalition talks with Angela Merkel's coalition.

The Bank of Japan made no changes to its monetary policy or its growth and inflation forecasts.

SWhile it sounded a bit more upbeat on inflation noting that inflation expectations are no longer falling it continues to see downside risks to inflation, and the one dissent was dovish. With core inflation running way below target no imminent exit from monetary stimulus is likely.

New Zealand inflation surprised on the downside for the December quarter highlighting that the move to higher inflation globally is still taking a while to get underway.

Australian economic events and implications

It was a light week for data releases in Australia, with skilled vacancies showing continuing growth albeit with some slowing.

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