The Week in Review: June 15, 2018

Market gains amidst a hawkish Fed and tariffs.

Investment markets and key developments over the past week

  • The past week saw most share markets gain as strong US data more than offset worries about a more hawkish Fed and tariffs, the ECB remained dovish, Italian risks receded a bit and the US-North Korean summit were seen as successful. Chinese shares were not helped by soft economic data but gains in global shares generally and lower bond yields helped the Australian share market with yield sensitive utilities and telcos being the strongest. Bond yields generally fell and while metal prices fell, oil and iron ore prices rose. A mildly hawkish Fed and strong US data at the same time as a dovish ECB and softer non-US data saw the US dollar rise to its highest since July last year and this saw the Australian dollar fall back below $US0.75.
  • Good news on North Korea and Italy, but the trade war threat remains. The Trump/Kim summit was a big deal for world peace and while some critics wanted more, no major peace deal has been achieved in a day – that it happened, that there is agreement to work towards the complete denuclearisation of the Korean peninsula, that there will be follow on talks to implement this and that the US will suspend military exercises is the best that could have been hoped for from the summit. It gives investors a bit of peace on this issue for at least a year. Tick for now. On Italy and Itexit worries there was a bit of relief with new Italian Finance Minister Tria saying that there has been no discussion of an Itexit. Budget conflict with the European Commission still lies ahead but our view remains that Italy stays in the Euro. So tick for now. Meanwhile the trade war threat remains with the US set to announce a final list of $50 billion of Chinese imports to be subject to a 25 per cent tariff. No tick here. Just bear in mind though that this should be no surprise to anyone as it's what Trump's May 29 statement said the US would do by June 15, it's still just another list and not yet implementation of the tariffs and if implemented they would cover less than 2 per cent of imports to the US so we would still be a long way from the Smoot-Hawley 20 per cent tariffs on all imports that helped make the Great Depression “great”. Trump also sees these announcements as a way of pressuring China into action on trade – so more classic Art of the Deal stuff. Ultimately a negotiated solution is likely – and this is what both the US and China want - but the risks are high, and the tariffs could well be implemented before the issue is resolved.

Major central banks slowly taking away the punch bowls but it's very gradual and there is still lots of punch around:

  • The Fed provided no surprises in hiking rates again for the seventh time this cycle but yet again it was a bit more hawkish and the “dots” have moved to four hikes this year. Our view remains four hikes this year and three next and we continue to see US money market expectations as too dovish. This should all mean ongoing upwards pressure on US bond yields but it's worth nothing that US rates at 1.75-2 per cent are still far from tight and so we are still a long way from the point where US growth is threatened.

Source: Bloomberg, AMP Capital

  • The ECB made no changes to monetary policy but confirmed that it “anticipates” ending its quantitative easing program in December after further phasing it down to €15 billion/month through the December quarter. However, it's been tapering its QE program since 2016, it has left the door open to extending QE into 2019 if needed (by making its ending “subject to incoming data”), it has indicated it will reinvest maturing assets for an “extended period” and that it expects no rate hike until at least mid-2019 and ECB President Draghi's comments were dovish. It took the Fed more than a year after ending QE before it started rate hikes. With inflation way below target, growth indicators softening a bit lately and uncertainties around Italy a rate hike is unlikely until 2020 at the earliest. So ECB easy money may be getting a bit less easy, but it still looks like remaining easy for a long while yet.
  • Finally, the Bank of Japan remains full steam ahead with its ultra-easy monetary policies. No surprise here with the economy contracting in the March quarter and core inflation falling again. While talk of the ending of ultra-easy monetary policy globally generates periodic excitement in markets and amongst commentators it's worth noting that it's now more than five years since the US 'taper tantrum' started it all off – so it's been a very gradual process – and I suspect global monetary policy will remain easy for years to come. Just less easy than it was.

Major global economic events and implications

  • US economy accelerating.
  • Small business optimism rose to its second-highest ever (with worker compensation and profit readings), retail sales growth was very strong in May, jobless claims remain ultra-low and consumer, producer and import price data for May show a continuing edging up in inflationary pressures, and point to core private compsumption deflator inflation (which is the Fed's preferred inflation measure) rising to 1.9-2 per cent year on year for May. The Atlanta Fed's GDPNow growth tracker puts the June quarter growth at 4.8 per cent.
  • Eurozone economy still slowing. Eurozone industrial production fell in April consistent with some softening in Eurozone growth – which will present a bit of a threat to the ECB's plans to end is QE program in December.
  • China slowing too. Chinese data mostly softened, suggesting the long awaited mild slowing in growth may be underway. Unemployment edged down in May to 4.8 per cent and home price gains picked up, but industrial production, retail sales, investment and credit growth all slowed. This may reflect noise in monthly data, but it may also be reflecting the impact of deleveraging measures which have hit ‘shadow banking.' This is broadly consistent with our view that GDP growth will slow to 6.5 per cent this year. But more moves to ease monetary policy are likely to ensure growth doesn't slow too much.

Australian economic events and implications

  • Australian data was back to being a bit on the soft side. Business confidence slipped a bit in May but remains solid, consumer confidence remains stuck around long-term average levels, housing finance continued to slow in April with tighter bank lending standards pointing to more weakness to come and jobs data was a bit soft in May. Employment growth was weaker than expected with full time jobs falling, and while unemployment fell slightly this was because of a decline in participation. Meanwhile underemployment rose slightly over the last three months to 8.5 per cent so total labour market underutilisation remains very high at 13.9 per cent.
  • While RBA Governor Lowe reiterated the mantra that the next move in interest rates is likely to be up, he also said any increase “still looks to be some time away” and indicated that to raise rates the RBA is looking for reduced labour market slack, faster wages growth and increased confidence inflation is picking up. At present there is no sign of reduced labour market slack and this is likely to continue to weigh on wages growth. We remain of the view that with trend growth likely to be remain subdued, bank lending standards tightening, Sydney and Melbourne house price falls having further go that the RBA won't start raising rates to 2020 at the earliest and in the meantime the next move being a cut can't be ruled out.

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