The Week in Review: May 11, 2018

Recapping the good (North Korea), the bad (US-China relations), and the ugly (Trump).

Global share markets rose over the last week, helped by a combination of good economic data and benign US inflation. This was despite the US withdrawal from the Iran nuclear deal, which pushed up oil prices. The positive global lead pushed up Australian shares despite weak retail sales, and little short-term stimulus from the Budget. Metal prices rose but the iron ore price fell slightly. The US dollar was pretty much unchanged as was the Australian dollar despite a mid-week fall below US75c.

Geopolitics: The good, the bad (but possibly okay) and the ugly

The good is of course North Korea, which continues to move in a positive direction with President Trump to meet Kim Jong-un on June 12 in Singapore. The bad is the US/China trade skirmish. But the noise around it is okay with President Trump and President Xi having a phone call, and a trip to the US by Vice Premier Liu. He is soon to continue the negotiations on trade, but don't expect a quick resolution as they are still talking, and the incentives remain strong to find a negotiated solution.

The ugly is Trump's confirmation that the US will withdraw from the Iran nuclear accord and reinstate sanctions. It's ugly because it threatens around 0.7 million barrels of Iranian oil exports a day at a time when the global oil market has tightened. It may see Iran cause more trouble in the Middle East and develop nuclear weapons, and it threatens the relationship between the US and its allies, notably France and Germany, that may stick to the accord (and possibly compensate any of their companies that are adversely affected by US sanctions). The oil price has already moved up, so the risks may be factored in. And of course, there is a way to go yet. The US sanctions on Iran and companies that deal with it, won't kick in until after a 90-180 day wind down period. And Trump's approach, as with many things, looks like a negotiating ploy to get a better deal. So the Iran nuclear deal is not necessarily over yet.

Meanwhile, over in Italy, the populist leftist Five Star Movement, and populist far right Northern League, look close to forming government. This was the worst possible scenario after the inconclusive March election given both parties background of euro scepticism and their support for irrational economic policies. While it's marginally negative for the euro, it's not an immediate threat, but it will slow a Macron led move to a more integrated Eurozone. And for Italy, it risks a renewed deterioration in the budget deficit and an undoing of structural reforms which is negative for Italian shares and bonds. That said, politics are often a mess in Italy, so what's new?

Mahathir returns as Prime Minister in Malaysia – now that's something! The uncertainty could negatively impact Malaysia's growth in the short term, and hence its share market, but it's a long-term positive for the country. The 61-year rule of former Prime Minister Najib's coalition (which was led by Mahathir between 1981 and 2003) is over and Malaysia looks like it's going back to what should have happened 20 years ago with Anwar to succeed Mahathir. Will have to look up what recalcitrant means again!

The Australian 2018-19 Federal Budget proved surprisingly responsible for a pre-election budget with stronger revenue used to drive budget repair in the short-term. If the Treasurer was playing Santa, he was a bit stingy. Tax cuts and even more infrastructure projects were the main goodies, but the immediate tax cuts are just $10 a week for low-to-middle income earners and won't be accessed until after June next year, and the overall fiscal stimulus in the year ahead is basically zero. Rather, the much hoped-for gains come next decade when the budget is projected to generate larger surpluses and the Government is promising to hand some of this back as tax cuts to stop revenue as a share of GDP rising above historical norms.  Based on current projections, this will allow tax cuts starting at around $10 billion a year in four or five years' time – see the next chart. Of course, this all assumes that the Government is re-elected, and that revenue grows by around 5.5 per cent per annum over the next four years, which are big ifs. A key risk here is the Government's assumption that wage growth will rise back to 3.5 per cent, which looks a bit optimistic. Nevertheless, it does make sense that tax revenue will be capped as a share of GDP around previous high levels and bracket creep returned to tax payers. The Budget also highlights the starker-than-normal choice faced by Australians running into the next election – between a higher taxing/bigger government offered by Labor, and a lower taxing/smaller government offered by the Coalition.


Source: Australian Treasury, AMP Capital

Major global economic events and implications

Small business confidence and job vacancies are keeping US data very strong, but inflation is only moving higher gradually. Consumer price inflation rose 0.2 per cent month-on-month (or 2.5 per cent year-on-year) in April, despite a 3 per cent rise in gasoline prices. This was less than expected as core inflation was weaker-than-expected and unchanged at 2.1 per cent year-on-year. Core producer price inflation remains in an uptrend, but edged down a notch in April. So, while inflation is continuing to trend up, it's only happening slowly – the Goldilocks scenario continues. Strong growth and continuing labour market tightness alongside jobless claims continuing to fall, will keep the US Federal Reserve normalising, but for now it can remain gradual, with the next hike still on track for June. The US March quarter earnings reporting season is now 90 per cent done, with 76 per cent beating on profits, 73 per cent beating on sales, and earnings up 24 per cent since last year. Strength has been broad-based, but the strongest sectors for earnings growth have been energy, technology, financials and materials.

The Bank of England left rates on hold as expected, but despite recent softer data, still sees a case to raise rate again this year.

Chinese data trade data remains consistent with continuing solid growth. with export growth rebounding to 12.9 per cent year on year in April and import growth rising to 21.5 per cent. Meanwhile CPI inflation fell to 1.8 per cent joy from 2.1 per cent but with core inflation running along at 2 per cent. So nothing to get excited about here.

Australian economic events and implications

Australian data was mixed with very strong readings for business conditions, and to a lesser degree, business confidence according to the April NAB business survey. Weaker-than-expected March retail sales highlighted the ongoing divergence between the business and household sectors as low wages growth is good for the former (at least for a while) but bad for the latter. Retail sales were flat in March and March quarter volume growth slowed to just 0.2 per cent. Strong net exports should make up for the implied softness in consumer spending in terms of March quarter GDP growth, but the downside risks to consumer spending remain with weak wages growth, high underemployment and now falling home prices in Sydney and Melbourne. The Budget has not provided much short-term support to households.
 

Shane Oliver is the Chief Economist at AMP Capital.

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