Week in Review: August 3, 2018

A mixed week in shares, and escalating tariff threats.

Investment markets and key developments over the past week

  • While US shares rose over the last week helped by strong earnings results and a bounce back in tech stocks, European, Japanese, Chinese and Australian shares fell as trade war fears continue to escalate. Despite this, bond yields rose. Commodity prices were mixed with oil and iron ore prices up but gold and metal prices down. The $US continued to push higher and the Renminbi and $A fell.
  • The regular drip feed of escalating tariff threats from Trump continued over the past week, this time threatening that the proposed tariffs on $US200bn of Chinese imports will be 25 per cent, not 10 per cent. Coming at a time when a 25 per cent tariff on another $US16bn of Chinese imports is likely to soon commence Trump is clearly intent on ramping up the pressure on China. A tariff of this magnitude will start to have a significant economic impact on China's growth (potentially knocking up to 0.5 per cent off growth) and probably also on the US as well. While there has been some talk that the US and China may be trying to restart trade talks it's not clear that China will be keen given the gun to its head and the May experience. It may also prefer to wait till after the mid-term elections thinking that the longer this goes on the greater the chance of a backlash against Trump and that Trump will be weakened if the Republicans lose control of the House of Representatives. In the meantime it's stepping up measures to support growth and allowing the Renminbi to keep falling. Trump really believes China's trade practices are unfair, but he's also tapping a vein of anti-trade/anti-Chinese sentiment amongst his supporters and may also be motivated by a Quixotic desire to slow the ascendancy of China as an economic power. Whatever the motivation it's increasingly likely a solution will not be reached until after the US mid-terms and that trade fears will continue to cause volatility in markets.
  • Meanwhile Trump is offering to meet Iran's leadership and has asked US Attorney General Sessions to stop the Mueller inquiry. The former may be a good thing (but it's doubtful as Iran is not North Korea and its leadership would regard a meeting as a media stunt) and the latter would be a Nixon like disaster (but won't happen because Sessions can't do it as he recused himself from the inquiry and Trump would have to fire Deputy AG Rod Rosenstein and keep firing Justice Dept officials until he finds someone who is willing to fire Mueller). Meanwhile, Trump's desire to end the Mueller inquiry does highlight that it may be a real threat to his presidency.
  • Ultra-easy monetary policy locked in for longer by the Bank of Japan, but with more flexibility. Despite all the anticipation the BoJ left monetary policy little changed with the overnight deposit rate remaining -0.1 per cent, the 10-year bond target at zero. While it injected more flexibility into its bond yield target by allowing an effective range of /-0.2 per cent, up from /-0.1 per cent, new forward guidance effectively locks the BoJ into ultra-easy monetary policy into 2020. Overall this is positive for Japanese shares, but not so for the Yen. While Japanese 10-year bond yields may drift up to test the 0.2 per cent level, Japan is unlikely to be a source of significant upwards pressure on global bond yields.
  • In Australia, average home prices are continuing to fall led by the once booming cities of Sydney and Melbourne – with more to go. Our assessment remains that with tighter lending standards, poor affordability, rising supply and falling capital gains expectations Sydney and Melbourne property prices will have a top to bottom fall of around 15 per cent spread out to 2020 which given falls already seen implies further downside of 10 to 12 per cent. We are not there yet, but FOMO (fear of missing out) risks becoming FONGO (fear of not getting out) for some investors.  Other cities are in much better shape and most are likely to see moderate growth such that the top to bottom fall in national average home prices will be more like 5 per cent. With falling home prices set to drive a negative wealth effect it's hard to see the RBA raising rates anytime soon and if anything there is a significant chance that the next move will be a rate cut.

Major global economic events and implications

  • US economic data remains strong. Personal income and spending remained robust in June and consumer confidence is high. The ISM manufacturing conditions index fell slightly in July but remains high. Employment data remains strong. Home prices are continuing to rise. While construction fell in June it was revised up for May. Consistent with this the Fed remains upbeat describing growth as “strong” (up from “solid”) and seeing inflation near target and so it remains on track to continue with gradual rate hikes with the next move next month.
  • US June quarter earnings reports are very strong. Of the 80 per cent S&P 500 companies to have reported so far 85 per cent have beaten on earnings by an average beat of 5.3 per cent and 72 per cent have beaten on sales. Earnings are up around 26 per cent year on year.
  • Eurozone growth slowed further in the June quarter to 2.1 per cent year on year, but at least core inflation rose to 1.1 per cent in July. However, with core inflation still way below target and growth slowing we still can't see the ECB raising rates until 2020.
  • While the Bank of England raised rates another 0.25 per cent, they have still only made it to 0.75 per cent (ie half the RBA's 1.5 per cent) and with Brexit uncertainty this maybe it for a while.
  • Japanese economic data was mixed supporting the continuation of ultra-easy monetary policy. While unemployment rose slightly in June, the jobs to applicants' ratio rose to its highest since January 1974 helped off course by a falling labour force. Meanwhile, industrial production fell much more than expected in June, but the manufacturing PMI for July was revised up slightly and points to a rebound.
  • Chinese business conditions PMI's softened in July with manufacturing export orders quite weak suggesting some impact from the trade skirmish. That said the PMIs are still mostly in the range of the last year or so and are consistent with a softening in growth as opposed to a collapse. Our forecast for GDP growth this year remains for a slowdown to 6.5 per cent. Meanwhile, the July Politburo meeting reinforced expectations for more policy stimulus mainly from fiscal policy. The meeting statement included 15 references to “stable”, “stability” or “stabilising” compared to an average of 6 such references in the previous 10 Politburo meetings, highlighting the greater focus on supporting growth in the face of the trade threat.
  • Meanwhile, policy is going the other way in India with the Reserve Bank of India raising its repo rate by 0.25 per cent for the second meeting in a row to 6.5 per cent. It makes sense when inflation is above the 4 per cent target and GDP growth is around 7.4 per cent.

Australian economic events and implications

  • Australian economic data was mixed. Retail sales volumes were very strong in the June quarter indicating consumer spending will help June quarter GDP growth, but the quarterly bounce looks distorted by food, retail price inflation is non-existent and with weak wages growth, high underemployment and falling home prices retail sales are likely to soften again this quarter. Meanwhile, building approvals rebounded in June but after several weak months leaving a weak trend, the value of residential alterations & additions and non-residential approvals trending down, private credit growth continuing to slow with investor credit contracting, July manufacturing PMIs falling albeit remaining consistent with growth and home prices falling for the ninth in month in a row in July. While the June trade surplus doubled expectations most of the surprise in relation to exports looks to be price related and so it looks like net exports will contribute to June quarter GDP growth but only modestly.

Shane Oliver is Chief Economist at AMP Capital

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