The big picture
In recent weeks, central banks around the globe have started providing more upbeat commentary on the economic landscape. And the much more optimistic rhetoric was clearly highlighted by Federal Reserve Chair Ben Bernanke, in his semi-annual testimony in front of Congress. He cited "tentative signs of stabilisation" in demand, the prospect of an improvement in export demand and early signs that businesses are starting to rebuild inventory level – all of which suggests a slower rate of contraction (and possible expansion) in the US economy over coming quarters.
Domestically, the latest minutes from the Reserve Bank’s last meeting suggested the downside risks to the economy are waning. Stronger retail sales, buoyant housing activity, the pick up in confidence levels and a more resilient Chinese economy should help support growth.
It seems the big question likely to weigh on central banks, is when to start raising rates. In the US, it is more likely that interest rates will remain low for an extended period of time. However, domestically the possibility of rate hikes in a year’s time cannot be ruled out, especially considering the Reserve Bank’s historical stance on being ahead of the inflation game.
So far, the domestic inflation story continues to show signs of moderating with the headline measure coming in at a 10-year low. However, the stickiness of the underlying inflation measures is concerning, especially considering that most consumers and even some economic forecasters would have believed Australia was in a recession over the last year.
The likelihood of any further interest rate cuts is fast diminishing. And investors will get a good indication of Reserve Bank’s thinking in early August, when it releases its Statement on Monetary Policy. There is a good chance that economic growth forecasts are likely to be revised up while inflation forecast will remain the same. Overall, CommSec is pencilling in the possibility that the Reserve Bank may call an end to the easing bias and a switch to a more neutral interest rate bias.
Interestingly, it’s not just central banks that are responding to the more positive economic data. Share markets around the globe have allied over the last couple of weeks on the back of better economic data and stronger than expected US earnings results. The rally is not only due to companies have surpassed expectations, but also as a result of more companies providing future guidance. The earnings guidance has given analyst and traders a clearer picture of earnings visibility and that knowledge has allowed investors to make a more informed investment decision – a key point that was lacking in the last 12 months.
The economic data over the coming week is largely of a second tier nature, and unlikely to really excite markets. On Tuesday, the June quarter business confidence survey is issued, along with a speech by Reserve Bank Governor Glenn Stevens. On Wednesday, new home sales and building approvals are released. The monthly inflation gauge and private sector credit close out the week on Thursday.
The business confidence numbers are largely backward looking. The result is essentially a summation of the monthly confidence numbers and unlikely to provide any significant new revelations about the business landscape. The speech by the Reserve Bank Governor, titled Challenges for Economic Policy, will be more keenly digested. Investors will be hoping to glean any fresh insight on the Reserve Bank’s current easing bias.
The Housing Industry Association releases the June figures on new home sales on Thursday. In May, new home sales fell by almost six per cent led by a decrease in sales of detached (free-standing) homes. The extension of the home owners boost will see potential home buyers take more time in shopping around for the best deal however CommSec expects a modest rebound in home sales to have occurred in June.
While homebuyers seem to be taking their time in purchasing a property, expect building approvals to show a substantial increase over June. CommSec tips an 11.5 per cent rebound in home building approvals after the substantial 12.5 per cent fall in May. Certainly the housing finance data points to stronger home building. And with home prices now rising across most of the country, investors are also drifting back to the residential property market
The one piece of economic data that has remained consistently weak is private sector credit. Unfortunately, this is more of a ‘lagging indicator’, tending to tell us where we’ve been rather than where we are headed. New loans get written every day, while older loans are retired. But it takes a while for the lift in lending to show through in terms of credit.
At present, the falling growth rate for credit reflects the tight monetary policy of early 2008, rather than the easier conditions from September last year. Owner-occupier house lending is lifting, and investors have started to edge back into the market, while consumers and businesses are still wary about taking on debt. Overall, private sector credit probably rose by 0.1 per cent in June with annual growth to near 16-year lows of around 3.3 per cent.
In the US, the highlight is easily the release of the latest economic growth figures on Friday. In the March quarter, the US economy shrank by just over 1.8 per cent – or at an annualised rate of 5.5 per cent. In the June quarter, it is more than likely that the US economy shrank again, but the decline may have been closer to 0.5 per cent, or around 1.5 per cent annualised. In other words, the US economy bottomed late last year, and while still contracting, is likely to come out of recession territory over the next three to six months.
Of the other economic data, new home sales figures are released on Monday with house prices, consumer confidence and manufacturing data expected on Tuesday. The durable goods orders and the Fed Beige book are slated for Wednesday.
The US reporting season has well and truly kicked into full gear. And so far, the results have surpassed what in hindsight looks to be rather bearish analyst expectations. Over the last two weeks 472 companies have reported earnings results and an overwhelming 72 per cent have managed to better expectations, with nine per cent coming in line with analyst views, and just 19 per cent of companies unable to live up to promise.
Over the coming week a further barrage of company earnings greets investors. Among those reporting on Tuesday are US Steel and Viacom, while Wednesday will see the release of results from Conoco Phillips and Time Warner. Barrick Gold and Motorola are scheduled to report on Thursday with Chevron and Magellan Health expected on Friday.
Turning to interest rates, the Reserve Bank may still be retaining an easing bias, but market pricing is painting an entirely different story. Go back two months and the overnight index swap market was effectively pricing in one further rate cut by the end of the year. However, the emergence of more positive economic data in recent months has seen that rate cut disappear in its entirety. In fact, the OIS market is pricing in a rate hike as early as March.
Currency and commodity markets have enjoyed a return to favour over the last couple of weeks as the global economic recovery story gains traction, resulting in an improvement in risk appetite. The safe haven Japanese Yen has lost just over 1.3 per cent against the US dollar since its June highs. Compare that with the riskier Australian dollar, which has benefited, rallying five per cent against the US dollar and seven per cent against the Yen. It seems like the once-popular Japanese carry trade (taking out a loan in low-interest Yen and depositing it in high-yielding currencies like the Australia dollars) is once again back in favour – especially considering the Aussie battler is expected to strength by 33 per cent against the Yen in the next year, ensuring a profitable foreign exchange return in addition to the high interest yield on offer.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
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