13 Jun Market View | May 2017
The Reserve Bank of Australia Board met on 2 May 2017 and left the official cash rate on hold at 1.5%. There has been no change in the official cash rate since August 2016. The Federal Government released its 2017/18 Budget, resetting its Budget and economic narrative to focus on “fairness, security and opportunity”. The Australian dollar was weaker over the month. Falls in bulk commodity prices – particularly iron ore and coal, led to the falls, in addition to concerns over the pace of growth in Australia. This has led to the market now pricing in the chance of interest rate cuts in Australia. The S&P/ASX 200 Accumulation Index fell by 2.8% during May – its largest monthly decline since January 2016. Meanwhile, global developed equity markets recorded another positive month in May, despite heavy news flow and elevated geopolitical uncertainty. In the US, markets are currently pricing in a 95% chance of a rate hike in June. On the political front, President Trump announced the withdrawal of the US from the Paris Climate Agreement, fulfilling a campaign promise.
The Reserve Bank of Australia (RBA) Board met on 2 May 2017 and left the official cash rate on hold at 1.5%, as widely expected. There has been no change in the official cash rate since August 2016.
The RBA continues to balance three key risks in the economy for its monetary policy deliberations: the outlook for inflation, the strength or otherwise of the labour market, and household financial stability.
The RBA released its quarterly Statement on Monetary Policy in May, reaffirming its forecasts that GDP growth will return to 3% in 2H 17 and inflation will eventually sustain a rise above 2%. There was only one change to forecasts, with GDP growth for 2018 revised higher by 25 basis points to 2.75% – 3.75%.
On inflation, no changes to forecasts were made, with a return to target band over the forecast horizon made.
The Federal Government released its 2017/18 Budget, resetting its Budget and economic narrative to focus on “fairness, security and opportunity”.
Major policy initiatives include an increased focus on transport infrastructure, funded by higher debt levels. It also includes new revenue initiatives – namely a levy on the five largest banks, an increase in the Medicare levy and a levy on foreign workers to pay for focussed spending initiatives on education, healthcare, small businesses and housing affordability.
The Budget deficit for 2017/18 is estimated at $A29.4bn (1.6% of GDP). This is down from the 2016/17 deficit, which is now estimated at $A37.6bn (2.1% of GDP).
The return to surplus is now in the projections for 2020/21 at $A7.4bn (0.4% of GDP). It will of course rely on the new saving and revenue measures being legislated and economic growth returning to trend.
Government net debt is expected to rise to $A354.9bn (19.5% of GDP) by June 2018, peaking to 19.8% by June 2019. By June 2021, it’s expected to equate to $A366.2bn (17.6% of GDP).
The NAB business survey for April showed a strong gain in business confidence, up to +13, from +6. Business conditions also remained at elevated levels, at +14 in April, up from +12 in March.
The April labour market report showed the unemployment rate fall to 5.7% in the month, down from 5.9%.
CoreLogic capital city dwelling prices fell by 1.1% in May, with annual growth slowing to 8.3% – down from 11.2% the previous month. For the month, falls occurred in Hobart (-4.8%), Darwin (-3.5%), Sydney (-1.3%) and Melbourne
The US Federal Reserve Open Market Committee (FOMC) met on 2 and 3 May 2017 and didn’t make any changes to policy, as widely expected. There were some concerns over how the Fed would deal with recent weakness in economic data. However, the Fed focussed on the positives in the labour market noting, “the labour market has continued to strengthen even as growth in economic activity has slowed. Job gains were solid, on average, in recent months, and the unemployment rate declined.” Currently, markets are pricing in a 95% chance of a rate hike in June.
In the minutes of the May meeting, an initial general proposal for balance sheet reductions was proposed by Fed staff. The proposed approach would set an adjustable cap (limit) on the dollar amount of securities that would be allowed to run off each month. This helps address the lumpy nature of maturities on the Fed balance sheet, and would mean there is a controlled run off, with the residual reinvested each month.
On the political front, President Trump announced the withdrawal of the US from the Paris Climate Agreement, fulfilling a campaign promise. Trump also released his first proposed budget, declaring it a “taxpayer first budget”. This includes no cuts to Medicare of Social Security retirement and increases in Defense spending and paid family leave initiative. Although most expect that the budget from the Congress will be substantially different from Trump’s proposal.
Employment was weaker than expected in May, with just 138k payrolls added, compared to 174k in April and expectations of 182k. The unemployment rate fell to 4.3% (from 4.4%), the lowest since 2001.
The second estimate of Q1 GDP was released and revised higher to 1.2% on a seasonally-adjusted annualised rate, with improvements in consumer spending and business investment.
Inflation rose by 0.2% in April, after a fall of 0.3% in March. The annual rate retreated to 2.2%, down from 2.4%. Core inflation was 1.9% per year.
The Bank of Japan (BoJ) did not meet in May. The next meeting is scheduled for 16 June 2017.
The preliminary estimate of Q1 GDP was released with growth of 0.5% per quarter and 2.2% on a seasonally adjusted annualised rate. This was better than expected, with stronger gains in business spending.
May inflation data showed headline inflation at 0.4% per year and underlying inflation (ex fresh food and energy) flat for the year.
The European Central Bank (ECB) did not meet in May, with the next meeting scheduled for 8 June 2017.
In May, the estimate for headline CPI was 1.4% per year, down from 1.9% in April. Core CPI growth rate also fell, now at 0.9% per year, down from 1.2%. This retreat was due to movements in fuel prices and airfares.
Unemployment rates continue to fall in the Eurozone. The rate was 9.3% in April, down from 9.4% in March.
President Macron was inaugurated as the French President in May and announced his first Cabinet. Macron appointed Edouard Philippe as the Prime Minister, the centre-right Mayor of Le Havre. Other appointments included a broad representation of right and left personalities, much needed ahead of the Parliamentary elections in June in which Macron’s En Marche! movement will find it challenging to secure an operational majority and execute on Macron’s election pledges.
In Italy, recent political developments suggest an early election is now likely. There is growing support for a new electoral law, with the approval of this law the key preliminary condition to receive a new election. This new electoral law would be similar to laws in Germany, and would include a new 5% threshold for the presentation of individual parties.
The Reserve Bank of New Zealand (RBNZ) met on 11 May and left the official cash rate on hold at 1.75%.
The RBNZ stated that “developments since the February Monetary Policy Statement on balance are considered to be neutral for the stance of monetary policy” and that “monetary policy will remain accommodative for a considerable period.”
The semi-annual Financial Stability report was also released and noted that house price growth had slowed in the past eight months due to tighter loan-to-value ratio restrictions and a more general tightening in credit and affordability pressures. Although any resurgence would be a concern as is the significant share of housing loans being made at high debt-to-income ratios
Some economic data released in the March showed some signs of a slowdown. Industrial production slowed to 6.5% per year to April, down from 7.6% in March. Retail sales also slowed to 10.7% per year, down from 10.9% in March. Fixed Asset Investment also retreated, now at 8.9% per year in April, down from 9.2%. This slowdown occurred after a faster pace of expansion in the economy in Q1 17 and some tightening in shadow bank lending and non-benchmark interest rates.
Moody’s downgraded China’s credit rating to A1 from Aa3, a one notch downgrade on concerns about rising economy wide debt at a time when potential economic growth is slowing.
The Bank of England (BoE) met on 11 May and voted by a majority of 7-1 to maintain the Bank Rate at 0.25%, and voted unanimously to maintain the stock of purchases of corporate bonds and government bonds. This ultra-low policy stance has been maintained despite an improved macroeconomic backdrop. Risk management considerations are taking precedence, with difficult Brexit negotiations to take place and some tightening of fiscal policy expected.
Despite this, there is some growing concern around the outlook for inflation. In April, CPI rose to 2.7% per year, up from 2.4%. This was helped by a lagged response to currency weakness. Core inflation also moved higher to 2.4% per year, from 1.8%.
The latest labour market report revealed a further drop in the unemployment rate to 4.6% as at March 2017. Although once again, despite the fall in the unemployment rate, there was limited uptick in wages growth.
Ahead of the election on 8 June, polls narrowed for Prime Minister Theresa May’s government. This suggests that it is less likely to deliver an increased majority to the Conservative party, which is what was initially expected when the election was called.
The Australian dollar (AUD) was weaker over the month. Falls in bulk commodity prices – particularly iron ore and coal, led to the falls, in addition to concerns over the pace of growth in Australia. This has led to the market now pricing in the chance of interest rate cuts in Australia. Against the US dollar, the Australian dollar fell 0.8% to $US0.7431 and also fell 0.4% against the sterling.
Larger falls occurred against the euro, with the AUD down 3.8%, as a market friendly outcome occurred in the French Presidential elections. Elsewhere the AUD was 1.4% weaker against the Yen and 3.8% against the New Zealand dollar.
Commodity prices were predominantly lower again in April, led by oil, coal, iron ore and some metal prices.
The price of West Texas Intermediate (WTI) Crude oil finished the month at $US48.3 per barrel, down 2.0% per month, while the price of Brent Crude oil was down 3.1% to $US50.8 per barrel. Prices did fall early in the month, before rebounding on expectations of further and deeper cuts by OPEC. In the end, OPEC members agreed to a nine-month extension of current production caps.
Iron ore prices continued to retreat in the month with the spot iron ore contract (Qingdao 62% Fe fines) down by 17.1% to $US57.02 per tonne in May, down from the recent peak of $US94.9 per tonne in February.
Coal prices fell in May by 12.1% post gains in April due to the impact from Cyclone Debbie in Queensland.
Base metals were mixed, with the London Metals Exchange (LME) Index down by 0.8%. Nickel was down again by 5.1% in May, the third monthly fall. Elsewhere, lead (-5.7%) fell while tin (+2.1%) and aluminium (+0.9%) rose. The spot gold price rose 0.1% to US$1,269/oz.
Global developed equity markets recorded another positive month in May, despite heavy news flow and elevated geopolitical uncertainty. On the positive side was a market friendly outcome in the French Presidential election and continued signs of global economic growth. On the negative were acts of terrorism in the UK and some negative political developments in the US, which could further delay Trump’s expansionary policy agenda.
The MSCI World Index was up 1.8% in US dollar terms in the month and 2.8% in Australian dollar terms.
The VIX Index, a market estimate of future volatility of the S&P500 Index, finished the month at 10.41, although it went as low as 9.77 and as high as 15.59 in the month on the political news in the US surrounding the firing of the FBI director.
In the US, the S&P500 (+1.2%), the Dow Jones (+0.3%) and the NASDAQ (+2.5%) all rose. There was some winding back of expectations of Federal Reserve interest rate hikes in the month on some weaker economic and inflation data.
MSCI Consumer Staples (+4.3%) was the top performing sector over May while MSCI Energy (-1.9%) retreated on lower oil prices.
Equity markets in Europe performed well as geopolitical risks eased in the month. Italy (+0.6%), France (+0.3%) and Germany (+1.4%) all rose. Greece rose 8.9% on positive progress on bailout talks with creditors. The FTSE100 rose 4.4% with the weaker pound, down 0.5% against the USD.
Asia markets were mixed, with the Japanese Nikkei 225 up 2.4%. The other major markets also moved higher with Hong Kong up 4.2% and Korea 6.4%, despite continued geopolitical tensions with North Korea.
The S&P/ASX 200 Accumulation Index fell by 2.8% during May – its largest monthly decline since January 2016. The market was dragged lower by weakness in the Financials sector (-7.7%), which alone comprises almost 40% of the Index. The ‘big four’ banks were sharply lower following the proposed Bank Levy in the Federal Budget and rising concerns on Australia’s housing outlook. Health Care finished down 2.1%, dragged lower by sector giant CSL.
Real Estate finished 0.8% lower, as retail concerns continue to weigh on Westfield in the US and Scentre Group in Australia. Industrials (+4.7%) had a strong month, led higher by Qantas Airways which released a positive 3Q17 trading update and FY17 guidance. Other key gains came from Telcos (+3.4%), Energy (+2.0%) and Utilities (+1.3%). Materials (-0.2%) finished the month flat, masking some divergent performance from companies in the sector.
The S&P ASX 200 A-REIT index declined by -1.1% in May in AUD terms. The industrial and office sub-sectors led the gains, while retail
The best performing A-REITs included Industrial A-REIT Goodman Group (+4.8%) and office A-REIT Dexus (+1.9%).
The worst performers included retail A-REITs Westfield Corp (-6.6%) and Vicinity Centres (-4.2%), which lagged on concerns that retail markets face challenging operating environments in the US and Australia respectively.
Listed property markets offshore fared better. The FTSE EPRA/NAREIT Developed Index (TR) climbed by 0.9% in local currency terms. Continental Europe was the best performing region, with a gain of 5.0%. The worst performing market was Australia with its -1.1% return.
Global emerging markets
Emerging market equities had another positive month on improved US dollar and lower government bond yields. The MSCI Emerging Market Index was up 2.8% in USD terms and 3.4% in AUD terms.
The MSCI EM Europe, Middle East and Africa was flat over the month.
Global and Australian developed market fixed interest
Talk of impeachment of President Trump dominated headlines and drove bond yields lower halfway through the month, derailing previous positive sentiment on the back of strong US economic data and the French election results. Ultimately this change in sentiment saw bond yields fall in the US and Australia (the latter further impacted by falling commodity prices) and flat to negative in Europe and the UK. There were no changes to monetary policy in the month and expectations remain high that the US Federal Reserve will raise rates at its June meeting.
Against this backdrop, 10-year government bond yields (whilst typically trading in a range of 17-34 bps) were down 8 basis points (bps) in the US to 2.20%, down 4 bps in the UK to 1.05% and down 1 bp in Europe to 0.30%. In Japan, yields traded in a narrow band of 5 bps, ultimately ending the month up 3 bps to 0.049%.
The spread between Australian and US 10-year yields compressed to a new low towards the end of the month as Australian yields continued to fall, whilst in the US there was a mild rebound as it became clearer that the process to impeach President Trump would not be quick. The overall impact on Australian 10-year yields was a 19 bps fall to 2.39%.
Global investment grade credit spreads saw some mild tightening in the month but again continue to be resilient to the wider market noise impacting government bond yields. Spreads tightened early in the month but moved wider on the back of the impeachment concerns before flattening into month end. Investment grade issuance in the US and Europe remained strong in the month.
Specifically the Bloomberg Barclays Global Aggregate Corporate Index average spread moved 3 bps tighter to 1.14%. US credit moved 3 bps tighter, with the Bloomberg Barclays US Aggregate Corporate Index average spread closing at 1.07%. In Europe, the spread on the Bloomberg Barclays European Aggregate Corporate Index was 2 bps narrower to 1.09% on the back of the French election results.
US high yield credit spreads bounced up and down early in the month but fell more notably following Trump’s firing of the FBI director. Overall though, the market closed little different from where it opened, with the Bank of America Merrill Lynch Global High Yield index (BB-B) tightening just 3 bps to 2.96% by month end. The high yield market continues to be impacted by downgrades, particularly in the energy and mining sectors.
Australian credit spreads moved a little tighter in the month, largely ignoring the volatility in outright yields. Specifically, the average spread relative to swap on the Bloomberg Australian Corporate Index moved 3 bps tighter to 87 bps. Banking spreads were impacted by the proposed government bank levy.
This document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) based on its understanding of current regulatory requirements and laws as at 5 June 2017.
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