Economic Update

Market Update (July 2017)

In each of the major economic regions we are seeing growth picking up but with little or no evidence of rising inflation. The perception that more central banks were likely to tighten policy either by raising rates or moderating asset purchases triggered by the ECB’s president led to a sharp rise in bond yields. More recently there is a growing belief that policy tightenings are likely to be more limited and cautious.

In the US recent data points to an economy growing at a 3% rate after just 1.4% in the March quarter. Somewhat perplexing, however, has been the continued undershooting on inflation which has become the subject of debate both within the Fed and across markets at present. Recently Fed chair Janet Yellen appeared to signal less confidence in achieving the inflation target and espoused a more dovish tone. Ms Yellen indicated that rates would not have to rise very much to achieve a neutral stance. Indeed some estimates of the current neutral real Fed funds rate are estimated to be around zero compared to the current real Fed funds rate of −0.5%. If inflation does remain muted then rates may not need to rise very much at all.

In the Eurozone the recovery seems solid and broad with all the major economies growing at respectable rates. Employment is growing and corporate pricing power is strengthening. Mr Draghi, the ECB president, triggered a jump in bond yields when he said that “deflationary forces have been replaced by reflationary ones”. A subsequent fall in the inflation rate led the ECB’s chief economist to take a more cautious line, stating that the task of raising inflation is “not yet accomplished”.

In Japan survey data suggest that growth remains solid with exporters benefitting from rising global demand and enhanced ability to pass on price increases to customers. The improved demand picture is reflected in the TANKAN report showing rising corporate confidence. Nonetheless inflation remains quiescent and wage growth extremely modest.

In China growth remains solid at 6.9% despite the tightening in financial conditions. Money supply growth is moderating to be in line with nominal GDP growth, suggesting a stabilisation in the debt to GDP ratio, estimated to be at above 250%. The yuan continued to strengthen against a relatively weak USD. Foreign reserves remained stable, suggesting that capital outflows have stabilised. The tightening in China remains measured and in proportion to the improvement in growth over the past 12 months. Further tightening may be forthcoming next year as the authorities use the opportunity presented by a more stable domestic and global growth environment to tackle financial stability risks.

Lastly, in Australian the RBA is projecting GDP growth above 3% in 2018, based on solid consumer spending, an end to the mining-related downturn, positive contributions from LNG exports and housing and a modest recovery in business investment. Growth of this magnitude, assisted by population growth around 1.6% p.a., would most likely usher in a change in monetary policy bias. Indeed, the RBA expects a modest lift in wages growth as the cyclical weakness in mining sector wages fades. However, the high level of private sector growth is likely to make businesses sensitive to even a modest rise in rates, suggesting the RBA will be cautious unless inflation or wage growth rise sharply.

Source: Lonsec Investment Outlook Report (July 2017)