Risk assets mostly firmed in April assisted by signs that economic growth in China based in Q1 2016 and by the US Federal Reserve staying on policy hold again at its latest FOMC meeting held in April. On the improving economic news from China commodity prices were mostly stronger too, assisting the Australian share market in particular. Major share markets mostly gained ground through April although one exception was Japan’s Nikkei down by 0.5% on building concerns about Japan’s economic prospects, especially after the Bank of Japan left monetary policy settings unchanged at its April policy meeting. Elsewhere, share market gains ranged from 0.7% for Germany’s DAX to 3.3% for Australia’s ASX 200 assisted mostly by better commodity prices boosting major resource company shares.
Australian credit improved again in April building on strong gains in March as concerns surrounding Australian banks and resource companies prominent earlier in the year continued to recede. On the interest rate front, central banks almost all decided to leave policy settings unchanged in April. In the case of the US Federal Reserve, there was an element of relief in the decision as some policy committee members had started to become more strident expressing views that US interest rates should rise further. In the case of the Bank of Japan there was some disappointment with the “on-hold” decision as the economy seemed in need of greater stimulus. The US 10-year bond yield rose in April by 20bps to 1.83%, while the 30-year treasury yield rose by 18bps to 2.68%. The Australian 10-year bond yield rose by much less than its US counterpart, lifting by only 2bps to 2.51%. Even though the RBA again left the cash rate unchanged at 2.00% at its early-April policy meeting there is a growing sense that the next move will be a rate cut after the Q1 CPI report provided evidence that Australian inflation is tracking much lower than previously realised or forecast by all analysts, including the RBA.
Returning to the US economy economic growth moderated noticeably in late 2015 and early 2016 with GDP growing at 1.4% annualised pace in Q4 2015 followed by only a 0.5% lift in Q1 2016. Personal consumption spending and particularly residential housing activity have been the mainstays of what US growth there is. Manufacturing activity and business investment spending have been weak. Employment growth has remained surprisingly strong given soft GDP growth and seems to reflect the greater importance of labour-intensive services in US economic activity. Non-farm payrolls remained strong in March, up by 215,000 after increasing by 245,000 in February. The unemployment rate edged up slightly in March to 5.0% from 4.9% in February, a sign that there is still a little spare capacity in the US labour force mostly coming from a rising participation rate. At its April policy meeting, the Federal Reserve noted softening economic growth, but also the continuing strengthening of the labour market. The Fed seems to be caught on the cusp of delivering a second interest rate hike, but baulks at each policy meeting on evidence that US economic growth is moderate at best. This situation may persist at the next meeting in June too and possibly beyond extending the now lengthy period that the Fed has managed to deliver only a single 25bps rate hike back in December last year.
In China, annual GDP growth continued to moderate to 6.7% y-o-y in Q1 2016 from 6.8% in Q4 2015, but there were signs in virtually all of the March economic readings that GDP growth should accelerate in Q2. March readings of exports, up 11.5% y-o-y; industrial production, up 6.8% y-o-y; retail sales, up 10.5% y-o-y; and urban fixed asset investment spending, up 10.7% y-o-y were all stronger than market expectations and well up on January/ February readings. Other indicators such as rising house prices and increasing bank lending also point to strengthening economic activity probably most induced by more expansionary economic policy settings. Monetary policy has been eased five times over the past year or so. More government spending has been initiated particularly through the conduit of regional government. The Renminbi has also been adjusted downwards over time. A further positive influence on China’s growth from these policy measures is likely in the near-term even though medium-to-longer-term growth prospects remain dependant upon how well China can rebalance the drivers of its economic growth towards domestic spending, especially by the household sector in China.
In Europe, too economic growth may be gaining some traction from very easy monetary conditions. GDP growth in Europe was surprisingly strong in Q1 2016, up by 0.6% q-o-q, 1.6% y-o-y. Europe’s unemployment rate, although still very high, continues to fall, down to 10.2% in March from 10.4% in February. One problem in Europe, and for that matter much of the world, is the continuing weakness of prices. Headline annual inflation was disappointingly soft in April at -0.2% y-o-y. Producer prices are even weaker down 4.2% y-o-y in March. Borderline deflation means that most companies will struggle and will find that the easiest way to improve profits is to keep cutting costs. The ECB has said that even after it eased policy further back in March it still stands ready to do more, although not necessarily by driving interest rates further in to negative territory.
Australian economic readings remain very mixed. The March labour force reading showed a return to strength with employment up by 26,100 but coming after three consecutive monthly weak readings. The unemployment rate fell to 5.7% in March. In contrast, most indicators of housing activity and retail spending have turned softer. Retail sales were flat in February after rising only 0.3% in January. Inflation was surprising weak in Q1 2016, falling by 0.2% q-o-q and taking the annual headline inflation rate down to 1.3% y-o-y. Underlying inflation reading were much softer than expected too and all sit well below 2% y-o-y, the bottom of the RBA’s 2-3% target range.
The RBA will produce its revised economic forecasts late this week in its quarterly Monetary Policy Statement. It will need to revise lower its inflation forecasts which are likely to show inflation sitting below target band for a relatively lengthy period. Another way of viewing this is that if monetary policy is left unchanged economic growth will track lower than might otherwise be the case if the RBA worked to lift inflation back inside target band. We see distinct pressure on the RBA to lower its cash rate further. The early Government Budget and the Federal election likely in July may complicate the timing of the next rate cut, but either this week or not far beyond we see a 25bps cash rate cut to 1.75%. A follow-up 25bps cash rate cut to 1.50% will probably be needed to ensure adequate pass-through of the lower cash rate to bank lending interest rates. Very low inflation means that low interest rates are likely to persist in Australia throughout 2016 and much of 2017 as well in our view.