For a more comprehensive round up of the week, listen to Stephen’s full report here.
Risk assets appear to be on an improving trend that we believe should carry in to early 2014 at least and notwithstanding the strong gains made in 2013 so far. The main reason why we are optimistic is that economic readings in the world’s biggest economy, the United States, and second biggest economy, China, have on balance taken a turn for the better increasing the likelihood that market global growth expectation for 2014 will steadily improve over the next few months. Importantly the most agnostic group about the sustainability of improving global economic conditions are some of the world’s key central banks, including the US Federal Reserve (Fed) and the Reserve Bank of Australia (RBA), but that implies very accommodating monetary conditions will persist until the data make a very solid case proven that the economic conditions have strengthened.
US economic releases over the past week showed two important positive surprises. First, the US economy grew at 2.8% annualized pace in Q3 well above the market consensus forecast of 2.0% and accelerating from 2.5% in Q2. While the composition of US Q3 GDP was softer than headline growth implied – final sales of US domestic product edged back to 2.0% in Q3 from 2.1% in Q2 – the outcome was still impressive given the very sharp headwind to US growth from lower government spending.
The second big surprise came from the US October nonfarm payrolls report showing an increase of 204,000 (market consensus forecast 120,000) with equally unexpected upward revisions to the readings for September (163,000 from 148,000 initially) and August (238,000 from 193,000). The US labour market appears to have sailed through the partial government shutdown early in October without losing momentum. If growth in nonfarm payrolls continues at near the pace registered in October when combined with big gains in household wealth over the past year, household consumption will most likely make a stronger contribution to US growth over coming quarters.
Importantly, the Fed wants to see even stronger payrolls growth and on recent internal research papers is mulling over whether its guidance to financial markets on what level of unemployment (7.3% in October) needs to be achieved before lifting the zero official interest rate. Currently the guidance is that the zero interest rate will be in place at least as long as the unemployment rate is above 6.5%, but that may change to 6.0%, or even lower over future policy meetings implying no change in the official interest rate until 2017 at earliest.
The run of economic readings in China over the past week or so also make it plain that near 8% annual economic growth (7.8% was recorded in Q3) is persisting in Q4. China’s export growth lifted in October to 5.6% y-o-y from -0.3% in September while industrial production improved to 10.3% y-o-y (market consensus forecast 10.0%) from 10.2% in September. October retail sales (13.3% y-o-y) and urban fixed asset investment spending (20.1%) were in line with market expectations. The outcome of the key third Plenum meeting is due by the middle of this week and is expected to announce plans for a range of economic reforms likely to drive an even faster pace of urbanization and capable of more than quadrupling the size of China’s economy by 2030.
In Australia too, positive economic surprises – stronger than expected September home building approvals (up 14.4% m-o-m), retail sales (up 0.8% m-o-m) and international trade position (a deficit of $A284 million against expectations of $A500 million) have outweighed the one negative, weaker than expected employment growth in October (up only 1,100). Even with confident predictions by retailers of much better than usual pre-Christmas trading conditions and weekly evidence of exceptionally strong home sales the RBA is still concerned that spending outside the mining sector will be insufficient to offset declining mining investment spending. The strong Australian dollar adds to the RBA’s concerns. At the very least, the RBA is likely to be very slow to accept that the economy is improving. If, as we expect, indicators of domestic spending continue to surprise positively over coming months, it is still likely to be the second half of 2014, at earliest, before the RBA starts to lift its cash rate. Our tentative forecast is that the first RBA rate hike will be in August 2014.