Maxim Monthly Market Insights

 

  • Australia’s economic growth rate has fallen to 2% with the lowest nominal rate of growth since the early 1960’s.
  • Even though the Aussie dollar is down more than 20 cents over the past 12 months and is providing an economic boon the RBA is back in play.
  • Global market instability is both a result and cause of downgraded local and global growth.

 

Australian growth hasn’t been this weak since the 60’s

Last month the RBA downgraded its growth profile for the Australian economy and it seemed more likely than not that this meant the chances of another rate cut had diminished. But, after a weaker than expected Q2 GDP released last week which showed that economic growth slowed to just 0.2%, taking the year to growth rate down to 2.0%, the chorus of analysts calling for both a lower Aussie dollar and further RBA rate cuts has grown. Of course this weakness will not have been unexpected by the RBA. Likewise, it’s too early to know how this, backward looking data, is going to impact the RBA’s outlook for the economy, especially when the Aussie dollar has now fallen under 70 cents, but the chances have increased that the RBA embarks on another round of rate cuts.


US Investment bank Morgan Stanley said in a note to clients last week that:

“The 2Q15 national accounts strengthen our conviction that Australia faces a persistent demand deficit, even with slower migration suggesting potential growth has come down by some 0.3ppt. We forecast unemployment to rise over the next 15 months to a peak of 6.8%, despite the weaker labour productivity evident in recent quarters. Thus, while the RBA is reluctant to use its remaining 200bp of conventional firepower, we forecast another 50bp of rate cuts to be delivered once housing momentum slows (we factor November and May in our base case).”

image004.gifAMP Capital’s Shane Oliver agrees.

Last week he said that, “The combination of an extended period of below potential growth, a rising trend in unemployment and weak inflation is likely to ultimately drive the RBA to cut interest rates again.” That’s important. But, it is the growing recognition, from Oliver and others that, the housing construction boom “looks to be at or close to peaking” which adds weight to those who think the RBA can cut again. That’s because construction has been such a big part of Australia’s economic transition over the past two years.

But, it’s the unexpected weakness in July retail sales, with a fall of 0.1% against market expectations of a 0.4% rise, which also fueled growing concern about the economic outlook. July’s weakness highlighted that the strength of retail sales in June appears to have been a simple pull forward of demand in reaction to the government’s accelerated small business depreciation scheme.

One, or even two, data points after the relative strength of the past year don’t make the economy weak. But like the RBA, businesses need to watch Westpac consumer sentiment and the NAB business surveys for an indication of whether the slowdown in growth in Q2 and the early part of Q3 is enduring. For the moment the Jury is still out and we are alert, not alarmed.

Global Growth is slowing and markets are at risk of more weakness.

aussie_dollar.pngMarkets are meant to serve the economy. They allow companies to raise capital, to enable investors to become owners of businesses via equity investment, they allow these businesses to hedge their borrowing and foreign exchange exposures, they allow farmers, producers and businesses to hedge their commodity exposures. Crucially they also allow ordinary citizens to build wealth for their families, for retirement.

But whereas financial markets, stock, bond, commodity and currency were always there to serve the real economy in the post-GFC world central bankers have turned the pyramid upside down.

Rather than have markets reflect what is happening in the underlying economy central bankers from in the US, UK, Japan, and Europe have reversed the usual correlation and used the stock market, super low interest rates, unconventional monetary policy, and quantitative easing to drive a wealth effect from “Wall Street” to filter through the economy and trickle down onto “Main Street”.

While there is little doubt this worked in 2009 to stabilise the markets, the global economy, rebuild confidence and stop the GFC morphing into a new “great depression” it also set up the risks that are now emerging in markets as we edge closer to the first Fed rate hike since 2006.

Make no mistake: the prospect of a return to interest rate rises from the central bank of the world’s largest economy marks a monumental pivot point for the global economy with ramifications that will be felt around the world.

image008.jpgNot only are traders worried about that, and what it might mean for stock valuations but they are now worried about the apparent global growth slowdown. China seems to be losing its way, both in markets and on the economic front. There is a risk – a very real risk – that after six years of free money and low rates, that even good economic data can really do much for the confidence of consumers and businesses.

That’s a dangerous cocktail for the Australian economy at a time of important economic transition. Much of the recent strength has been related to housing construction and the wealth effect of rising property prices. That looks at an end and prices on the ASX are back at levels last seen 2 years ago. BUT, the risk of an event doesn’t mean the event is certain to occur. The outlook remains extremely uncertain however.

Tying it all together: I’ve been consistently optimistic about the Australian economy. I continue to believe the massive fall of the Aussie dollar will help the economy stabilise from the many headwinds it now faces. But for the first time in years the risks are not as skewed toward economic optimism.

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