Maxim Monthly Market Insights - February 2016

 

• 2016 has kicked off with a bang as the competing forces of central bank policies, collide with the chill wind of a slowing Chinese and US economy.

• Markets have gone into a funk, stabilised, rallied off their lows but are still vulnerable to further pressure and aggressive selling. It's clear that in 2016 the volatility of volatility is rising across global markets.  

• From a local perspective the ructions pose fresh risks for the Australian economy but for the while the RBA has an easing bias. It also has a positive expectation about growth in the year ahead, here at home, and among Australia's major trading partners.

 

RBA - the Claytons easing bias

 

The Reserve Bank released its latest quarterly statement on monetary policy (SoMP) in early February. The document makes clear that the RBA was not expecting the strength in employment that Australia has experienced since the last SoMP in November. That’s a very positive shock in what has increasingly become a clouded outlook in 2016.

The bank also highlights that the combination of monetary policy and the lower Australian dollar continue to work together to support the economy (our emphasis):

The Reserve Bank Board reduced the cash rate by 50 basis points in the first half of 2015. The available data suggest that the accommodative stance of monetary policy and the depreciation of the exchange rate since 2013 have supported growth and assisted the rebalancing of economic activity towards non-resource sectors of the economy. This process has been particularly apparent in the labour market. Employment growth over 2015 was stronger than was expected a year ago and the unemployment rate fell by more than had been expected. Despite this, output growth has remained below average.

That doesn't mean there isn't “scope for easier policy, should that be appropriate to lend support to demand” the bank said. But it made very clear the preconditions for such an easing when they said, both in governor's statement and the SoMP, that they will assess any new information, "to judge whether the recent improvement in labour market conditions is continuing and whether the recent financial turbulence portends weaker global and local demand.”

Portends is an interesting word for the RBA to use. yet they still hold a positive outlook for the local economy noting that:

Growth in Australia’s major trading partners is forecast to remain around its current rate over the next two years. The US and euro area economies are expected to grow at an above-trend pace, while growth in the Asian region is expected to ease a little further, driven by a further moderation in Chinese growth.

The RBA noted the housing market has started to show signs of cooling in price terms but that foreign buyers would continue to support the construction phase of the current building boom. As a result, it’s clear that the RBA retains great comfort with current settings and the economy would need to diverge materially from current forecasts for them to act on their easing bias.

But if it does, they will. 

 

But there are still risks to Australia’s economic outlook

 

As any business owner knows, however, it's not all beer and skittles in this Australian economy in transition. There are still significant headwinds for the economy, business and consumers.

Take for example Business Investment intentions. The ABS report on private new capital expenditure shows businesses reporting falls of around 20% this year. Yet current Treasury and consensus forecasts are for a much smaller fall than this. In the single digits. That is even though capex intentions in the ABS survey have been a good guide of actual business investment in the past.

The RBA itself wondered about what the market ructions might "portend" as highlighted earlier. And there is little doubt, and history shows, that there is a risk that 2016's market ructions could put further downward pressure on investment intentions.

Which board, senior management, or small business owner wants to take a big bet at a time like this. Of course fortune favours the brave. But most business leaders are of a conservative bent. Richard Branson, Bill Gates, Dick Smith, the boys from Atlassian, Steve Jobs, Elon Musk, and Jeff Bezos are the exception, not the rule. 

Another risk to the outlook is the potential for a retracement of what has been an incredible run in Australia's employment recently.  The NAB business survey’s employment sub indexes points to weaker growth ahead. Statistical anomalies at the ABS suggest this is a possibility as well. Employment growth likewise is well ahead of trend and the RBA itself has said it has been surprised by the strength in employment growth.

How far could it pull back? It is easy to envision a release over the next few month which sees a cumulative pullback of 100,000 jobs or more given recent strength and sample rotation issues.

That is important because expectations about employment drive decision about consumption. At the moment employment has been strong yet domestic demand has still been relatively weak with nominal growth the lowest since the early 1960's. 

That means that any setbacks in consumer confidence or expectations could materially impact domestic growth. That’s not unusual in context with recent growth, which has been fuelled by net exports. But that also means there is still plenty of spare capacity in the economy. This has an upside, no inflationary pressure which gives the RBA room to ease if required.

One other thing worth noting. Sydney house prices have stopped rising BUT hardly anyone talks about the fact Australian debt is up 49% since 2008 (China 79%) while Australian household and government debt has risen exactly the same as their Chinese equivalents.

 

Innovation Nation

 

2016 has started off with uncommon volatility in markets and the economic outlook.

Central banks sure of the path have been caught out and had to react. The bank of Japan has eased, the ECB will ease again, the Bank of England has pushed away any idea of tightening out into the ether, the RBA has pushed the door open to rate cuts if needed, and its widely expected the Fed will soon re-calibrate its own expectations of its tightening cycle.

Consumers and business owners in Australia and around the globe can't help but notice the changed outlook. They will react by changing spending and investment intentions until the dust settles. That implies a period of slower growth in the months ahead than previously expected. 

 

Tying it all together: AUSTRALIAN GROWTH HAS DEFIED EXPECTATIONS FOR THE BEST PART OF A QUARTER CENTURY. THE RBA CLEARLY SEES THIS AS THE MOST LIKELY OUTCOME IN THE PERIOD AHEAD AND IS RELATIVELY UPBEAT AS A RESULT. BUT IF IT NEEDS TO ACT TO LOWER RATES AND THE AUSTRALIAN DOLLAR, IT WILL. 

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