Maxim Monthly Market Insights - June 2015

Australian GDP in Q1 was strong. But there is plenty of devil in the detail which means the RBA retains a firm easing bias.

The fall in stocks on the ASX continues with the market now down a little more than 8% from the peak just 5 weeks ago.

It all makes for a slower economy. But as US rates rise and the Aussie dollar falls the economy should continue to slowly improve over the next year.

 

Strong growth, weak economy – what gives?

 

In economics it’s often difficult to gauge information gained from a signal relative the unwanted information that comes from background noise.  That’s because of the way data is surveyed, reported and revised as time passes. It makes measuring and predicting where the economy is and where it is likely headed more difficult than economists admit.

Take Australia’s Q1 GDP print of 0.9% for example. That’s a fantastic print. Consumption was up, the lower Aussie dollar and productive capacity built during the mining boom kicked in, and housing construction did its bit. But, the government and business investment were a drag on the economy. So the wash up was strong numbers that when broken down suggest slow momentum. That meant year on year growth fell to just 2.3%.

Tying it all together: Australia’s economic transition is occurring with a lower Aussie dollar, and consumer spending doing their job. Employment remains strong but the key concern remains business investment. Confidence needs to improve and until it does the RBA has an easing bias.

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Strong but weak. That’s confusing.

 

Key here, in the context of signal and noise, is that the underlying volatility within the components that make up the GDP number. Indeed, Westpac chief economist Bill Evans wrote “despite a strong headline result the details of the March quarter national accounts update were poor and will have come as a significant disappointment for the Reserve Bank, the weaker picture around
consumer spending in particular.”

Evans argues that the reduction in savings which, he says accounted for most of the uptick in consumer spending, given slow wages growth, was involuntary and thus not a signal that consumers are reacting positively. I’m not sure I agree given the strength of employment and the fact that it is just short of an all-time record. But, there is little argument that the economy is growing at a slower pace than is desirable. That means the RBA continues to have an easing bias. But the good news from Evans and the OECD is that growth in Australia is expected to increase back to a more ‘normal’ 3% in 2016 as the weaker Aussie dollar and economic transition gains pace over the next 12 months.

 

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Send in the ‘clowns’

 

After the solid 0.9% Q1 GDP release earlier this week, Australian Treasurer Joe Hockey took aim at those doubting the strength of the economy, declaring them to be “clowns”. But Westpac’s senior currency strategist Sean Callow is out with a report defending these “clowns”, saying the flow of data has been weak enough lately to give anyone cause for concern.


The weakness in Business Investment, something the government is trying to address with the $20,000 accelerated depreciation allowance in the Budget, is the key concern going forward.
But, the risk Hockey runs with his rhetoric is that he undermines the uplift in consumer and business confidence that will have flowed from the Budget. Hockey has over-reached here.
Dealing with the facts isn’t foolish

 

In some part the domestic recovery, at least consumer spending, has taken strength from the wealth effect of the big rally in the ASX 200 in the 3 months from December 2014 to March 2015. That drove the index from around 5,100 to up near 6000 (15.49%). But, having failed at 6,000 the first time the index then failed multiple times over the following two months before breaking lower as the banks and miners came under heavily selling pressure. That’s left the ASX 200 down 500 points (8.33%) from the highs.

While not in the business of forecasting the ASX’s trading range the market looks set to remain under pressure as the 4 ‘Major’ banks (which make up a massive 26.88% of the ASX200 capitalisation) remain under earnings and regulatory pressure. Likewise BHP and Rio (which themselves make up 16.86%) also remain under pressure.

That makes what happens in US markets as the Fed raise rates doubly important for the ASX and the wealth impact on Australian households and consumption.

What the looming US interest rate hike means for Australia Janet Yellen, US Fed Chair, and her colleagues at the fed have said many times over the past couple of months that the weakness in US Q1 2015 GDP (-0.7% annualised) is transitory and due to a change in seasonal factors. That’s been code for ‘we know many analysts think the economy is too weak to start raising rates but we are going to do it anyway because we are right and you are wrong’.

So news that the US jobs market, wages and housing are back with strength highlights that it’s a question of when, not if, the Fed’s emergency measures and super low interest rates begin to be unwound.

This is important not just for the US economy, but also for the global economy, for markets and, closer to home, the Australian economy. The RBA, and others expect that the key impact on the Australian economy will be to drive the Aussie dollar lower. US investment bank Morgan Stanley believes the Aussie dollar will fall below 70 cents by 2016. While that will make holiday’s in the US, and overseas internet shopping more expensive it will provide a solid boost to Australian growth – Tourism, education and other exports will be the big winners.

 

Tying it all together

Australia’s economic transition is occurring with a lower Aussie dollar, and consumer spending doing their job. Employment remains strong but the key concern remains business investment. Confidence needs to improve and until it does the RBA has an easing bias.

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