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er20130607BullGlobalEconomyandMarkets (1).pdf

er20130607BullGlobalEconomyandMarkets (1).pdf

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Published by: Sarah Crawford on Jun 07, 2013
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06/11/2013

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1
Bulletin
Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based arereasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.
Big issues for global economy and markets
7 June 2013
Over the last week I have been visiting real money managers andhedge funds in London.I have been emphasising the following key messages:
Australia’s mining boom is slowing more sharply than hadbeen suspected, posing a growth challenge for the Australianeconomy.
Business and consumer confidence has failed to respondto the RBA’s rate cuts with the deleveraging sentimentdominating spending and investment/employment decisions.
Inflation pressures have eased in Australia with companieslacking pricing power and soft labour markets easing wagepressures.
The recent fall in the AUD has largely resulted from marketfears of an imminent tapering of securities purchases by theUS Federal Reserve, sparking a boost to the US Dollar and acorrection to the 'over valued' currencies, such as the AUD.This correction is likely to be phased out over coming monthsas US data disappoints and markets push back the timing ofthe tapering process.
The Fed sees the fall in the US labour market participationrate as cyclical rather than structural. Any improvement in USgrowth is likely to see a rise in the participation rate, therebyslowing the fall in the unemployment rate and ensuring thatQE policy holds well into 2014.
Reserve Bank concerns around a resurgence of inflationarypressures are likely to be allayed with a stronger AUD andongoing evidence of a lack of pricing power for Australianfirms.
Concerns around a housing bubble in the Australian economyare over done. Regional disparities in underlying economies,ongoing deleveraging by the household sector and a lackof participation by First Home Buyers will constrain pricepressures.
Global growth is likely to ease in 2014 as China slows, Europeremains in recession and US consumers are cautious in lightof limited improvements in the US labour market.
European risks are still apparent. Spain is currently rated atBBB, on negative watch. One more downgrade would seeSpain go sub investment grade necessitating widespreadselling by investors who cannot hold sub investment gradepaper. Such a development is likely to see a markeddowngrade in global growth and extensive financial instability.
Under these circumstances the Reserve Bank will be requiredto ease rates by 75bps over the course of the next year.The next cut is expected in August, in response to a benigninflation report and ongoing evidence of limited traction fromrecent rate cuts.There is a high degree of confidence amongst the customersaround three key big picture issues:
I.
US economy will surprise on the upside
II.
AUD is unlikely to recover and may fall further
III.
European risks are much diminished.Of course those views are directly opposed to the messagesI have been delivering during the meetings. It has made forinteresting discussions. The issues are also inter-related. If theUS does surprise on the upside then the Fed tapering will beaccelerated, bringing down the 'QE over valuation' of the AUD.Our view, of course, is that US data will surprise on the downside,arguments around the structural fall in the participation rateare over done (it is still weak demand that has lowered theparticipation rate) and the sharp fall in the US unemployment ratehas been exaggerated by the fall in the participation rate.In fact, my rejoinder in those AUD discussions is that the fall inthe AUD has already priced in the tapering. If the tapering timing(next few Fed meetings) gets pushed back then that will lead toa 'bounce' in the AUD, especially given the prevailing negativesentiment and associated short positioning. The optimism aroundthe US economy is largely related to the debt/balance sheetdebates – with some suggesting corporate and households arein good shape, and that the government's budget position isimproving.Our view is that household leverage is still too high and it is tooearly to declare victory on government debt, particularly given ourgrowth outlook. We expect income growth to be relatively soft– wages and jobs are still looking weak. Given this, and withouthouseholds supplementing demand with leverage, spending willremain subdued.Of course, others who have argued for AUD to be overvalued'for years' are finally getting some encouragement. While we see'fair value' around USD 0.93 these people see it 'sub 80' on aPPP basis. We do agree that the path of the AUD will impact RBApolicy. Our call for the RBA to push rates to 2.0% will be impactedby the AUD profile. A marked fall in the currency would precludeaggressive cuts in the near term as the RBA pauses to assess theimpact on inflation, growth and confidence of a lower AUD.That sentiment seems to be behind the RBA's more cautious
 
2
Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based arereasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.
assessment of the inflation outlook in the Governor's lateststatement prompting us to confirm our August cut forecast.However this statement preceded the surprisingly weak Marchquarter GDP print encouraging speculation of a July move. Givenour prior for a much lower cash rate (2.0% target) we do notdismiss the July possibility, especially if our expectation of aretracement of AUD back towards parity develops over the nextfew weeks.Finally, discussions around European risks were interesting. Itwas generally confirmed that global fund managers (who have 7%of assets invested in Spain/Italy) and European fund managers(who have around 20% of assets invested in Spain/Italy) would beforced to sell in the event of a downgrade. It was also recognisedthat most managers have been forced to hold Spain due to a riskof underperformance.The optimists argue that: the Spanish data is improving (secondderivative); the ECB has arranged to buy Spanish paper; andthat the rating agencies would not dare downgrade Spain dueto potential financial market disruptions. Others were muchless sanguine, recognising the potential risks but claiming thatcompetitive forces would not allow them to disinvest.Others highlighted Italian elections and structural decay in Franceas the more important risks to the European story.Overall a fascinating trip, highlighting how our markets areso intricately linked to the big global issues. I remain verycomfortable with our key views and will enjoy watching our storyunfold from the safety of my holiday abode!
Bill Evans
, Chief Economist
 
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