Week in Review
It was a huge (positive) week for global financial markets, thanks to a dovish tilt from the US Federal Reserve and an easing in US-China trade tensions. Equities rose and bond yields fell, while the $A strengthened despite a slump in iron-ore prices.
The biggest jolt to markets came from a speech from US Fed Chair Jerome Powell who validated recent dovish sentiment from other Fed members by arguing that the Fed funds rate was “just below the broad range of estimates” of the neutral policy rate. Given this broad range (according to long-run Fed funds forecasts by voting Fed members) is from 2.5% to 3.5%, and the Funds rate is currently 2.25%, Powell in effect just stated the obvious. But in terms of emphasis, it marks a big shift from what he indicated back in early October – which helped send markets into their recent tailspin – when he said “we may go past neutral, but we’re a long way from neutral at this point, probably.” Although a rate rise later this month still seems locked in, there’s now the tantalising prospect that the Fed could pause its rate hike agenda as early as the new year. The market, at least, is now pricing only one rate rise for 2019.
The other big news came on the weekend, with the US and China agreeing to try and negotiate a trade deal within the next three months. As I suspected, the US has agreed to postpone a planned January tariff increase, though they may still go ahead if no deal is ultimately reached. My base case is that Trump is increasingly keen to secure “a deal”, and China might just throw enough (potentially only token) concessions his way to enable him to declare a victory of sorts and remove this growing source of risk from Wall Street and the US economy.
Meanwhile, US economic data remained encouraging last week, with solid growth in household income and spending and a reassuringly benign report on consumer price inflation (annual growth in the so-called core-PCE eased from 1.9% to 1.8%).
In Australia, the big news was a welcome upgrade to the 2018-19 non-mining business investment outlook in the September quarter capital expenditure (“CAPEX”) survey. The latest estimate now suggests non-mining investment will grow by almost 10%, or broadly similar to the pace of this financial year. That’s just as well as the home building boom is fading and ongoing weakness in Sydney (and Melbourne) property prices are posing increased downside risks to consumer spending next year. Despite the good global and local news, the S&P/ASX 200 was strangely muted last week.
Fed chair Powell testifies before Congress mid-week, which could shed further light on the strength of his recent dovish conversion. OPEC also meets over the weekend, which could cement a production cut agreement so as to help put a floor under oil prices.
Otherwise, the key test for markets will be Friday’s US payrolls report. The market is anticipating another solid jobs gain (+200K), with the unemployment rate and annual growth in average-hourly earnings holding steady at 3.7% and 3.1% respectively. The wages outcome remains critical – even if the Fed desires to turn dovish, it won’t be able to if America’s tight labour market starts to create accelerating wage growth. When and if we get rapidly rising wages (not my base case) it would signal US capacity constraints have finally been hit, in which case there’d be no way but down for stocks and the economy.
In Australia, Q3 GDP is released on Wednesday and should show a slowdown in growth to around 0.6% – from super charged 0.9% in Q2 – thanks to a drop back in (on-again off-again) consumer spending and gathering weakness in housing construction. Of course, partial data over the next few days could change this outlook, especially if business inventories or company profits surprise in either direction. Either way, it’s unlikely to change the still very steady outlook for local interest rates. After last week’s lack lustre effort, there’s a chance local stocks could belatedly join in the party if global market celebrations continue.
Have a Great Week!