Australian Markets Weekly

Blockbuster week in Australia with loads of key economic data, an RBA rate decision tomorrow, and a speech from the RBA Governor on Wednesday.

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It’s all happening! Except in Markets.

Blockbuster week in Australia with loads of key economic data, an RBA rate decision tomorrow, and a speech from the RBA Governor on Wednesday – more on this below.

Plenty happening offshore as well with the highlights to be US non-farm payrolls Friday (another 200k+ jobs gain likely which leaves the Fed on track to hike in mid 2015), the European Central Bank likely easing monetary policy again on Thursday to head off rising deflation risks, and geopolitical tensions rising in the Ukraine/Russia.

For all this, we’d note that financial markets are becalmed. AUD has traded a narrow US92 to 95 cents for the past five months, meanwhile the VIX (traded volatility on the S&P500) at 12 is not far off recent and all-time lows – see chart below. We’re not sure when market volatility will turn up but we know it will one day. With the Northern Hemisphere Summer lull officially ending today with the US Labour Day holiday, and macroeconomics/geopolitics in play, perhaps it’s not that far away.

A soft Q2 GDP outcome will be smoke without fire

Turning to the local economy, we expect this week’s economic data to show that Q2 was quite weak – perhaps even negative – but that we’ve seen an improvement in more recent months.

The Q2 slowdown reflects several factors, not the least being that Q1 expanded a rapid 1.1%. A large part of that Q1 increase was a surge in resource sector exports which more recent trade data tells us has been almost entirely reversed in Q2 – Tuesday’s Balance of Payments data will confirm the actual detraction. The other partial data we’ve received so far have tended to be on the soft side – including retail sales due to the drop in confidence around the May Commonwealth Budget.

At this stage we expect Wednesday’s data to show GDP expanded a modest 0.2% in Q2. A negative outcome is possible if stocks/inventories (out today) swing sufficiently the wrong way.

A soft or negative Q2 quarter for GDP will create plenty of headlines. We wouldn’t read too much into it though.

For one just about everyone expects a soft outcome – the Consensus is for +0.4% and the RBA’s forecast in their August SoMP implies they are also looking for an increase around +0.4%. Second, the slow Q2 came after a rapid Q1 – so probably best to read these two numbers together. Finally, there are signs that at least some of the softness in Q2 may have reversed through July and August.

Retail sales are a good example of this and we expect Thursday’s data to show sales lifted a sizeable +0.9% in July – the Consensus is +0.4%. Several factors likely drove the improvement: 1) we’ve seen a bounce back in consumer confidence from the post Budget lows and 2) we saw sharp lift in the retail sector in NAB’s July Business Survey. Note that NAB’s Online Retail Index for July is out on Wednesday.

Animal Spirits returning?

Another positive piece of news came out of last week’s Q2 Capex report. While the Q2 result was soft there was more hopeful news when firms were asked about their future Capex plans. We know that Capex is set to fall sharply in 2014/15 as mining investment falls. The better news is that we are finally starting to see an improvement in Capex plans for the non-mining companies – the Survey points to a 10-12% increase in 2014/15 Capex for industries outside of mining and manufacturing.

Now this is hardly a boom but it will encourage the RBA who in recent speeches have lamented about the lack of risk-taking by business. They want to see a bit more of the “animal spirits” Keynes talked about. Perhaps!

RBA on hold – language tweaks less supportive of rate cuts

For tomorrow’s Board meeting, the RBA is sure to leave the cash rate at 2.5% and almost certain to repeat that “On present indications, the most prudent course is likely to be a period of stability in interest rates.”

Of course, this prudent course remains a balancing act between an $A that is too high for their liking and interest rates that are too low. They’d prefer a different mix for sure.

NAB still sees the RBA staying on hold as they wait for the mix of forces on the economy to resolve – this could take some time. We have also been warning that if the RBA need to do anything in the next year it is more likely to be a cut. On balance, recent developments have reduced the risk they may need to cut again and language tweaks in Tuesday’s Statement should reflect this.

Over the past month encouraging news has been the improvement in the NAB Business Survey and Capex expectations. A bit worrying has been the apparent reacceleration in house rices in recent months. The main piece of soft data last month was the rise in the unemployment rate from 6.0 to 6.4% in July, although some of this looks to be statistical quirk/sampling/changes.

Overall, the RBA remain awkwardly on hold. Market pricing reflects a small chance they may need to cut again and the first hike now not priced until early 2016. This market pricing is now a little softer than our forecast but overall close enough not to quibble.

NAB Lifts Near-Term AUD forecasts

We have revised our end 2014 forecast to 0.88 from 0.85, still looking for an eventual fall to 80 cents. The end-Sep forecast is maintained at 0.90.

We have not lost faith in our long-standing forecast for significant AUD depreciation. However, the conditions under which the decline is precipitated may take longer to eventuate, due to the low level of market volatility. Our present value model shows it is the low level of volatility which is the most significant contributor to the stronger than expected AUD. We would need a rise in volatility to drive a move lower in the AUD, and this may take longer to occur than previously thought. We still look to higher US interest rates, lower commodity prices and the terms of trade to fundamentally lower the AUD over the forecast horizon.

Week ahead

As noted, a huge week here and abroad. Locally, as well as the Q2 GDP and July retail sales already mentioned we also get July building approvals (to be soft) and house prices. Offshore, as well non-farm payrolls and the ECB meeting we have central banks meetings in Japan, the UK and Canada.

The ECB is the only Bank expected to make a policy change, with our European Research team expecting them to reduce the main refinancing rate by 10bps to 0.05%. In their view, Draghi’s speech at Jackson Hole, where he warned that ‘the risks of doing too little’ on demand side policies ‘outweighed the risks of doing too much’ and that the Governing Council ‘stand ready to adjust our policy stance further’ were signals that Draghi has now decided that deflationary risks have risen enough to merit further easing. They also expect Draghi to give more clarity on the ECB’s plans for private sector asset purchases, but these will come down the track if other measures aren’t working.

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