The RBA, the Fed and a Postcard from Japan

• This week we report on the views of Japanese clients of Australia following a recent trip there. The main points were: (i) most Japanese investors retain a favourable view on the outlook for the Australian economy; (ii) there remains considerable interest in Australian bonds and other interest-bearing instruments – including in the newly-issued 30-year bond – given Australia’s relatively high (and positive); (iii) Japanese investors also appear mostly favourably disposed towards the $A on account of both their optimistic view on the Australian economy and the belief that the RBA will not cut rates again anytime soon; (iv) the global bear steepening trend for the yield curve is expected to continue; and (v) Australian house prices and the sustainability of Chinese growth were the key questions asked. There was little awareness of the apartment settlement and oversupply risks that we are closely focused on at the present time.
• In terms of our economics presentation, we focused on increasing signs that the mining sector may have reached bottom and the continuing support for the Australian economy from many elements of Chinese growth – reflected in strong growth in tourism and foreign students on the services side – and in strongly rising exports of gold, wood, wool, wheat, meat, beverages and confidential items.
• Domestically our concerns at the present time centre on signs that momentum has slowed both in NSW and in retail spending. Both are important obviously by virtue of their size – and in NSW’s case (along with Victoria) has been important in offsetting much of the weakness emanating from the mining sector/regions. While we expect the recency of the past two interest rate cuts, the higher headline CPI and recent reacceleration of house prices in Sydney and Melbourne to be sufficient to see the RBA hold fire in November, it would not surprise to see a dovish statement in light of these economic trends, which are likely to be closely studied over coming months by the RBA.
• Offshore, it is also a very big week with the Bank of Japan, the Fed and the Bank of England all meeting. No rate changes are expected however there will be strong focus on whether there is any further progress toward or stronger hints of a Fed move in December, which is widely expected. There is also important US data – the ISMs (Tuesday and Thursday) and non-farm payrolls on Friday – and China publishes its PMIs on Tuesday.
• In markets, the main trends over the past week were gains in the $A on the crosses as the $US broadly gained and the $A held its ground versus the $US. Bond yields also continued to edge higher.

 Japanese investors’ views of Australia

• We recently met with local and foreign life insurers and funds management firms on a trip marketing the Australian economy in Japan. There is still very keen interest in Australian fixed income securities given negative interest rates in Europe and Japan and very low interest rates generally around the world.
• There were a lot of questions about the new 30-year Australian government bond (both before and after the issue), with the 3% yield again standing out on a global comparison. A number of investors were very interested in the issue but needed the amount on issue to build as internal guidelines prevent owning too large a proportion of any single issue.
• The main questions Japanese investors had on the Australian economy were the perennial favourites of house prices and the sustainability of China’s economic growth. There was also a good deal of interest in Australia’s new central bank governor (would he be more hawkish than Governor Stevens – we thought not noticeably) and also some discussion of the negative political environment. For the most part, there was not that much focus on the apartment oversupply/settlement risk situation, which is a reasonably significant issue for investors to follow over the next 12-18 months in NAB’s opinion.
• Japanese investors for the most part remain optimistic on the outlook for the Australian economy, with some noting the recent strength in state government spending and that the capex outlook was no longer as weak as expected. [We noted also potential strength in defence spending in coming years]. Most did not expect the RBA to cut rates further in the near term, though nor did they expect an interest rate increase for an extended period, which inclined them to a constructive view of the $A and to be overweight Australian bonds versus US Treasuries. That said one investor was quite worried about the potential for China to be in a bubble and so was bearish on Australia and the $A. In general, Australia’s high yields were the main attraction and this was also seeing more money flowing into spread product and into longer-dated securities.
• One investor voiced his concern about the volatility of the Australian employment data (unsurprisingly). We agreed and suggested that the unemployment rate and full-time male employment had generally been less volatile indicators, though now even these series were impacted by substantial volatility on a monthly basis. The best one can do is to look at the trends in each of these sub-series.
• Most investors thought the trend to global yield curve steepening would continue, encouraged by the BoJ’s new policy, higher oil prices, the perceived backing away of central banks from even more negative interest rates, expected further tightening by the Fed and increased requests from central banks for greater use of fiscal policy. One client was worried that the BoJ would not have quite as much control over the yield curve as it might hope, while another thought the steepening trend would have a negative influence on REIT markets, which have been correlated with long bond yields.
• A number of insurers that sell $A-denominated life insurance products had recently started selling 20-year life insurance products, which was generating demand for longer-dated Australian assets. The proportion of these products denominated in $A outweighed those sold in US$ by a factor of around 3:1. This made me wonder about the impact on the $A and flows into Australia from Japan if Australian yields did fall below those in the US over the next year or so as the Fed tightened and the RBA continued cutting rates.

• Some of the different views expressed:

1. An improving trend for the trade balance excluding iron ore was noted (higher coal prices are likely to accentuate this trend in the near term at least);
2. One client did not expect much further Fed tightening as they were looking for a US recession next year;
3. Demand for Australian apartments out of China may wane somewhat in the near term given the significant cheapening in London apartments after the recent sharp drop in the GBP post Brexit. That said, Australian property prices were still seen as relatively attractive in RMB terms given the big drop in the $A against that currency over the past three years.

• I gave two interviews to the Japanese press. The topic they were most interested in was my view of Japan’s negative interest rate policy, which – as many of you would know – I am not a fan of, believing that central banks did not do sufficient due diligence on the substantial costs associated with negative interest rates.
• Apart from the issue of apartments, I also covered growing signs that the mining economy had bottomed and continuing support from the Chinese economy for many aspects of Australian growth, as represented by strength in exports of wood, gold, wheat, wool, meat, beverages and confidential items among others. What’s worrying us most on the Australian economy in the short term is the slowing that seems to be going on in NSW and in the Retail Sector, both large parts of the economy.

For full analysis, download report

•  Australian Markets Weekly:  31 October 2016 (PDF, 224kb)

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