Stephen Halmarick, Chief Economist at Colonial First State Global Asset Management, shares his insights on the US Presidential election outcome, and what this means for financial markets.

The election

For the second time in 2016, the global geopolitical landscape has shifted dramatically (and traditional opinion polling has been shown to be severely lacking) with the election of Donald Trump as the 45th President of the United States. The win for Donald Trump and the Republican Party has come as a great surprise to the consensus in the US and, evidently, to the majority of financial market participants given the initial reaction in markets yesterday – with a significant ‘risk off’ move before a recovery in US trading. As stated previously (see Blog 6, the Travelling Economist in Japan and the US), we had based our economic, policy and market forecasts on a Clinton victory and so we will need to update our thoughts – although we provide some initial views below. The victory by Donald Trump looks to have been much more comfortable than almost any commentator was expecting – and indeed the election has seen a much stronger vote for the Republican Party than even the Republican Party itself expected.

Importantly, Donald Trump won a majority of the Electoral College votes. With a majority of 270 College votes required, Donald Trump has won 279 (as at approximately 7am Sydney time) and is likely to win the last two states, Michigan and Arizona and their 16 and 11 Electoral College votes respectively, to finish with 306. His unexpected victory has been achieved by flipping several blue states that had previously voted for Obama in 2012, including Pennsylvania, Ohio, Michigan, Wisconsin, Iowa and Florida. While Trump was expected to do well in the rust belt and former manufacturing heartland, this outcome is far beyond what anyone expected.

In addition to the victory by Donald Trump, the Republican Party has retained a majority in both the Senate and House of Representatives. The Senate and House results are still being finalised but at this stage, it looks like the Republican Party is likely to have a 52/48 majority in the Senate (down from 54/46) and a 239/196 majority in the House of Representatives (down from 247/188).

Words being used to describe the result are ‘tectonic’, ‘revolutionary’ and a significant vote against the political status quo. The implications are likely to be far reaching – in both a political and economic sense.

Secretary Clinton’s relatively early concession to President-elect Trump and calls from her and President Obama for unity and support for him suggest there is recognition that, much like ‘Brexit’, the biggest challenge to come will be knitting the country back together after such a toxic and divisive campaign.  Indeed, Trump’s victory speech was much more conciliatory than many expected given the tone of his campaign, with him even offering thanks to Clinton for her “service to our country”.

President Trump

As we noted in our previous US Election blog (2 November 2016), Donald Trump’s policy priorities are expected to be:

 Tax reform: including a substantial reduction in both income tax (down to three basic rates, 12%, 25% and 33%) and cuts in the company tax rate to around 20%-25% (from 35% currently).

 Healthcare reform: Repealing Obamacare with a focus on reducing costs and entitlements.

 Defence: Increased spending on both Defence ($US450bn) and Veteran’s programs ($US500bn).

 Trade policy: A much more aggressive trade policy, including naming China as a currency manipulator and imposing tariffs on selected Chinese imports, changing the terms and conditions and NAFTA and abandoning the Trans Pacific Partnership (TPP). We would note, however, that there is considerable uncertainty of whether Trump as President could act unilaterally on trade policy, or whether he would need the support of Congress (which may not be forthcoming) to change policy, especially treaties such as NAFTA.

 Immigration reforms: Reduce the flow of both legal and undocumented immigrants, including some deportation efforts and much tougher rhetoric.

 Infrastructure: An infrastructure spending program of approx. $US300bn over coming years.

 Other: Housing finance reforms, loosening M&A regulations, loosening media ownership and liberalizing energy drilling requirements, reversal of some climate change policies.

Implications of President Trump policies

It is our view that, over time, Donald Trump’s policies would, as announced, be highly stimulatory, expansionary and, ultimately, inflationary.

In terms of implications for financial markets we see three phases for the period ahead – but with less confidence on the exact timing of these trends.

1. The initial market reaction, globally, was ‘risk off’. Global equities were down, the USD was down against other major currencies and US Treasury bond yields were down. This is a very similar reaction to that seen after the ‘Brexit’ vote.

At one stage in the US (late afternoon on 9th November AEST), the S&P and NASDAQ Futures were down 5%, the maximum drop permitted by the Chicago Mercantile Exchange before trading curbs are triggered. Globally, the Japanese Nikkei closed down -5.4%, Hong Kong’s Hang Seng 2.2% and the ASX200 down 1.9%.

However, once US markets opened, the ‘risk off’ sentiment quickly reversed with most equity markets closing higher, UK FTSE100 closed up 1% while the Euro Stoxx 50 index was up 1.1% and in the US the S&P 500 is currently trading around +1.1% while the Dow Jones is 1.4% higher.

In bond markets, much like equity markets, we saw the initial ‘risk off’ sentiment quickly reverse as US markets opened and yields rose sharply on the result, with US 10yr yields up 20bps to 2.07%. Initially Australian 10yr bonds were down 14bp to 2.21%, but in overnight futures trading yields have increased 29bps to 2.49%. In currency markets, the USD initially weakened with the DXY index at one stage down 2.1% before recovering through US trading to be up 0.76% on the day. The Mexican Peso is down 7% against the USD, which has been seen as a proxy for a Trump win given his rhetoric around Mexico.

The USD finished stronger against most currencies, with the US up against the Yen (+0.72% to 105.8) and Euro (+0.75% to 0.914) but down against the Pound Sterling (-0.38% to 0.804). The AUD is weaker by 1.1% against the USD at $US0.765.

The ‘risk off’ mode was based on the view that Donald Trump is a vote for significant change in the US political system. This change will likely bring uncertainty and, as we know, markets do not like uncertainty. However it is fair to say that phase one has been shorter than expected.

2. The second phase of the market reaction, which appears to have begun sooner than we anticipated, is likely to be ‘risk on’, with positive sentiment towards equities and weakness in bonds. This is based on the view, as already mentioned, that Donald Trump’s policies are very stimulatory, expansionary and inflationary.

If he was able to get is election policies through Congress (which could be more likely given the Republican’s majority in both the House and Senate), we are likely to see a near-term acceleration in the pace of growth of the US economy and a surge higher in the USD.

The equity markets could potentially respond positively to this stimulus – especially those with significant cash holdings off-shore and those companies involved in sectors of the US domestic economy that stand to benefit from Trump’s nationalistic policy focus.

3. Phase three of response to President Trump’s policies are, not likely to be as supportive. The key issue here, in our view, is that the inflationary implications of Trump’s policies are likely to see the Federal Reserve raise interest rates much more aggressively than currently priced into markets as inflation takes hold.

This could be expected to see Treasury bond yields move sharply higher – short-circuiting the stronger economic data. Trumps anti-trade policies and commitment to increasing tariffs are also likely to be inflationary and negatives for growth. The implication here is that, perhaps within a year or so of President Trump’s policies being introduced, the US economy could weaken significantly (possibly head towards recession), with the USD, bond yields and the equity markets all likely to decline as well.

Economics overview

• Australia: The Reserve Bank of Australia (RBA) Board meet on 1 November 2016, as widely expected, the cash rate was held unchanged at 1.5%.
• The statement remained largely similar to the October statement, with inflation still described as “quite low” and “…expected to remain low for some time.”
• The RBA did however, tilt slightly dovish on the commentary around the labour market, noting that “employment growth overall has slowed”. This was slightly tempered by the observation that “forward-looking indicators point to continued expansion in employment in the near term.”
• The statement also suggests little chance of changes to the forecast in the Statement on Monetary Policy, due Friday – “The Bank’s forecasts for output growth and inflation are little changed from those of three months ago.”
• Policy guidance was left unchanged from October – “the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time”
• Q3 16 Consumer Price Inflation (CPI) data was released and was slightly above consensus estimates. Headline CPI rose 0.7%/qtr and 1.3%/yr, from 1.0%/yr in Q2. Key drivers included increases in fruit (+19.5%/qtr), vegetables (+5.9%/qtr) and electricity (+5.4/qtr) prices, this was partly offset by falls in telecommunication equipment and services (-2.5%/qtr) and fuel (-2.9%.qtr).
• Underlying inflation, the RBA’s preferred measure rose to 0.4%/qtr, slightly down from 0.5%/qtr in Q2 16. The annualised rate fell slightly to 1.5%/yr from 1.6%/yr. Both measures of inflation are still below the RBA’s 2-3% target band
• The September labour market report showed the unemployment rate decreased by 0.1% to 5.6%, driven by a 0.2% fall in the participation rate to 64.5%. The number of people employed fell by 9.8k below the +15k expected. The decrease was entirely driven by full time employment (-53k) while part time employment rose (+46k), continuing the recent trend towards flexible and part-time employment.
• Consumer confidence increased over the month with the index up 1.1%/mth to 102.4. The largest gains were seen in the Economy 1 year ahead (+5.8%) and consumer sentiment (+1.1%) components.
• US: The US Federal Open Market Committee (FOMC) meet on 1-2 November 2016 and as widely expected left the official Fed Funds target rate unchanged at 0.25%-0.5%. While the November meeting was never considered “live” given its proximity to the US Presidential Election, markets and ourselves continue to expect a rate increase at the 13-14 December FOMC meeting.
• In detailing the policy decision, the Fed statement was little changed from that released at the time of the September FOMC – with the Fed continuing to signal that a rate hike at the 14 December FOMC is the base case.
• The Fed’s statement repeated the view that “near-term risks to the economic outlook appear roughly balanced” and that they will continue “to closely monitor inflation indicators and global economic and financial developments”. Given this, the Fed noted that “the Committee judges that the case for an increase in the federal funds rate has continued to strengthen but decided, for the time being to wait for some further evidence of continued progress towards its objectives.”
• On inflation the Fed upgraded their commentary a little, stating that inflation “has increased somewhat since earlier this year but is still below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports” and that “market-based measures of inflation compensation have moved up but remain low.”
• The first estimate of Q3 16 GDP was released at 2.9% on a seasonally-adjusted-annualised-rate, better than the 2.6% expected and an improvement on 1.4% in Q2 16. The better than expected print was helped by a recovery in net exports and an increase in soy bean exports (US$38bn annualised rate) which contributed 0.9% to the headline figure.
• Growth in Q3 saw a slowing in domestic demand with consumption (+2.1%, down from 2.7% in Q2), business capital spending (+1.1%) and government spending (+0.5%) all weak or slowing.
• Employment was slightly weaker than expected in September increasing by 156K, but still more than enough to cover the estimated natural increase in the labour force (~90k). Despite this, the unemployment rate increased to 5.0%, from 4.9% driven by a 0.1% increase in the participation rate to 62.9%. This increase in the participation rate suggests that there is still some excess slack in the labour market which may not be picked up by the unemployment rate and should encourage the Fed to run the economy a little hotter.
• Average hourly earnings data for September was weaker than expected at 0.2%/mth, the annual rate increased to 2.6%/yr from 2.4%/yr in August.
• Inflation as picked up slightly. Headline CPI was up 0.3%/mth in September with the annual rate increasing to 1.5%/yr. Core CPI increased 0.1%/mth with the annual rate falling 0.1% to 2.2%/yr. Inflation continues to be driven by shelter and medical costs, with energy (+2.9%/mth) also contributing to the increase in headline CPI.
• The Fed’s preferred measure of underlying inflation, the Core Personal Consumption Expenditure, was stable at 1.7%/yr in September, around the level is has remained for most of 2016.
• Europe: The European Central Bank (ECB) meet on 20 October 2016 and left monetary policy unchanged, as largely expected.
• ECB president Draghi dampened expectations that asset purchases would be tapered and reiterated the forward guidance that QE would continue at the monthly pace of EUR80bn until there was a sustained increase in the path of inflation consistent with the ECB’s objective.
• The market is expecting an extension of the ECB’s QE program which is due to end in March 2017 at the December meeting.
• The first estimates of CPI for the euro area in October showed an increase of 0.5%/yr, the fastest since 2014. Core CPI was stable at 0.8%/yr still well below the ECB’s 2% target. Inflation was aided by the increase in oil prices over the last year with energy prices down -0.9%/yr in October compared to -3%/yr in September. Services remain the main driver of inflation at +1.1%/yr.
• The political deadlock in Spain ended over the month with Mariano Rajoy of the centre right Peoples Party sworn in a PM after winning a confidence vote, ending a 10 month period with no government.
• UK: The Bank of England (BoE) Monetary Policy Committee (MPC) did not meet in October, the next meeting is scheduled for 3 November 2016.
• Over the month it was confirmed that the BoE governor Mark Carney would leave his role in 2019, before the end of the full 8 year term (2021), but long enough to see the UK through the Brexit. The decision appears to be due to personal/family reasons and not political pressure as speculated.
• Q3 2016 GDP was better than expected increasing by 0.5%/qtr with no sign yet of a “Brexit” slowdown. The annual rate increased to 2.3%/yr. Growth was entirely driven by service (+0.8%/qtr), while industrial production (-0.4%/qtr) and construction (-1.4%/qtr) slowed.
• CPI data showed inflation increased by 0.2% in September, driven in part by rising oil and core goods inflation. The annual rate of inflation increased to 1.0%/yr from 0.6%/yr while core inflation increased to 1.5%/yr from 1.3%/yr. Rising oil prices and a lower currency are expected to continue driving inflation higher over the next year.
• NZ: The Reserve Bank of New Zealand (RBNZ) did not meet over October, the next meetings will be 10 November 2016.
• Q3 16 CPI was stronger than expected at 0.2%/qtr and 0.2%/yr, down from 0.4%/yr in Q2 16 and still well below the RBNZ’s target of 1-3% on average over the medium term.
• Canada: The Bank of Canada (BoC) left rates unchaged at 0.5% at their 20 October 2016 meeting.
• September CPI increased by 0.1%/mth while the annual rate rose to 1.3%/yr from 1.1%/yr. Core inflation was stable at 1.8%/yr.
• Japan: The Bank of Japan’s (BoJ) meet on 1 November 2016 and left monetary policy unchanged as widely expected.
• China: The People’s Bank of China (PBoC) left monetary policy unchanged during the month with no rate cuts or reserve requirement ratio easing.
• Q3 16 GDP released in October showed growth once again stable at 6.7%/yr, the middle of the 6.5%-7% target band where it has remained for all of 2016.
• Inflation increased in September for the first time since February, rising to 1.9%/yr from 1.3%/yr in August. Food price inflation continues to be the major driver of inflation, rising to 3.2%/yr in September from 1.3%/yr in August.
• Chinese producer prices as measured by the PPI increase 0.1%/yr in September, the first increase since 2012 and up from -5.9%/yr one year ago.

 Australian dollar

• The Australian dollar strengthened against most major currencies over October. The AUD was down 0.7% against the USD to $US0.7608, but rose against the euro (+1.85%), the sterling (+5.42%), yen (+2.90%) and NZ dollar (+1.18%),
• Improving commodity prices and terms of trade over the month supported the currency.

Commodities

• Commodity prices were mixed over October with metals varied and weakness in energy, except coal which saw significant increases.
• The price of West Texas Intermediate Crude finished the month at $US46.86/bbl, down 2.9%, while the price of Brent was down 4.2% to $US48.61/bbl. Oil prices rose early in the month, around optimism that a potential OPEC deal would reduce excess supply. Before falling in the last week of October as the market realised any production cuts would be difficult to achieve and would likely exclude key OPEC producers (Iran, Iraq, Nigeria and Libya).
• Increasing activity in the US energy sector also weighed on markets with US rig counts now up nearly 40% from the lows reached in May this year.
• Gas prices were mixed with the US Henry Hub spot price down 7.9% to $US2.79/MMBtu while the UK natural gas price was up 18.5% over August.
• Iron ore prices were stronger over October, up 15.3% to $64.38/metric tonne, as measured by the benchmark price of iron ore delivered to Qingdao China, the highest level is May 2015.
• Coal was the best performing commodity over the month with increasing demand from China, due to domestic mine closures, pushing prices higher. The price of Newcastle thermal coal increased 50.4% to $108.6/metric tonne over the month.
• Zinc (+3.4%) and Aluminium (+3.6%) rose over October while Nickel (-0.9%), Lead (-2.8%), Gold (-3.3%) and Copper (-0.2%) were all weaker.

Australian equities

• The ASX/S&P 200 Accumulation Index lost 2.2% during October, with most industry sectors finishing the month lower. Health Care (-8.3%) was among the worst performers, dragged lower by industry heavyweight CSL.
• Bond proxy sectors continued September’s decline, as the market reacted to rising bond yields and a potential rise in US interest rates. AREITs (-7.9%) and Utilities (-3.0%) once again underperformed the broader market.
• Energy (-2.3%) started the month strongly, but finished lower as doubts surfaced around OPEC’s commitment to cut production. Whitehaven Coal had another strong month on the back of rising coal prices, adding to the 333% share price appreciation since the start of 2016.
• Materials (1.3%) outperformed the market with strong performances from Fortescue Metals and Rio Tinto, which benefitted from a strengthening iron ore price.
• Financials (0.7%) edged higher, led by banks as sentiment towards the sector improved. Banking stocks typically enjoy investor interest during October, as three of the big four banks go ex-dividend in the first half of November.

Listed property

• The S&P ASX 200 A-REIT index continued its recent decline, falling by -7.9% in October. Higher bond yields dampened sentiment towards REITs and other income-oriented investments.
• Office A-REITs held up relatively well on the view that robust leasing demand from the financial services, legal and technology sectors would support Sydney and Melbourne’s office markets.
• The best performing A-REITs were Charter Hall Retail REIT (-1.9%), which stabilised following steep declines in August; and Dexus Property Group (-2.3%), which held an investor day and provided a first quarter update.
• The worst performing A-REITs were Iron Mountain (-12.1%) and Scentre Group (-10.4%). Although neither company announced material news, broader sector underperformance weighed on both stocks.
• Listed property markets offshore also dipped in October. The FTSE EPRA/NAREIT Developed Index (TR) fell by -5.7% in US dollar terms. Despite ending the month lower, Hong Kong (-1.3%) was the best performing region for a third consecutive month, followed by Japan (-1.4%).  Property securities in Continental Europe and the UK lagged.

Global developed market equities

• Global equity markets were mixed over October with weakness in the US and strength in Japan and European peripheries. Volatility continued over the month as markets reacted to changes in the oil price, political concerns in the US and the prospect of a Fed rate hike in December.
• The MSCI World Index was down 2.0% in US dollar terms in the month of October and -1.3% in Australian dollar terms.
• In the US, the S&P500 (-1.9%), the Dow Jones (-0.9%) and the NASDAQ (-2.3%) were all weaker, driven by broad market weakness. While earnings largely beat (reduced) expectations, the results were more “less bad” than good.
• US markets also stumbled at the end of the month as it was revealed the FBI had found more Clinton emails in a separate investigation.
• On a sector basis, MSCI Financials (+2.13%) was the best performer, as bank stocks climbed with rising yields. MSCI Health Care (-6.94%) was the worst performer as political noise around drug pricing and earnings concerns of medical device companies carried over to the rest of the sector.
• Equity markets in Europe were stronger over the month. The large cap Stoxx 50 Index rose 1.8% driven by strong performance in the periphery, with Greece (+4.5%), Italy (+4.4%) and Spain (+4.1%) all stronger. Elsewhere the UK FTSE100 (+0.8%), France (+1.4%) and the German DAX (+1.5%) all rose.
• Asia markets were mixed with the Japanese Nikkei 225 (+5.9%) and Taiwan (+1.3%) up while Singapore (-1.9%) and Honk Kong’s Hang Seng (-1.6%) fell.

Global emerging markets

• Emerging market equities were almost flat over October in USD terms with the MSCI Emerging Market Index up 0.2%, outperforming DM equities.
• Despite the 3% rally in USD index and higher US yields emerging markets performed well in local currency terms aided by the pick-up in key commodity prices.
• MSCI EM Latin America was the best performing region over the month rising 9.72% in USD terms with a strong rebound in Brazil (+11.2%) driven by positive political developments
• MSCI EM Europe, Middle East and Africa (-0.28%) and MSCI EM Asia (-1.54%) underperformed.
• The Shanghai Composite Index was stronger, up 3.2% on stable Chinese growth and stronger  domestic consumption.

Global and Australian developed market fixed interest

• The month of October saw a global move higher in bond yields, on the back the growing consensus that global monetary policy may be reaching the end of its effectiveness. The market’s focus has subsequently shifted towards the time when stimulus may begin to be reduced from current levels, even though central banks have not announced any such plans at this stage.
• Key contributors to bond market moves over the month included the expected Fed rate hike in December, uncertainty over Brext (which drove weaker UK bond prices) and the movements in the oil price.
• The Australian bond market followed the lead from offshore, with yields rising strongly over the month. However, domestic influences were also a driver of this move, as evidenced by the larger move in Australian yields over their US equivalents. In particular, the new RBA Governor Phil Lowe’s emphasis on the flexibility of the central bank when looking at inflation suggested that further rate cuts are now less likely even if the inflation outlook is lower than forecast.
• The biggest moves in 10-year yields were in the UK (+50 bps) and Australia (+44 bps) with Germany (+28 bps) and the US (+23 bps) still posting solid rises. Japanese 10-year yields rose a smaller 4 bps reflecting the cap at 0% that the Bank of Japan implemented as part of its yield-curve focussed monetary policy strategy.

 Global credit

• Despite the notable sell-off in government bond yields, credit spreads moved little in the month. Demand for spread product remains favourable buoyed by accommodative global monetary policy and low issuance. Geopolitical events risk and uncertainty over the growth outlook are keeping spreads range bound as supply is subdued as companies are hesitant to invest (and hence issue debt to fund investment). As with government bond markets, credit markets are likely to see increased volatility in the run-up to Election Day in the US. Despite continued oscillations in oil prices credit spreads largely moved sideways with a small tightening in both physical and synthetic credit indices.
• Specifically the Barclays Global Aggregate Corporate Index average spread moved 6 bps tighter to 1.28%. The US and European spreads also moved 6 bps narrower with the Barclays US Aggregate Corporate Index average spread down to 1.25% and the Barclays European Aggregate Corporate Index to 1.09%.
• At the end of the month ratings agency S&P put a number of non-major bank Australian lenders on negative outlook, on the back of concerns the overinflated property market may give way for a sizeable correction. This follows the major banks and Australia’s sovereign ratings outlook both being moved to negative earlier in the year.
• Following notable tightening in Australian credit spreads last month, there was little movement intra-month in the average spread (relative to bond) of the Bloomberg AusBond Credit Index. This series closed as it opened at +107 bps. Issuance in Australian credit was subdued, although there was some longer-dated non-financial corporates which were readily absorbed by the market.

Market View – September 2016

By Carlos Cacho, Analyst, Economic and Market Research – Colonial First State

Summary

As the major central banks around the world met in September, cash rates were left unchanged. Most recently on 4 October 2016, The Reserve Bank of Australia Board met for their first time with Dr Phil Lowe as Governor leaving the cash rate unchanged at 1.5%. The US Federal Open Market Committee left the official Fed Funds target rate unchanged at 0.25%-0.5%. The European Central Bank left monetary policy unchanged, while the market expected an extension of the ECB’s QE program due to end in March 2017. And as largely expected, the Bank of England’s Monetary Policy Committee left policy unchanged at their September meeting. Meanwhile, the Bank of Japan released its promised “comprehensive reassessment” of their monetary policy easing program. The ASX/S&P ASX 200 Accumulation Index returned 0.5% during September. Despite some weakness during the first half of the month, the Index recovered to finish in positive territory. Volatility returned to Global equity markets over September after an unusually quiet August and July. Markets reacted to uncertainty around central bank policy as Fed speakers attempted to talk up the likelihood of rate increases later this year and the BoE, ECB, BoJ and Fed all met.

Australia

The Reserve Bank of Australia (RBA) Board met on 4 October 2016, for their first time with Dr Phil Lowe as Governor. As widely expected, the cash rate was held unchanged at 1.5%. Also as expected, Governor Lowe has taken the opportunity to re-write some aspects of the statement. Although, critically, the words describing both the inflation and policy outlook are unchanged. On inflation: “Inflation remains quite low. Given very subdued growth in labour costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time.” In terms of policy guidance, there was very little, with the RBA repeating the view that “having eased monetary policy at its May and August meetings, the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.”

The Q2 2016 GDP report for Australia came in largely in-line with expectations and marks the 25th consecutive year of economic growth.

Quarterly GDP came in at slightly below expectation 0.5% per quarter vs 0.6% per quarter; while the annual rate increased to 3.3% per year, from 3.1% per year in Q1 2016, in line with market expectations and a 4 year high. One of the most positive signs from the report is the increase in real gross domestic income to 1.9% per year from 0.4% per year, largely driven by a 0.95% per quarter increase in Q2 2016 and the improvement in the terms of trade.

The biggest contributions to growth came from Public investment (+0.7%), Government consumption (+0.3%) and Inventories (+0.3%) while Non-residential building (-0.8%) and Net exports (-0.2%) were the largest detractors.

The August labour market report showed the unemployment rate decreased by 0.1% to 5.6%, driven by a 0.2% fall in the participation rate to 64.7%. The number of people employed fell by 4k below the 15K expected. The decrease was entirely driven by part time employment (-15.4k) while full time employment rose (+11.5k) reversing some of last month’s move.

Retail sales in August were up +0.4% per month, above the +0.2 per month expected. The largest increase was in department store sales (+3.5% per month) following a 5.8% per month fall in July. Cafes and Restaurants were also stronger, up 1.2% per month.

Consumer confidence increased over the month with the index up 0.3% per month to 101.4. Gains were seen in the current conditions (+3.5%) and year ago family finances (+3.5%) components, while one year ahead expectations for finances (-2.3%) and the economy (-4.6%) declined.

US

The US Federal Open Market Committee (FOMC) met on 20-21 September 2016 and as widely expected, left the official Fed Funds target rate unchanged at 0.25%-0.5%. In detailing the policy decision, the Fed “judges that the case for an increase in the federal funds rate has strengthened but decided for the time being to wait for further evidence of continued progress towards its objectives”. The Fed’s statement noted that “near-term risks to the economic outlook appear roughly balanced” and that they will continue “to closely monitor inflation indicators and global economic and financial developments”.

In addition the committee noted that “the labour market has continued to strengthen, and growth of economic activity has picked up from the modest pace seen in the first half of this year… job gains have been solid, on average… household spending has been growing strongly but business fixed investment has remained soft” Interestingly the FOMC decision was not unanimous with three members of the committee dissenting and calling for a 0.25% increase in the federal funds rate The FOMC maintained their forecast for 2017 and 2018 growth at 2% per year and added 2019 to their forecasts, where they see growth at 1.8% per year.

The majority of the FOMC members now believe there will be just one rate hike this year (down from two), two in 2017 and three in each 2018 and 2019. The expected long-term rate was also lowered from 3% to 2.9%. As mentioned is last month’s Market Watch, employment increased by 151k per month in August, weaker than the 180k per month expected. Despite this, the unemployment rate was stable at 4.9%, where it has remained for the past 3 months.

Inflation remains subdued. Headline CPI was up 0.2% per month in August with the annual rate increasing to 1.1% per year. Core CPI increased 0.3% per month with the annual rate increasing 0.1% to 2.3% per year. Inflation continues to be driven by Rents (+3.8% per year) and medical costs (+1% per month) which had their largest one month increase in 32 years. The Fed’s preferred measure of underlying inflation, the Core Personal Consumption Expenditure, increased to 1.7% per year in August, the cyclical high it last reached in February 2016.

Consumer confidence increased more than expected in September to 104.1, a 7 year high. The large increase was driven by increasing optimism about the labour market and present economic conditions. Manufacturing sentiment measured by the ISM Manufacturing PMI also increased more than expected to 51.5 in September from 49.4 in August. The increase was driven by pick-ups in the orders and production indices and likely aided by the gradual increase in US rig counts over recent weeks.

Europe

The European Central Bank (ECB) met on 8 September 2016 and left monetary policy unchanged while the market expected an extension of the ECB’s QE program due to end in March 2017. The only concrete thing that came from the meeting was to task “the relevant committees to evaluate the options that ensure a smooth implementation of our purchase programme.” During the Q&A ECB President Draghi said that the committees have a full mandate to redesign the programme and look at all policy options including QE, interest rates and TLTROs. While no timeframe was given, any decisions seem likely only at the December meeting. This is likely a response to the constraints the ECB is nearing in the implementation of its QE program.

In addressing questions of why policy was not changed, Draghi answered that the March package was working very well and that the forecast had simply not changed enough since June. Despite acknowledging that it would take a bit longer to get back to price stability and that risks were still on the downside

The first estimates of CPI for the euro area in September showed an increase of 0.4% per year, the fastest since 2014. Core CPI was stable at 0.8% per year still well below the ECB’s 2% target. Inflation was driven by the increase in oil prices over the month, with energy prices down  -3% per year in September compared to  -5.6% per year in August.

UK

As largely expected, the Bank of England (BoE) Monetary Policy Committee (MPC) left policy unchanged at their 15 September meeting. On the economy the MPC noted that the outlook had improved for 2H16 with “less of a slowing” now expected compared to their August forecast and near term momentum “slightly to the upside”.

On their longer term outlook, the MPC stated that it was still too early to draw inferences for 2017 and beyond, and that the “contours” of the economic outlook following the Brexit vote had not changed.

On the outlook for monetary policy, the committee maintained the language from the August meeting that “a majority of members expect to support a further cut in Bank Rate to its effective lower bound at one of the MPC’s forthcoming meetings during the course of this year” to a level that is “close to, but a little above, zero”.

Timing of the UK’s exit from the EU has been firmed up with PM May confirming that Article 50 will be invoked before the end of March 2017, starting the 2-year negotiation process. PM May also offered more details on the likely deal, confirming that the UK would seek to take back control of immigration even at the cost of access to the single market.

Japan

The Bank of Japan’s (BoJ) met on 21 September 2016 and released its promised “comprehensive reassessment” of their monetary policy easing program – known as Quantitative and Qualitative Easing with Negative Interest Rates (QQE-NIR).

They concluded that in order to achieve the “price stability target of 2% at the earliest possible time” the BoJ would “introduce QQE with Yield Curve Control” by strengthening the QQE-NIR program.

The BoJ is now aiming to undertake “yield curve control”, by controlling both short-term and long-term interest rates. The short-term rate will remain at -0.1% and 10yr JGB yields will now be targeted at around 0%. The BoJ has also made an “inflation-overshooting commitment” in which the BoJ “commits itself to expanding the monetary base until the year-on-year rate of increase in the observed consumer price index (CPI) exceeds the price stability target of 2% and stays above the target in a stable manner.”

Australian dollar

The Australian dollar strengthened against most major currencies over September. The AUD finished up 1.9% against the USD to $US0.7664, driven by better than expected growth and improving terms of trade.

The Australian dollar rose against the euro (+1.07%), the sterling (+3.12%), and NZ dollar (+1.48%), but fell against the yen (-0.08%) over September.

 

Commodities

Commodity prices were stronger over September with oil and most metals up.

The price of West Texas Intermediate Crude finished the month at $US48.24 per barrel, up 7.9%, while the price of Brent was up 6.2% to $US50.19 per barrel. Oil prices moved higher after OPEC announced a preliminary agreement to reduce production by up to 750k bpd at their meeting in Algeria. While the deal has been announced, cuts will not occur till the 30 November OPEC meeting were individual quotas and supply cuts will be decided. Given the pressure on OPEC budgets and desire to increase supply by several members (including Iraq, Iran, Nigeria, Venezuela and Algeria) a sustainable agreement to reduce production seems unlikely.

Gas prices were mixed with the US Henry Hub spot price down 3.5% to $US2.84/MMBtu while the UK natural gas price was up 17% over August.

Iron ore prices were slightly weaker in September, down 5.3% to $55.86/metric tonne, as measured by the benchmark price of iron ore delivered to Qingdao China.

Nickel (+8.3%) was one of the best performing metals over the month after news of several mine closures (due to environmental violations) in the Philippines, the largest producer, drove prices higher.

Zinc (+2.9%) and Lead (+11.5%), Gold (+0.7%), Copper (+5.4%) and Aluminium (+3.7%) all rose over September.

 

Australian shares

The ASX/S&P ASX 200 Accumulation Index returned 0.5% during September. Despite some weakness during the first half of the month, the Index recovered to finish in positive territory. The Materials sector was the standout performer during the month, returning 5.6%. Large diversified miners BHP Billiton (10.6%) and Rio Tinto (8.4%) both posted strong gains. Consumer Staples (1.7%) and IT (0.8%) also finished the month higher.

Bond proxy sectors fell during the month as the market reacted to rising bond yields.  REITs and Utilities fell by 4.3% and 3.3% respectively. Telecommunications fell by 4.0%, dragged lower by TPG Telecom (-29.3%) which was sold off on the back of disappointing FY17 guidance.

Listed property

The S&P ASX 200 A-REIT index declined by -4.3% in September. Property securities fell sharply early in the month on profit taking, before recovering some ground in the second half of the month as supportive valuations rekindled investor demand.

The best performing A-REIT was Growthpoint Properties Australia (+6.9%), which rallied as its long-running takeover of GPT Metro Office Fund drew close to completion.  Charter Hall Group (-12.6%) fell after the sale of a large stake in the company by an institutional investor weighed on its share price. Dexus Property (-5.9%) also underperformed, following a run of strong performance from this office-focussed A-REIT.

Listed property markets offshore generated mixed returns in September. The FTSE EPRA/NAREIT Developed Index (TR) fell by -0.9% in US dollar terms. Hong Kong (+4.0%) was the strongest performing region for a second consecutive month, followed by Singapore (+2.8%).  Property securities in Australia and the UK lagged.

Global shares

Volatility returned to Global equity markets over September after an unusually quiet August and July. Markets reacted to uncertainty around central bank policy as Fed speakers attempted to talk up the likelihood of rate increases later this year and the BoE, ECB, BoJ and Fed all met.

The MSCI World Index was up 0.4% in US dollar terms in the month of September but down -1.5% in Australian dollar terms. In the US, the S&P500 (-0.1%), the Dow Jones (-0.5%) were weaker while the NASDAQ (+1.9%) rose, driven by strong performance in the technology sector. MSCI Energy (+2.66%) was the best performer as the rebound in oil prices and the news of the OPEC deal buoyed energy markets, MSCI Information Technology (+2.50%) also performed, driven by Apple’s early September product launch event. MSCI Financials (-1.40%) was the worst performer as news of Deutsche Bank’s US$14bn fine from the Department of Justice and concerns around the bank’s solvency rattled financial markets.

Equity markets in Europe were mixed over the month. The UK FTSE100 (+1.7%), Spain (+0.7%) and France (+0.2%) rose while The German DAX (-0.8), Italy (-3.2%) and the large cap Stoxx 50 Index (-0.7%) all fell.

Asia markets were mostly stronger with Singapore (+1.7%), Taiwan (+1.1%) and Honk Kong Hang Seng (1.4%) all up while the Japanese Nikkei 225 (-2.6%) fell.

 

 Global emerging markets

Emerging market equities were up in September with the MSCI Emerging Market Index up 1.1% in US dollars.

With a weaker USD and stronger commodity prices EM equities continued to perform over September.

MSCI EM Europe, Middle East and Africa was the best performing region over the month rising 2.54% in USD terms with Strength in Eastern European and some African markets.

Asia also performed with the MSCI EM Asia Index up 1.42% with gains in Pakistan (+2.10%), Indonesia (+1.69%), Vietnam (+1.67%) and other EM Asia markets. The Shanghai Composite Index was weaker, down 2.6%. MSCI EM Latin America was also down 0.87%.

The Reserve Bank of Australia (RBA) lowered the official cash rate at its 2 August meeting by a further 25bps to 1.5%, a new all time low. There was no meeting of the US Federal Open Market Committee (FOMC) in August, with the next meeting to be held on 2021 September. The Chair of the FOMC, Janet Yellen, delivered a key-note speech at the annual Jackson Hole economic symposium in August. This year’s symposium was ‘Designing Resilient Monetary Policy Frameworks for the Future’. As largely expected, the Bank of England (BoE) cut the benchmark interest rate by 25bps to 0.25% at its meeting on 4 August 2016. The European Central Bank (ECB) and the Bank of Japan (BoJ) also did not meet in August, with their next meetings scheduled for 8 and 21 September.

Australia as mentioned in the July edition of Market Watch, the Reserve Bank of Australia (RBA) lowered the official cash rate at its 2 August meeting by a further 25bps to 1.5%, a new all time low. The Q2 Capex survey released in early September was weaker than expected, -5.4% per quarter compared to the -4% per quarter anticipated. The decline was mostly related to mining and structures. On the positive side, spending on plant and equipment was up 2.8% per quarter, more than expected and a positive for Q2 GDP which is due in September.  Forward looking components of the capex survey were also better than expected. Total capex intentions for 2016/17 were upgraded to AUD$105 billion from AUD$91 billion, implying an annual fall of 19% per year compared to 25% per year previously.   The July labour market report showed the unemployment rate decreased by 0.1% to 5.7% while the participation rate was steady at 64.9%. The number of people employed increased by 26,200, above the 10,000 expected. However the increase was entirely driven by part time employment while full time employment fell over the month. Quarterly wage data released over the month showed an increase of 0.5% per quarter with the annual rate steady at 2.1% per year, suggesting income growth is likely to remain weak. Retail sales were unchanged in July, below the +0.3 expected. The weak print was driven by a 6.2% decrease in department store sales while cafes and restaurants (+1.2%) and food (+0.7%), which now represent 55% of retail sales, improved. Consumer confidence increased over the month with the index up 2% to 101. Gains were seen in almost all sub-indices with the largest improvements in 1 year ahead economic expectations (+3.5%) and 1 year ahead family finances (+4.3%). Confidence has likely been boosted by the second rate cut from the RBA and the continued strength in house prices. Australian house prices rose by 1.1% in August, taking annual house price growth to 7.0% per year, up from, 6.1% in July. Annually, Sydney (+9.4%) and Melbourne (+9.1%) continue to be the best performers while Perth (-4.2%) and Darwin (-4.2%) continue to lag.

There was no meeting of the US Federal Open Market Committee (FOMC) in August, with the next meeting to be held on 20-21 September. The Chair of the FOMC, Janet Yellen, delivered a key-note speech at the annual Jackson Hole economic symposium in August. The title this year’s symposium was ‘Designing Resilient Monetary Policy Frameworks for the Future’ and Janet Yellen’s speech focused on ‘The Federal Reserve’s Monetary Policy Toolkit: Past, Present and Future.’ While the Fed Chair’s presentation was focused more on the medium-to-long term, rather than the current policy, deliberations of the Fed Chair did take some time to discuss the current economic situation and outlook.  Yellen stated that recent developments had been a little more positive. US economic activity “continues to expand, led by solid growth in household spending”, although business investment remains “soft” and net exports are “subdued.” The Fed Chair highlighted that even though “economic growth has not been rapid, it has been sufficient to generate further improvement in the labour market.” In terms of the outlook, the Fed Chair repeated the standard view that “the FOMC expects moderate growth in real GDP, additional strengthening in the labour market, and inflation rising to 2% over the next few years. Based on this economic outlook, the FOMC continues to anticipate that gradual increases in the federal funds rate will be appropriate over time to achieve sustained employment and inflation near our statutory objectives.” Additionally, however, the Fed Chair was clearer than usual on the policy outlook, stating that “in light of the continued solid performance of the labour market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.” Employment was stronger than expected in July, increasing by 275,000 before a weaker than expected print in August at 151,000. Despite this, the unemployment rate was stable at 4.9%,  Average hourly earnings data for August was weaker than expected at 0.1%, bringing the annual rate down to 2.4% per year from 2.6% in July.  Inflation remains subdued. Headline CPI was flat over the month and fell to 0.8% per year in July from 1.0% in June. Core CPI increased 0.1% with the annual rate falling 0.1% to 2.2%.  Energy (+1.3%) and transport (+0.6%) increased while apparel (-0.4% per year) and food (-0.1%) declined.   The Fed’s preferred measure of underlying inflation, the Core Personal Consumption Expenditure, persisted at 1.6% per year in July, a level which it has remained around for the past 6 months. Retail sales were flat over the month after increasing by 0.6%/ in June. Sales excluding autos were down 0.3%. Durable goods orders surprised on the upside in July posting a 4.4% increase driven by a strong rebound in aircraft orders and a recovery in core capex order (+1.6%).  Europe The European Central Bank (ECB) did not meet over August. The next meeting is on 8 September 2016. GDP data released for the Euro area was confirmed at 0.3% per quarter, in line with expectations. Annual growth for Q2 2016 fell to 1.6% per year from 1.7% in Q1 2016.  German growth was above expectations, recorded at 0.4% per quarter over Q2. The annual rate fell marginally to 1.8% per year from 1.9% in Q1. Exports and Government spending drove growth as household spending slowed and business investment fell over the quarter.  CPI for the euro area weakened in July printing at -0.6%, dragged down by the fall in oil prices. On an annual basis inflation remains at 0.2% per year, well below the ECB’s 2% target UK As largely expected, the Bank of England (BoE) cut the benchmark interest rate by 25bps to 0.25% at its meeting on 4 August 2016.  The BoE also announced additional policy easing in the form of GBP60 billion of sovereign QE over the next six months and up to GBP10 billion of corporate bond purchases over the next 18 months. The BoE also introduced a new Term Funding Scheme (TFS) to “reinforce the passthrough of the Bank Rate cut” which provides four-year funding to banks with the explicit intention of facilitating a lower bank rate, conditional on bank lending staying positive.

Along with the changes to monetary policy the BoE also updated its forecasts, with 2017 growth revised down from 2.3% to 0.8% and inflation projected at 2.4% over the next couple of years. Nationwide House Price data over the month showed a surprising pickup in August, +0.6%, with the annual rate rising to 5.6% per year from 5.2%. Retail sales were also stronger than expected, up 1.5% in July comparted to the +0.3% the market anticipated. The largest gains were in department store sales (+4.1%) and clothing and footwear (+5.1%), likely aided by the weaker pound and summer tourists.  Annually, retail sales are up 5.9% per year. CPI data showed inflation decreased by 0.1% in July, driven by the volatile transport services component. The annual rate of inflation rose to 0.6% per year from 0.5% while core inflation fell to 1.3% from 1.4%.   Japan The Bank of Japan (BoJ) did not meet in August.

The next meeting is scheduled for 21 September 2016. GDP was flat over the second quarter, down from 0.5% per quarter in Q1 2016. Growth was dragged down by slowing consumption growth (+0.2% per quarter) and a fall in business spending (-0.4%). The annual rate of growth is now 0.6% per year. Headline CPI remained low at -0.4% per year over July while the core measure excluding food and energy fell to 0.3% per year from 0.5% per year in June, both well below the BoJ’s 2% target. Australian dollar  The Australian dollar weakened against most major currencies over August. The AUD finished down 1.0% against the USD to $US0.7521, driven by the August RBA rate cut and rising Fed rate hike expectations.  The Australian dollar fell against the euro (0.88%), the sterling (-0.32%), and NZ dollar (1.83%), but rose against the yen (+0.20%) over August.
Source: Bloomberg as at 31 August 2016 Commodities Commodity prices were volatile in August with oil stronger and metals mixed. The price of West Texas Intermediate Crude finished the month at $US44.7/bbl, up 7.5%, while the price of Brent was up 6.6% to $US46.89/bbl. Oil prices moved higher on reports of a potential production freeze agreement between OPEC and non-OPEC producers at the September meeting in Algeria. While any deal seems unlikely to materially impact markets given recent increases in production by Saudi Arabia, Iraq and Iran, markets still responded positively to the news. Gas prices were down with the US Henry Hub spot price down 0.1% to $US2.94/MMBtu while the UK natural gas price was down 30.8% over August. Iron ore prices were slightly weaker in August, down 0.7% to $58.97/metric tonne, as measured by the benchmark price of iron ore delivered to Qingdao China. Zinc (+3.0%) and Lead (+4.5%) rose in August while Gold (-2.9%), Copper (-6.3%), Nickel (8.1%) and Aluminium (-1.8%) were all down over the month. Bloomberg as at 31 August 2016 Australian shares, the ASX/S&P ASX 200 Accumulation Index returned -1.6% during August. Despite some large swings in the share prices of individual companies, the share market as a whole remained largely flat during the month.  The focus for investors in August has been ‘reporting season’, where most ASX-listed companies formally announce their financial results for the six or 12 months ending 30 June 2016. In keeping with recent reporting seasons, we have seen big bounces for good results, and ‘misses’ punished heavily. This was particularly evident in the Health Care sector, with Ansell and Primary Health Care rallying strongly on upbeat results, but CSL selling-off sharply as FY17 guidance disappointed. Earnings revisions in the Australian equity market as a whole have continued to slide.

Upward revisions to Mining and Materials failed to offset the larger downward revisions to Energy, Insurance, Telco and Healthcare.   With interest rates globally expected to remain low for an extended period, investors continue to favour quality stocks with a relatively high and perceived stable dividend yield. Stocks in the Consumer Staples sectors, for example, continue to perform well. Listed property The S&P ASX 200 A-REIT index declined by 2.7% in August. Reporting season saw investors take profits in the sector, following year to date gains of 22.6% over the seven months to the end of July 2016.  A-REIT earnings numbers were generally positive and in line with expectations, helped by a resilient residential property market and a strong office market in Sydney. Diversified A-REIT Mirvac (+5.4%) outperformed after providing robust earnings guidance of between 8% and 11% for the coming financial year.  However Westfield Corp (-2.8%) lagged despite reporting a 5.4% increase in annual net profit, driven by increased spending at its flagship malls and positive property revaluations.  Listed property markets offshore also declined in August. The FTSE EPRA/NAREIT Developed Index (TR) fell by 2.6% in US dollar terms. Hong Kong (+0.3%) was the strongest performing region, followed by the United Kingdom (+0.2%).  Property securities in Australian and the US lagged.        Global shares Global equity markets were relatively quiet over August with all eyes on the Olympics while northern hemisphere summer holidays and the end of reporting season led to limited news. Those who remained watched closely for any signs of potential Fed tightening and any Brexit related slowdown – which has so far proved elusive.  The MSCI World Index was down 0.1% in US dollar terms in the month of August and up 0.7% in Australian dollar terms.  In the US, the S&P500 (-0.1%) and the Dow Jones (-0.2%) were weaker while the NASDAQ (+1.0%) rose. MSCI Financials (+2.91%) was the best performer in August driven by increasing rate hike expectations while the MSCI Utilities (5.31%) was the worst performer for much the same reason. Equity markets in Europe continued to take back some of their post-Brexit losses. The German DAX (+2.5%), Italy (+0.6%) and Spain (+1.5%) all rose along with the large cap Stoxx 50 (+1.1%) while France (+0.0%) was flat. UK equity markets also rose as signs of a Brexit slowdown failed to appear. The internationally focused UK FTSE 100 was up 0.8% while the more domestically focused mid-cap FTSE 250 was up 2.6%.  Asia markets were more mixed with Singapore (1.7%) down while Taiwan (+0.9%), Honk Kong Hang Seng (5.0%) and the Japanese Nikkei 225 (1.9%) all up.
Source: Bloomberg as at 31 August 2016.  Global emerging markets Emerging market equities were up in August with the MSCI Emerging Market Index up 2.3% in US dollars. Despite a stronger dollar and increasing odds of a Fed hike global investors continued to look towards emerging markets, particularly Asia, as developed markets struggled to make gains over the month. An investor survey released over the month showed active managers had reduced their short positions and were neutral EM equities for the first time in several years. Asia was the best performing region with the MSCI EM Asia Index up 3.85% with gains in China and the Shanghai Composite Index (+3.6%) driving the performance. Thailand (+1.6%) and Indonesia (+1.6%) and India (+1.4%) all rose while the Philippines (-2.5%) was down. MSCI EM Latin America was up 0.43%, driven by strength in Mexico (+1.9%) and Brazil (+1.0%) while Argentina (-0.4%) fell. MSCI EM Europe, Middle East and Africa reversed some of last month’s gains closing down 2.72% in US dollar terms, led by weakness in Saudi Arabia (-3.5%) and Czech Rupublic (-2.6%).