12 January 2018
Investment markets and key developments over the past week
The news that the BoJ was trimming its purchases of government bonds was taken by investors as a sign of monetary policy tightening. However the central bank didn’t actually give any formal guidance around its policy stance, so the news looks to have been slightly misinterpreted by markets. The BoJ is far from tightening interest rates, with its current policy of negative interest rates and targeting the bond yield working well. Inflation is still closer to 0%, rather than the 2% target, so a change to the current monetary policy stance is some time away. The appreciation of the yen this week may have more upside, as Japan’s current account surplus remains high.
Reports that China is looking to buy less US bonds also caused a further leg up in bond yields, but there is no sign that this has actually been adopted as official Chinese policy (and is also not the first time that a story like this has been released). Reports around the BoJ and China are mostly noise but we still think that bond markets are vulnerable this year as global growth improves and inflation lifts (particularly in the US) which will put upward pressure on bond yields.
The ECB December meeting minutes were read as hawkish. It appears that the Governing Council is preparing markets for a future adjustment to monetary policy with the minutes indicating “the Governing Council’s communication would need to evolve gradually…if the economy continued to expand and inflation converged…towards the Governing Council’s aim”. It was noted that the current stance of monetary policy (the ECB’s asset purchase program) was in line with policy that was better suited to crisis mode. The ECB’s current bond buying program is due to continue at a pace of €30 billion per month until September 2018. We do not read the latest commentary as a sign of a change in ECB policy. While the ECB will want to start thinking about eventually lifting interest rates, it’s still too early for the Eurozone to absorb tighter monetary policy, particularly as core inflation is low.
There was more chat from US Federal Reserve officials about potentially adopting a different monetary policy targeting mechanism with the latest talk about price-level targeting, which was recently mentioned by San Francisco Fed President Williams as well as the former Federal Reserve Chair Bernanke. A price-level monetary policy target will aim to maintain a certain level of prices, rather than price growth (which is what the current inflation-rate target does). In practice, a price level target would mean that the central bank would be more reactive to deviations from the price-level because it would not look through temporary deviations from an inflation rate (as is currently done). This would also mean that inflation would tend to be more volatile with periods of very low inflation (or deflation) followed by periods of high inflation to make up for prior misses. It is generally thought that price-level targeting will favour a “lower for longer” approach in monetary policy which suits the current environment as the US Federal Reserve has been noticeably shy of its 2% inflation target for years. The discussion has come about as policymakers consider tools available in the case of an economic downturn. While the US Federal Reserve may explore its options around its monetary policy framework and what other tools are available to it, a change to its current framework is unlikely in 2018 – which will be the first year for new US Federal Reserve chair Jerome Powell.
Major global economic events and implications
Chinese price data was a little weaker than expected, with consumer prices up by 1.8% over the year to December and producer prices up by 4.9%, but this is still well up over the past year. The improvement in commodity prices has been an important driver of higher producer prices.
In the Eurozone, the labour market continues to improve with the unemployment rate nudging a little lower to 8.7% in November, industrial production up in November and retail sales were a little stronger over the month.
Japanese labour cash earnings were up in November while consumer confidence was a little weaker.
Australian economic events and implications
What to watch over the next week?
The Bank of Canada meets next week and markets are anticipating a 0.25% rate hike (the last rate hike was in September 2017), which would take interest rates to 1.25%.
Fourth quarter Chinese GDP should show growth over the year to December tracking at 6.7% (from 6.8%) which would be in line with recent stability in Chinese data. Industrial production for December is expected to show annual growth of 6.1%.
In Australia, January consumer confidence is released and may show a lift from the new year. Housing loans are likely to decline slightly in November. The employment figures should show a slight fall in jobs growth over December because of the huge rise in the prior month. A small fall in employment would still mean strong annual growth in jobs, as well as a low unemployment rate.
Outlook for markets
Australian shares are likely to do okay but with returns constrained to around 8% with moderate earnings growth. Expect the S&P/ASX 200 index to reach 6,300 by end 2018.
Commodity prices are likely to push higher in response to strong global growth.
Low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors.
National capital city residential property price gains are expected to slow to around zero as the air comes out of the Sydney and Melbourne property boom and prices fall by around 5%, but Perth and Darwin bottom out, Adelaide and Brisbane see moderate gains and Hobart booms.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running at around 2.2%.
After a further short-term bounce higher, the A$ is likely to fall to around US$0.70, but with little change against the yen and the euro, as the gap between the Fed funds rate and the Reserve Bank of Australia’s cash rate goes negative. Solid commodity prices will provide a floor for the A$ though.