Markets were mixed in October as investors tried to digest a wide mix of influences. These included firmer economic readings in several key economies, increasing likelihood of a rate hike by the US Federal Reserve (FED) in December, the US Presidential election and ongoing concerns and uncertainty about Brexit. That said, markets remain buoyed by accommodative US monetary policy, a stabilisation of global growth prospects and potential agreement by OPEC to cut oil production. Most share markets have fallen in early November, impacted by the polling in the US election. The ASX200 suffered one of the bigger falls of the month, down by 1.9%, even though there were signs that the economy continued to grow reasonably well. Resurgent support for Donald Trump, whom others had written off, spooked markets however, the FBI clearing of Clinton in the email saga and more recent polling has seen markets recover somewhat. As I had said last month, Trump is a genuine chance and as I as I write, Trump has been confirmed as the 45th US President. Markets have initially reacted violently only to recover somewhat. Bond markets have reacted swiftly and are predicting a less than 50% chance of a rate hike in December.
Starting with the US economy, there is evidence that economic growth strengthened in Q3 with the advance reading of Q3 GDP showing 2.9% annualised growth. This is up from 1.4% in Q2. Growth in the US economy appears to be coming from private consumer spending, business investment and exports. Economic readings for September and October while erratic show reasonably strong new housing activity, improving factory orders and consistently strong non-farm payrolls. The unemployment rate edged down to 4.9% in October from 5.0% in September.
US consumer sentiment and confidence indicators have tracked lower in October, reflecting uncertainty around the US Presidential election and the prospect of higher interest rates. The US economy is traveling very well with strong employment growth, low unemployment and rising wages. As with the UK, and other western developed economies, there are widespread perceptions of declining national well-being coupled with a desire to shake up the establishment (Parliament and key decision makers). In the UK a voice was found in Boris Johnston that resulted in Brexit and in the US a voice has been found in Donald Trump, the outcome at the time of writing is yet to be determined although increasingly looking like a Trump victory. Trump?s messages of tearing up free-trade agreements and cutting immigration would make the US smaller less affluent economy over time. The outcome of the election will make a material difference to the US and global economic outlook. Consensus view is that a Trump win implies weaker US Dollar and growth prospects with the FED likely to hold rates steady in December to combat a deteriorating US economic outlook. Gold will be a clear benefactor. Royston Capital view is that his domestic policies are likely to be inflationary and that his foreign policy is the great unknown. Fiscal spending is after all what Royston Capital has been calling for over a number of years and thus the FED to raise rates in December as previously expected.
Growth in Australia?s major trading partners remains a bit below average and is expected to decline a little reflecting a further moderate easing in growth in China. Longer term risks associated with high and rising debt in China remain, although the near term downside risks to Chinese growth appear to have subsided, in large part due to strong growth of government funded infrastructure spending and buoyant conditions in property markets. We reported last month that the stabilisation in commodity prices was as a result of a stabilisation in China. This trend appears to be continuing. GDP growth in Q3 at 6.7% y-o-y was identical to annual growth in Q2 and Q1. The rebalancing of growth drivers in China?s economy towards services and domestic consumption, and away from heavy manufacturing is progressing.
In China September retail sales growth lifted 10 10.7% y-o-y from 10.6% in August. Urban fixed asset investment spending grew 8.2% y-o-y from 8.1%. Industrial production continued to fade in September, up 6.1% y-o-y from 6.3% in August.
The rise in commodity prices this year has resulted in an increase in Australia?s terms of trade. The terms of trade are expected to remain above the low point reached earlier this year reflecting the expectation that Chinese demand for steel will remain resilient in the near term and that Chinese production of bulk commodities will not increase substantially. However, the Chinese authorities can relax efforts to reduce overcapacity in their mining industry in response to sharp increases in bulk commodity prices. Spending on infrastructure projects is also not anticipated to continue at the current rate.
In Europe, recent economic readings are consistent with the region stuck in low growth environment. GDP grew by 0.3% q-o-q, 1.6% y-o-y in Q3 and Q2. Inflation is up slightly in November preliminary readings to 0.5% y-o-y while unemployment rate is flat at 10% over September and August. The European Central Bank (ECB) continues to signal that is has done as much as it can on its own to support growth and like many other regions is calling on greater fiscal policy support. The attention of policy makers remains diverted to borders and Brexit providing little head space to pursue more expansionary budgetary policies.
The Australian economy is showing signs of reasonable growth but with fading economic strength likely in Q4 2016 in line with our view on the terms of trade and commodity prices discussed above and in line with our comments last month. GDP growth accelerated to 3.3% y-o-y in Q2 from 3.1% in Q1 and there are signs that GDP growth may hold around 3% y-o-y for Q3 with strong contribution expected from net exports.
While exports are strengthening, other indicators of Australian economic activity are mixed. Home buying remains strong in Sydney and Melbourne but with housing finance commitments showing signs of softening and lending institutions confirming further restrictions on housing lending during October. Retail spending was up 0.6% m-o-m in September from 0.5% in August but weakened materially in volume terms. Australia?s labour market is showing a low unemployment rate at 5.6% although employment has fallen in August, -8,600 and September, -9,800. Indications are for moderate employment growth in the months ahead and the unemployment rate is expected to edge a little lower over the next couple of years. However, there is uncertainty about how much spare capacity there is and the extent to which it will ultimately feed into inflation.
Inflation continues to hold comparatively low in Q3. The CPI was up 1.3% y-o-y below the RBA?s 2-3% target and expected to remain below the target through to the end of 2018. The RBA is inclined to leave its cash rate on hold, but we see some risk that bank lending rates will drift higher and the Australian dollar could move higher too. This unwanted effective tightening of monetary conditions may trigger the RBA to cut the cash rate possibly in May or June 2017. The consensus view is that forces behind a rate cut could materialise sooner with Donald Trump as US President given all expectation for lower economic growth prospects around the world as a result of foreign policy. This will become clearer in early 2017.