Weekly Market Update – 1st may 2015

• Shares had a soft week reflecting a combination of somewhat messy economic data, uncertainty about the US Federal Reserve (Fed) and a backup in Eurozone bond yields. There is also an element of profit taking after recent strong gains, particularly in Europe and Japan. US shares fell 0.4%, Eurozone shares lost 2.7% and Japanese shares fell 3.3%. Australian shares lost 2% after failing to break through the 6000 level for the fourth time, not helped by a bounce in the Australian dollar, indications APRA may move faster to raise bank capital requirements and talk of Australia losing its AAA rating. Bond yields rose, but this was mainly led by Europe. The US dollar continued its correction and this saw most commodity prices up and the Australian dollar briefly bounce above US$0.80.

• The Fed is still in no hurry to raise rates. There were no real surprises from the Fed. While it’s not too fussed about the weak start to the year in US economic growth, its post meeting statement left the impression that a June hike is looking very unlikely. September remains my base case, but just bear in mind that the Fed is now in data dependent mode so a run of stronger economic data and more evidence of stronger wages growth could still bring its first rate hike forward again.

• The Australian dollar briefly bounced above US$0.80 for the first time since January – more bounce ahead? With the Australian dollar breaking resistance levels, it could have a bounce to around US$0.85. The Reserve Bank of Australia (RBA) will need to be on guard against this though as it would further threaten the return to reasonable economic growth. The recent Australian dollar bounce adds to the case for another rate cut on Tuesday and a step up in efforts to jawbone it lower.

• German 10 year bond yields are up fivefold from two weeks ago. Admittedly that’s not hard when you are coming from just 0.07% so there is a danger in reading too much into it. But it is worth noting that signs of improved Eurozone growth are continuing to mount, deflation fears are ebbing and a “reform for funding” deal looks closer for Greece. Higher Eurozone bond yields partly explain why US and Australian bond yields are up.

• What is the Chinese share market telling us? Chinese shares are up 120% over the last year and while it’s well known to be a highly speculative market its last three big swings were associated with turning points in Chinese economic growth: the 2007-2008 bear market was associated with a collapse in growth from 12% to 6%; the 2008-2009 bull market led a growth surge from around 6% to 12%; and the 2009-2013 bear market led a slump in growth from around 12% to 7%. So it begs the question whether the current share market surge is presaging a growth upturn. Certainly the shift to easier policy highlighted by the latest Politburo meeting – is pointing in this direction, although nothing like the 2009 to 2010 growth surge is likely.

• It’s coming up for Budget time again and surprise, surprise there is another debate whether Australia will lose its AAA sovereign rating. While Australia’s still low level of public debt has suggested that the risk is low, the Budget in a week’s time will be the seventh in a row that has projected or implied a return to surplus within a reasonable time frame. One could be forgiven for starting to think that such projections/commitments are hollow. So the short answer is that if Canberra does not provide more confidence of a return to surplus within a reasonable time frame then the AAA rating will be at risk. While sovereign bond yields often don’t go in the direction implied by sovereign rating changes its better not to take the risk, given the potential flow on to borrowing costs through the economy.

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