Weekly Market Update – 29th June 2018

Investment markets and key developments over the past week

• The past week saw geopolitical concerns around trade, in particular the US-China relationship which continues to dominate investment markets. This saw most share markets fall, with US shares down 1.3% for the week, Eurozone shares down 1.5% despite a Friday rally on the back of an EU immigration deal, Japanese shares down 0.9% and Chinese shares down 2.7%. Australian shares remained relatively resilient, falling just 0.5% for the week, with higher oil prices boosting energy stocks. Bond yields continued to fall on the back of safe haven demand. Commodity prices were mixed with gold, copper and iron ore prices down, while oil continued to move higher after OPEC’s decision to raise production by less than feared the surge in global oil prices over the last week is likely to add around 5 cents a litre to Australian petrol prices. The US$ was virtually flat over the last week but the A$ fell slightly.

• Another strong financial year for investors. While the December half year was strong as global share markets moved to factor in stronger global growth and profits helped by US tax cuts, the last six months have been messy for investors with US inflation and Us Federal Reserve (Fed) worries, trade war fears, uncertainty around Italy, renewed China and emerging market worries and falling home prices and the Royal Commission in Australia. Despite this, the 2017-18 financial year has seen pretty solid returns for well-diversified investors.

• US trade-related tensions with China remain high. President Trump’s decision to support a strengthening of the Committee on Foreign Investment in the US (CFIUS) process so it can prevent foreign investors from violating US intellectual property rights, rather than declaring an economic emergency in relation to Chinese investments under the International Emergency Economic Powers Act (IEEPA) is less provocative towards China than had been feared. But ultimately the ‘proof will be in the pudding’ and in the meantime, there is still no sign of the US and China restarting trade negotiations ahead of the July 6 start date for tariffs on US$34 billion of Chinese imports. So, it’s looking very likely that the first round of tariffs will be implemented. The base case remains that some form of negotiated solution will be reached, but things are likely to get worse before they get better.

• The European leaders summit looks to be seeing ongoing plodding towards greater Eurozone economic integration and an agreement on an EU-wide “Australian” solution to its migration problem, focussed on beefed up external border security (stopping the boats) and holding centres (possibly offshore) to process immigrants. The progress on immigration looks to be enough to keep Italy onside and to keep Merkel’s coalition government in Germany together. All of which is a positive for Eurozone assets, albeit the Italian budget issues remain for the months ahead.

• What’s up with Chinese shares and the Renminbi? Is it a bad sign for global growth? From its high in January, the Chinese share market has fallen around 22% and the Renminbi has fallen around 6% from its April high. These sort of moves are naturally inviting comparisons to the 2015-16 plunge in Chinese shares and the Renminbi. The weakness has been triggered by signs of slowing growth in China, worries that this will be made worse by a trade war with the US and with the shift to Chinese monetary easing weighing on the Renminbi. However, it’s very different to 2015 when Chinese shares plunged nearly 50% (after previously more than doubling in value to a forward PE of around 19 times) amidst an unwinding of margin positions, government moves to support the market and a shift to a new way to manage the currency that led to capital outflows. This time around the share market fall started from low double-digit PEs and the PE is now only around 10.5 times, there has been no panicky unwinding of margin positions, economic data is arguably more stable, and there is more confidence in how the currency is managed. In fact, the fall in the Renminbi is a mirror image of the rise in the value of the US$, which against a basket of currencies is up nearly 8% since April. For these reasons, the fall in Chinese shares and the Renminbi is less worrying for the global and Australian economies than it was in 2015-16, which is why Australian shares have not been falling at the same time.

• In Australia, some small banks have raised mortgage rates in response to a blowout in short term funding costs and others may follow. As noted several times in this Weekly Report lately, the gap between bank bill rates and the expected RBA cash rate has blown out in recent months relative to normal levels (by around 0.35%) and it was only a matter of time before banks started to pass this on, given they get about 20% of their funding from this source (more so for the smaller lenders which have been the only ones to move so far). Initially the blow-out was driven by the same thing occurring in the US (which was partly driven by US companies returning cash held overseas in US dollars back to the US) but it has continued in Australia, possibly reflecting a desire to lock in funding ahead of the financial year-end (after the squeeze into the March quarter end), the Westfield takeover and regulatory reforms including the impact of the Royal Commission.

Source: Bloomberg, AMP Capital

• However, there are a few things to note. First, the increased cost of funding for banks only amounts to less than 0.1% if it’s fully passed on to all rates, so it’s small. Second, banks so far seem to be focussing the pass-through on rates other than traditional owner occupiers on principle and interest loans given the desire to avoid more adverse publicity – which will reduce the impact on households. Big banks which are yet to move, but likely will are expected to do the same. Finally, it’s not a sign that the RBA has suddenly lost control apart from the small nature of the rise, banks have been doing out-of-cycle moves for a decade now and yet the main driver of the big picture trend in rates remains what the RBA does and right now they aren’t doing anything. So don’t expect big changes in traditional mortgage rates. What the latest mortgage rate hikes do though is provide a reminder to households (if one is needed) that rates can go up, and at the margin, along with tightening bank lending standards, they make it even less likely that the RBA will hike rates anytime soon.