Last week we talked about higher corporate profits, lower GDP and very poor personal
savings and wage growth. These are key benchmarks to monitor the ASX and Australian
business life on a whole. Today we will explore a different set of metrics as we continue to
access the health of Australian investment potential.
Higher FDI Commitments To Australia
FDI has been fairly level since 2008, roughly $50 Billion AUD. The FDI inflow was extremely
low in 2015, just under $30 Billion AUD. The latest figures from 2016 show a dramatic
increase to its highest level $64.8 Billion AUD, that’s over a 100% increase. Australia’s
competitive advantage is mining, it is likely that investment is flowing towards mining. What
could that mean for base commodities? How much of that is China?
Lower FX Reserves
Forex reserves are the hidden weapon for monetary policy control. The reserves stood at the
highest over the last quarter at $88.4 Billion AUD. The recent figures show the RBA drawing
down those reserves to $84 Billion AUD. What does that mean for you FX traders? If a
country sells its reserves well they only end up doing one thing to compensate, very clever
move from the central bank, especially in a devaluation environment.
To conclude – The investment into Australia is strong, supporting the picture that long-term
business growth is inevitable. What we don’t know is what sector is benefiting the most, an
educated guess would say mining, this may mean higher commodity prices are on the
horizon, especially base metals. The picture around FX reserves, explains the recent
dramatic rise in the Australian Dollar, whether the RBA continues down this path we would
need to see the next set of figures but one thing is clear the RBA is supporting a Dollar
devaluation at least in the near term. This is what happens when the FED exports its
inflation, all CB’s must play ball.
Over the next month we are going to focus on the fundamentals driving the Australian
economy and some of the asset plays we have to consider. A more focused approach to our
growing readership of our newsletter. More connected articles should help you build a strong
fundamental case for asset allocation.
Lower GDP Growth Rate
GDP dropped by $100 billion AUD from $1.3 trillion AUD to $1.2 trillion AUD. This is largely
due to the impact on the mining sector. Mining production fell from 11% in July 2014 to 0.9%
today. This no doubt would force the Australian economy to diversify into other sectors, this
process will be slow but the picture is likely to improve in the future.
Higher Corporate Profits
This is a metric that reveals a lot about the potential for re-investment into the economy.
Corporate profits grew from $77bn AUD to $82 bn AUD. Solid growth on the quarter. This
should turn attention to equity markets in Australia if this trend continues. We believe that
investment is likely to increase in the business and there will be some inflows into the
Personal Savings Down And Low Wage Growth
The personal savings ratio has fallen from 9.5% to 4.7% from July 2014 to now. This is a
similar picture to most countries as middle income earners suffer from price inflation and
higher living costs. Consumer spending is likely to be debt fueled, so we are expecting a
drive towards easing in terms of monetary policy. FX guys, you know what that means…
To conclude – It really depends on what you consider positive for asset growth. Higher
corporate profits means more investments, job creation and in turn spending. However with
lower wages in the real economy, this may not materialize, this is being reflected on lower
GDP output. Monetary easing is stemming the blood loss but the future is uncertain at best.
Their is a case for equity growth and bullish stocks, profitable companies are investable but
with investors focused on the politics rather than the numbers only the hardened investor will
see any opportunity.
This week Brexit is back on the agenda. I recall remarking that Carney’s statement of a
possible rate hike was a ruse, like he has done many times before, proving the Bank Of
England is becoming more and more political. Well, we see that some of the points coming
out of the Brexit negotiations were enough to shakeup the market.
The key points on the table are the rights of European citizens and the best way to deal with
freedom of movement. The UK has already capitulated, simply they will import all the
European laws and exclude the ones they don’t want. We all know what this means, the slim
conservative majority in Parliament will not succeed and we end up with the exact same
laws as before. The European team have already made it clear that we cannot move forward
to trade negotiations unless the matter of Euro citizen rights is resolved, the March 29th,
2019 date can only be extended if all 28 member states agree.
It seems we are heading for
an even softer Brexit. It is early days but the Pound will be under pressure for now.
Sterling sold off against the Euro as the market prioritized Gilts ahead of cash. Let’s see
where this circus goes next.
Once again the market appears to be knee jerking on no real change in the stance of the Federal Reserve Open market committee. The key highlights for me in the Yellen testimony was moderate growth, Federal funds rate increase, and Gradual increase, that’s the whole speech right there. So in truth the FED is targeting 4% on the funds rate but will increase gradually, the economy is growing moderately with unemployment largely confined to African Americans and Hispanics in her own words. So if this trend continues middle class America is relatively safe and life goes on.
The market reaction to the Yellen testimony was a stronger Dollar versus currencies like the Swiss Franc but movement was confined to the Canadian Dollar and Australian Dollar and the Stock market got a boost which shows investors bought it and it is, go stocks! For now all is okay on the United States front.
This Could Be A Game Changer
It is time to take a keen interest in the coffee futures market, this is one commodity you should keep aneye on. Coffee is a commodity that has been faced with supply issues since 2015 there were some really dramatic price increases back then. In October 2016, Coffee futures traded 175.40c/lb before hitting the floor last month. In 2016 harvest figures for Columbia show a 9% decline in yield from the previous year, local prices in Brazil are quite high and the market is expecting a poor harvest in Honduras all this could further increase the price of the commodity. There is a strong chance that the 110.00c/lb floor will hold, if this is the case, then this has to be a rebound of that critical floor, it won’t be long before we are back up to those critical 150.00c/lb highs if we are right.
Coffee futures tend to correlate strongly with the Brazilian Real, so watch any movements on that currency. A move in coffee futures could signal a recovery in the entire commodity market space. We have already seen some movement in Oil prices and Copper prices. However the dramatic move on commodities this week during the NFP is a sign. Robusta Coffee futures had a dramatic fall on Thursday, so something is clearly afoot. We will have to wait and see.
Carney ponders a rise in UK interest rates
It feels like a repeat of 2014. Mark Carney comes out with the UK interest rate rise prospect story, in the middle of a deep crisis, the market goes to all time highs, he later comes out and says the data has changed and this is no longer an issue and then moves to ease into the economy. Let’s not forget that Mark Carney is a dove and actually voted to keep the UK’s interest rates on hold in the June minutes, the 3 descents were Kristen Forbes who has voted 3 times for a rate hike since March, Ian McCafferty who voted 4 times for a 0.75% hike in 2015, instead the rate was cut to 0.25%, Michael Saunders has only been on the MPC since September last year, I doubt a newcomer will drastically impact monetary policy.
So in my opinion the central bank is playing politics and that always for me increases the risk on the asset. I do expect the volume in Sterling to decline despite the rise, at least till there are some definitive answers out of the Brexit negotiation. There is a lot of evidence that personal debt is back to 2008 levels and the need for tightening lending is there but a move on UK interest rates now would impact mortgages and this will not be great for an uncertain Brexit, so it is prudent for Carney to support the Pound in the short-term and support the political class who need to look sure footed negotiating in Europe but that also means an upside ceiling. We are definitely sitting this one out. Enjoy the ride folks!
Well, the true cost of Brexit is becoming a tough pill to swallow day by day. We are simply astonished that people actually thought it was a good idea to Brexit and consider a no deal possibility, surely it would have been wise to advocate a quit of EEA and a remain in the EFTA, much like Norway, this would have been a better prospect to sell markets. Instead, in the face of what was a chaotic scenario, they sold the so called “Hard Brexit”. Well, I don’t see it folks, it looks like it will be a soft landing. So now Britain looks like a country with weak leadership, uncertain prospects and divided populations.
This has no doubt impacted the economic picture, GDP came in at 0.2% growth on the quarter lower than Greece, inflation was up to 2.9% from 2.7% but that is likely because the Pound dropped in value and we are a net importer. Sadly, the BoE chose to doctor a 6-3 vote, so 3 members believe we should raise rates,this supported the pound for now. Really? Does anyone believe that the UK would raise rates? I dare them! It appears that the true cost of Brexit will be in economic welfare, so brace yourselves for a tough road ahead and with the FED aiming for a 3% rate by 2020, I expect more devaluation in the future. As long as Austerity remains the focus of this parliament, then we would need to see monetary policy carrying the QE baton to maintain a balance.
Trump Vowing To Control The Federal Reserve
The Federal Reserve has always been that organisation that controlled its own destiny and that of the entire financial world. There are those who sit on the right that would have us believe that the FED has been overtaken by the left and needs reform. To some degree politics has influenced the Federal reserve but for the most part it has been for the benefit of the stock market, thus the middle classes. It is rather baffling to see the Republican right somehow feeling the need to attack the FED, seeing the FED has had little interest in politics or politicians. Let’s not forget, the FED is a private bank and simply wants to make money and that means higher rates.
Unless you lived under a cave for the past decade, you would know that rates have been low so profits for the FED have been low. Yellen is pushing for a likely 3% by the end of the decade. So why is the Dollar still relatively down? The big elephant in the room is the trillions of dollars of debt on the FED balance sheet. Yep! We have not forgotten. In 2008 the Federal reserve embarked on treasury and mortgage backed security purchases, some $4 trillion worth. So now the Trump administration wants to see those treasuries sold off, a kind of aggressive tightening, this would have a major impact on bond prices thus creating unnecessary stability. The other option is to let those treasuries mature since most are under 5 years, this is probably the safer and smarter way and this is what the FED wants. The market clearly does not trust the FED will get what it wants because Yellen may get fired, if this doesn’t happen then she resigns in 2018 anyway, this would mean a new chair, I am sure the President is already looking for his next candidate to swear fealty. So what now? Short answer… Who the hell knows? Not quite an answer, just another question.
So we think that longer term the Dollar will maintain value prone to information shocks and this doesn’t make for a pleasant investor experience. It’s a new dawn of far right control politics. Not that it will get anywhere.
Trump wants to break the Canadian economy but Oil prices still likely to rise
The United States Dollar is caught in a commodity story. Oil and other commodities have been very low hurting countries that are commodity producing. Canada is one of the largest producers of WTI Crude, it is currently running a trade deficit of $370m CAD, Debt is at 91% of GDP and unemployment rose from 6.5% to 6.6% over the month, Canada is showing modest economic growth of 0.2% over the quarter but all in all it is under pressure. The truth remains, Oil prices are relatively low and Canada is not the only unhappy kid in the room.
Donald Trump has pushed against NAFTA, backed Shale and Coal, this is no doubt causing issues for the Oil price. The Canadians need to see Oil prices higher and this tends to drive the Canadian Dollar. This is however all speculation, in reality the US president is under siege and Canada may not have to act at all, the former FBI director is accusing the president of potentially obstructing justice, collusion and lying. The US Dollar has started to fill the impact as money flows into bonds and general safety. This may be perfect timing for OPEC and other Oil producers to strike a blow and push prices up.
The Canadian Dollar is showing signs of recovery, with momentum building. No matter what we say the figures show that if Oil prices can’t recover to at least $50 a barrel most countries will be staring into the abyss, especially Canada.
Australia interest rates expected to remain low
Hardly anyone is talking about Australia that appears to be sailing ahead very calmly with a very decisive approach to monetary policy. Australia was one of the last countries to get hit by the financial crisis, so was one of the last to recover. Mining towns like Perth saw the brunt of the economic downturn with many people losing jobs and simply having to diversify skills. It has been a few years on and the Australian economy is bouncing back.
This recovery has been partly due to the RBA’s effort to stimulate the economy by cutting the Australia interest rates aggressively, in just over 2 years the rates have come from 3.5% to 1.5%. The market has remained bearish on the Australian Dollar into every RBA meeting, most G7 countries have their rates under 1%, I won’t be surprised to see the RBA favour another rate cut. Figures however don’t lie. Australia has shown strong GDP growth rate of 2.4% annually, despite a slight fall in net exports. The mining sector is also the strongest GDP contributor increasing over the quarter from AUD28.3BN to AUD29.3BN, a positive sign that the economy can expect more growth.
Let’s face reality, all the above is great but none of it matters if the Central bank remains desperate to devalue the currency by cutting the Australia interest rates, a cheaper currency boosts exports, with falling net exports, it will be wise to keep a loose monetary policy. The 6th of June will be interesting, as the RBA meets again, guidance is likely to stay the same but any hint of further cuts will send the Aussie south once more.