Economics: Markets Hang On a Laundry List
Share markets continued to recover in March. The ASX200 rose by 4.1%, to 5082.8, its first monthly increase this year. This still left it down by 4% in the March quarter, the worst start to a calendar year since 2008. But the index is still up by 6.7% from where it was on 12 February, which is looking more and more like the low point. The US share market again did better. The S&P500 index rose by 6.6% in the month and thus scraped into positive territory (up 0.8%) for the March quarter; a remarkable result given that the first six weeks of the year were the worst ever for the US market. Since 11 February, the US share market has risen by 12.6%.
This recovery shouldn’t have come as a complete surprise. As I have written earlier, the weakness of markets in the New Year reflected an overly pessimistic view of the outlook for the global economy. 2016 looks like being yet another year of stubbornly slow growth, but that is a long way from the near-recession outlook apparently priced into markets in early-February.
Markets these days hang on every word of policymakers, particularly those of the monetary persuasion. There were two major pronouncements in March.
First, the European Central Bank announced an expanded programme of quantitative easing, which in the ordinary course of events would have cheered markets enormously. The gloss was taken off to some extent, however, when Mario Draghi, the head of the ECB, made a statement suggesting there would be no further easing (in his view because there would be no need, but markets still weren’t impressed).
Second, the US Federal Open Market Committee met and decided to do nothing, signaling the likelihood of only two further rate rises this year, down from the four initially indicated last December. It should be noted that markets never believed the first “forecast”, and they still think that rates will rise at an even more glacial pace than indicated by the Fed.
Late in the month, the Fed chair, Janet Yellen, gave a very dovish speech. She argued that there was more slack in the labour market than may appear, given that the unemployment rate has fallen to just 4.9%, and she is apparently not convinced that the recent uptick in many measures of inflation is permanent.
Remarkably, Dr. Yellen gave a laundry list of conditions that would need to be met for rate hikes to continue. The list includes: foreign economies and their financial markets need to stabilise; the dollar can’t appreciate further, since this would depress inflation and exports, and hurt U.S. manufacturing; commodity prices need to stabilise to help foreign producers find a better footing for growth; the housing sector needs to make a larger contribution to U.S. output; and inflation needs to continue to rise. The clear implication was that rate rises should be only gradual for several years. If this turns out to be the case, then markets will have to look elsewhere for volatility.
Dr. Yellen may get her way as far as commodity prices are concerned. Oil prices and iron ore prices both appear to have hit bottoms and have shown significant, if somewhat unsteady, gains. Indeed the spot iron ore price rose by more than 23% in the first quarter, despite the fact that at time of writing it has fallen for seven consecutive days. In the case of oil, the apparent intention by OPEC members to stabilise production has clearly helped. The Brent oil price rose by more than $3 (about 8%) in the month, and is now up by about 33% from its late-January trough.
Interestingly, one other commodity to have done very well in the March quarter is gold, the price of which has risen by more than 15% so far this year. One for the gold bugs!
To date, the US dollar is also heeding the lady’s wishes, having fallen over the course of the month, albeit gradually.
Meanwhile back in Oz
There were two pieces of good economic news in March. First, GDP growth for the year to the December quarter 2015 was reported at 3%, the highest reading since the March quarter of 2014. The unemployment rate also fell, from 6% to 5.8%, despite a third successive month of only soft employment growth. Each of these labour-market updates should be treated with the proverbial grain of salt. The fall in the unemployment rate only undoes the rise (which looked odd at the time) in February, while the soft employment numbers follow three months of strong readings. Other labour-market indicators, such as vacancies, suggest that continued improvement is likely.
The currency was a big story in March. The $A rose from 71.7 cents to 76.6 cents over the course of the month. Reasons included the beginnings of a recovery in commodity prices, the downward adjustment in the market’s probability of a further rate cut in Australia, and the likelihood that interest rates in the US will be lower for longer. Oddly, the fact that the exchange rate has risen as the market has “priced out” a further rate cut actually increases the chance of such a cut. The RBA has made it clear that it would be happier with a lower $A, so the rise in the latter must be a source of frustration. Of course, almost all central banks would like their currencies lower!
There is one other factor that could precipitate a further rate cut; suppose that we get a surprisingly low CPI inflation result at end-April. A May rate cut cannot be ruled out completely, although bear in mind that the first Tuesday in May has already been reserved for a different major economic event, namely the rescheduled Budget.
My view is still that the RBA will keep rates on hold for the foreseeable future.
I have revised my end-of-year forecast for the currency from 67 cents to 70 cents, mainly because the US dollar has weakened in the past month.
My end-of-year forecast for the ASX200 remains at 5400. One last thing to bear in mind: over the past 30 years the average gain in the Australian share market in April has been bigger than in any other month.
Source: Written by Chris Caton, Chief Economist at BT Financial Group