Markets meet tough challenges

22 Feb 2016

By Shadforth Financial Group

Geopolitics and social issues overshadow fundamentals

Geopolitical issues dominated global news headlines as the year drew to a close, overshadowing macro and micro fundamentals. The battle against Islamic extremists in the Middle East, terrorist attacks in Paris and the ongoing refugee crisis in Europe all contributed to political and social unrest, raising levels of anxiety and weighing on market sentiment. While devastating from a humanitarian and social context, we do not expect these ongoing issues to have a major impact on the fundamentals that drive global markets.

The price of oil continued to plummet as OPEC nations increased production levels despite the global oversupply of oil. While there is sharp focus on how the decline in the oil price affects oil-exporting nations, such as Russia and Canada, the Reserve Bank of Australia (RBA) expects the overall impact on global Gross Domestic Product (GDP) growth to be positive. Australia and its major trading partners, as net importers of energy, would expect to benefit from a prolonged period of lower oil prices.

Oil price falls

US rates lift off while Europe continues with easy money

As widely anticipated, in December the US Federal Reserve; often referred to as the Fed, announced an increase in the federal funds rate by 0.25 per cent to a range of 0.25 per cent – 0.50 per cent. This was the first rate increase in almost a decade and signalled the end of an extraordinary period of US monetary policy following the Global Financial Crisis. The impact of the interest rate increase on share markets was slightly positive as investors were provided with some clarity after months of speculation regarding the timing of the Fed “lift off” and it also confirmed the Fed’s confidence in the improving fundamentals of the US economy. Economic data released during the quarter confirmed the continued strengthening of the world’s largest economy.

The Fed’s statement accompanying the rate rise implied that further increases to interest rates will be gradual and dependent on continuing evidence of US economic recovery. We believe that further interest rate increases are necessary in order to avoid deflation, reduce upwards pressure on asset prices (which could make conditions ripe for crash-type scenarios) and to enable the Fed to have sufficient fire power to stimulate the economy should the need arise. We envisage that US interest rates will be increased in a slow and measured manner and remain below ‘normal’ levels for some time to come.

The European Central Bank (ECB) continued its implementation of expansionary monetary policy in the quarter announcing a six-month extension to its quantitative easing program and cutting the deposit interest rate by a further 10bps to negative 0.30 per cent.

Australian residential property comes off the boil

Concerns over the overheated east coast property market began to ease as 2015 drew to a close, and macro prudential policy moves made by the banking regulator through the year continuing to take effect. The auction clearance rate in Sydney tumbled from 76.30 per cent at the start of the quarter to 59.80 per cent by the end of December.

The RBA kept the cash rate on hold at a record low
2.00 per cent through the quarter as economic data released was broadly positive. Consumer confidence and retail sales data was strong and reports from retailers point to strong sales over the crucial pre-Christmas and Boxing Day sales period. The unemployment rate in Australia fell to 5.80 per cent and labour force data released in the quarter was well ahead of market expectations. Business confidence and business conditions figures were also strong.

Despite the largely positive macro indicators, sentiment over the Australian economy remains lacklustre. Australia continues to transition from a commodity-driven economy towards a greater focus on service industries. Many of these industries, including education and tourism, are beginning to reap the benefits of the decline in the Australian dollar over the past few years.

Recent trade data indicates that services exports now contribute more to domestic GDP growth than iron ore exports, for the first time in six years.

Slowing Chinese demand for resources will certainly impact Australian exports, however, other sectors benefiting from the changing economic landscape will increase their contribution to GDP growth and help to offset this.

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