Market Update

For the quarter ended April 2017

Healthy growth momentum

Credit, money and liquidity indicators in developed economies suggest a healthy pace of growth for the rest of the year. Although manufacturing has eased off highs in some markets over the past month, this has been offset by an increase in non-manufacturing activity, especially in the United States and Euro area. Chinese growth expectations have also recently been upgraded and other Emerging Markets are also benefiting from increased global activity and a pick-up in trade volumes.

Geopolitical risks still remain, although political risks appear to have been overstated with election indications/outcomes in Europe so far, more positive than anticipated. This has no doubt been helped by the European Union’s (EU) relatively healthy underlying economic momentum, with growth expectations for 2017 also revised higher.

In the United States, political risks are also likely to have been overstated after several of President Trump’s policy plans failed to gain Senate or Congress support. Tax and deregulation reforms are the more important economic drivers and these issues are expected to be progressed through the rest of this year.

As a consequence of growth, headline inflation has accelerated and core inflation in many economies is at or near Central Bank targets. The United States Federal Reserve has already raised rates three times this cycle and is expected to increase rates two to three more times this year. The European Central Bank has signalled continued support for the EU economy with monetary stimulus, but has also indicated that tapering of quantitative easing measures could begin later this year.

These changes would be supportive of an appreciation of the United States Dollar (USD) and Euro, but also underlines that economic data supports an upward trend in long-term interest rates.

Figure 1. Global reflation as growth improves

Figure 1 April 2017

Source: Forsyth Barr analysis, Bloomberg

Equity markets rebound

The positive backdrop allowed equity markets to deliver solid gains over the last three months. In New Zealand Dollar (NZD) terms, the best performing market over the quarter was France, followed by Germany and then the United Kingdom. Australian equities also continued their strong performance, helped by improving sentiment towards commodities and also improved sentiment towards financials.

European markets benefited from the improving outlook and from political risks proving to be overstated. For the United States, political issues including President Trump’s inability to repeal Obamacare and set-backs on building the Mexican wall, were largely dismissed by markets with tax and deregulation reforms more important. Removing regulation alone should save companies billions in costs and encourage CEOs to expand their businesses once the shackles are off, boosting revenues in the future. Besides proposed tax cuts, the Trump Administration is also arguably one of the most pro-business administrations in history and while tax cuts are likely to boost earnings, deregulation may have a more immediate positive effect on earnings.

New Zealand equities produced positive returns but lagged international markets. Building company downgrades held returns back in the current quarter, as building costs have led to downgrades in margins and expected activity levels.

The NZD was also notably weaker over the quarter, with the relative attractiveness of New Zealand’s economic story losing some of its appeal relative to the positive momentum in economies further afield. 

Figure 2. Weaker NZD positive contributor over quarter.

Figure 2 April 2017

Source: Forsyth Barr analysis, Bloomberg

RBNZ on hold despite inflation

Recent inflation data, including data in New Zealand, has headline inflation levels nearing Central Bank targets. However, the Reserve Bank of New Zealand (RBNZ) is expected to maintain the Official Cash Rate (OCR) steady at 1.75% for at least the remainder of 2017, with the memory of moving too quickly in 2013 staying its hand, as is its preference for a weaker NZD.

In its decision-making, the RBNZ continues to stress concerns around the potential for increased protectionism in global markets and they are also mindful of migration keeping a cap on wage inflation.

On the other side, housing risks remain but the use of macro prudential tools (e.g. higher loan to value requirements), coupled with domestic bank capital requirements, have reduced the supply of credit and raised its cost, causing housing demand to moderate.

However, higher long-term interest rates are still expected, albeit slower than we first thought. This is likely to be driven by global economic strength and a gradual pull-back from quantitative easing measures by Europe later this year, and potentially the US Federal Reserve (Fed) reducing its balance sheet as securities mature (~US$250bn pa) from 2018. The Fed has also signalled a tightening bias, with the Federal Reserve median expectations inferring that (if New Zealand rates remain on hold) United States short term interest rates could be higher than those in New Zealand by mid-way through 2018. 

Figure 3. US Fed Funds & RBNZ OCR Forecasts

Figure 3 April 2017

Source: Forsyth Barr analysis, Bloomberg

The small declines that occurred during the last quarter are therefore viewed as a pause in the rally and not a change in the medium term direction. The declines have also been helped by expected issuance being delayed, although this should be a timing issue rather than a permanent trend.

 

Market Statistics

Market Stats April 2017

Source: IRESS

* 25 bp (basis points) is equivalent to 0.25%

 

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