Investment markets and key developments over the past week
Despite a bounce on Friday in US and European shares, global share markets had a rough week as they were weighed down by worries about the US Federal Reserve (Fed), tough action against US companies seeking to reduce their tax by relocating outside the US, worries about Chinese growth, geopolitical concerns and worries about the loss of breadth in the US share market rally. US shares fell -1.4%, Eurozone shares fell -1.9% and Japanese shares fell -0.6% but Chinese shares continued to recover and rose 0.8%. In addition to the influence of falling global share prices, falling iron ore prices and the retreat of foreign investors to the sidelines saw the Australian share market fall another -2.2% giving up its gains for the year. Weakening share markets saw bonds rally suggesting in part that investors fear that talk of US rate hikes is premature. The outlook for relatively tighter monetary policy in the US versus other major regions saw the US$ continue to rise, leaving it up nearly +7% over the last three months. This is also weighing on commodity prices. The falling iron ore price and the rising US$ saw the A$ continue its slide.
Geopolitical threats are continuing. While the global threat from the Ukraine conflict seems to be receding a bit, the conflict with ‘IS’ in the Middle East is hotting up bringing with it the threat of global terrorist activity. So far global oil supplies are not under threat, with the oil price running below the levels when IS in Iraq first started hitting the headlines. But increasing prospects for the deployment of ground forces in Iraq by the US and its allies and talk of the terrorist threat are weighing on investor confidence. Terrorist attacks are horrible in terms of their human consequences and there is no doubt that an IS terrorist attack in a western country would be taken badly by share markets. But the experience with various Al-Qaida related attacks (9/11, Bali Bombing, 2005 London bombings, etc) is worth recalling: after an initial negative impact share markets bounced back as it was clear that there would not be a major economic impact and it seemed the effect on markets weakened as the terror threat continued. It took just over a month for the US share market to recover from its -12% post 9/11 slump and it took the UK share market 1 day to bounce back from its -1.3% fall on the day of the July 2005 London bombings.
In Australia, the Financial Stability Review of the Reserve Bank of Australia (RBA) expressed concern that the housing market is becoming too speculative and that if left unchecked it poses risks to the broader economy for when the property cycle turns back down. As a result Australian Prudential Regulation Authority (APRA) has stepped up its surveillance of the banks and given the desire to avoid a rate hike at this point the RBA is discussing with APRA further steps that may be taken to ensure sound lending practices are maintained, particularly with respect to property investors. The focus looks like it may be on tougher capital requirements and interest rate tests banks apply when assessing new loans rather than restrictions on loan to valuation ratios. It is likely that if the property market does not cool soon an announcement could be made in the next few months. To the extent that the use of macro-prudential controls might delay the first rate hike further into 2015 it could be good news for existing home borrowers.
The term “macro prudential controls” is really just the latest buzzword for the failed credit rationing policies used prior to the 1980s. The RBA would be well aware of the risk of unintended consequences – eg, the potential impact on first home buyers many of whom are investors these days and in forcing borrowers into the shadow banking system – but it no doubt feels such controls are better than raising interest rates right now.
The A$ is continuing to slide helped by an ascendant US$, the continuing slide in the iron ore prices (now down -41% year-to-date) and the possibility that the use of macro-prudential controls to slow the housing market will further delay the first rate hike in Australia. Comments by the Reserve Bank of New Zealand Governor Graeme Wheeler that the level of the NZ$ was “unjustified and unsustainable” also helped as they apply just as much to the level of the A$. I remain of the view that by year-end the A$ will have fallen through the January low of US$ 0.8660 on its way to around US$ 0.80 over the next year or so. A lower A$ will help rebalance the economy.
Please click here to read the full article: Weekly Report ~ 26 September 2014