Investment markets and key developments over the past week.
Share markets pushed higher over the last week helped by better than feared US earnings results, good economic data and a continued unwinding of disaster fears from early this year.
US shares rose 1.6%, Eurozone shares gained 4%, Japanese shares rose 6.5%, Chinese shares rose 3.1% and Australian shares gained 4.5%. The US share market is now up 1.8% year to date. The “risk on” tone saw bond yields and commodity prices (except gold) rise with even the iron ore price making it back to around US$60/tonne.
While the US dollar rose slightly, the Australian dollar pushed back to around US$0.77, helped by stronger commodity prices and Australian data.
Surprise, surprise – the IMF has downgraded its global growth forecasts yet again to 3.2% for this year from 3.4% and to 3.5% in 2017 from 3.6% – adding to headline concerns about the global growth outlook.
But just bear in mind that the IMF is just catching up to investor concerns that drove the financial turmoil early this year and, in any case, the IMF has been perpetually downgrading its growth forecasts for years now (see the chart below). Invariably the IMF starts off forecasting global growth for the year ahead to be around 4% and then progressively revises it down to around 3%.
In other words the latest IMF growth downgrades are nothing new.
More significantly, a lot of the fears that drove markets lower earlier this year are still receding:
Chinese economic data is looking healthier; those that really matter at the US Federal Reserve (the Fed) are continuing to indicate that it will be cautious and mindful of global conditions in raising interest rates; the US dollar has come off the boil relieving pressures on emerging markets; the Chinese renminbi is proving to be stable on a trade-weighted basis; and fears around Eurozone banks appear to be fading.
A long anticipated meeting between OPEC and Russia in Doha ended without any agreement to freeze oil production, as Saudi Arabia insisted that any freeze must include Iran which didn’t attend the meeting.
This was always a high risk as Iran was most unlikely to participate, as it’s still recovering from sanctions.
So, after rallying strongly from its February low, expect a short-term knee jerk pull back in the oil price in reaction, with a flow-on to other risk assets including shares.
However, regardless of the outcome of the meeting, it does look as if the global oil market is gradually heading back towards balance, as production is being cut elsewhere including in the US which should help the oil price continue to stabilise.
It’s coming up to Budget time again in Australia (3 May) and, as always, everyone is having their say, including the ratings agencies.
The perpetual delay in returning the budget to surplus (see next chart) has not threatened Australia’s AAA sovereign rating so far, but comments by Moody’s expressing scepticism about the limited scope for meaningful spending cuts or tax reform suggest that ratings agencies may be losing patience.
Despite a commitment from both sides of politics to return to surplus it’s hard to be optimistic about spending cuts unless the government faces a more cooperative Senate and meaningful tax reform looks dead in the water (again).
However, there is some reason for optimism in that the cycle of each successive budget update pushing out the return to surplus may not be repeated in the May Budget, as a higher iron ore price (it’s now around US$60/tonne versus the mid-year economic and fiscal outlook assumption of US$39) and stronger employment growth provide a bit of a boost to revenue.
This is all about “parameter” changes though and the absence of an improvement in the structural deficit may continue to test the patience of the ratings agencies, so the risk to the AAA rating may still rise.
Would a downgrade to AA1 really matter? The experience of other countries suggests the impact on bond yields would be limited but it could boost private sector borrowing costs marginally.
And it would be a blow to the national psyche and a sad outcome, given that it took 16 years to regain the AAA rating after it was last lost in 1986.