Economic Update | August 2017
After gains in June, the Australian dollar was stronger again in July, supported by rising commodity prices and expectations that the RBA could join other central banks in removing monetary policy accommodation, particularly after the Bank of Canada lifted rates. US dollar weakness was also evident as the market reduced the scale of future Federal Reserve rate hike forecasts on the back of weaker inflation data and reduced expectations of tax reform in the US given Congress’ failure to pass healthcare reform.
As a result, the Australian dollar rose 4.1% against the US dollar to $US0.8003, its highest level since May 2015. The AUD also rose against the Sterling (+2.6%), the Euro (+0.4%), Japanese Yen (+2.2%) and NZ dollar (1.5%).
Commodity prices were generally higher in July, supported by a lower US dollar and further signs of a synchronised pick-up in global economic growth. West Texas Intermediate (WTI) crude oil finished the month at $US50.17/bbl, up 9.0%. Gains were driven largely by a late-month fall in the US dollar and Saudi Arabia’s pledge to reduce crude exports.
Iron ore prices rose strongly in the month, with the spot iron ore contract (Qingdao 62% Fe fines) up by 13.5% to $US73.7/t. Stronger than expected economic growth figures in China and other industrial indicators helped propel the iron ore price higher.
Base metals were generally higher, with the London Metals Exchange (LME) Index rising by 4.4%. Nickel (+8.8%) and copper (+7.3%) rose strongly, helped by stronger Chinese economic data. Tin (+3.4%), lead (+1.8%) and zinc (+1.3%) also rose. Precious metal prices were stronger, with gold up 2.2% to $US1269.44 an ounce. Silver rose 1.2%.
The S&P/ASX 200 Index finished the month flat (0.0%), despite some volatility. In a repeat of last month, there was considerable divergence in the performance between industry sectors.
With the Australian dollar continuing to rise against other major currencies, the biggest loser was Healthcare (7.5%), since companies like CSL, Cochlear and ResMed derive a significant proportion of their earnings from overseas. Bond proxy sector Utilities (5.3%) was impacted by rising bond yields, while Industrials (-2.9%) fell on a combination of a strong Australian dollar and rising bond yields. Telcos (4.3%) were also dragged lower by sector giant Telstra, which has been under pressure on investor concerns around earnings and dividend risk.
On the positive side, the Materials sector (+3.5%) was strong on the back of rising commodity prices. Financials (+1.2%) were supported by the large banks, which rebounded after the better-than-expected ruling on capital requirements from APRA.
The S&P/ASX 200 A-REIT index finished the month largely unchanged (0.1%), having fallen by as much as 3.6% on global developments.
The industrial A-REIT sub-sector continued its run of longer term outperformance (+1.1%), again outpacing the retail (+0.6%) and office (0.4%) sub-sectors over the month.
Among the better performing A-REITs in July were Vicinity Centres (+7.0%) and Rural Funds Group (+8.1%), whose investors supported a $78.6m capital-raising to strengthen the balance sheet. Vicinity announced a 5% buyback and asset revaluations, which boosted net tangible assets by 3.3%.
At the other end of the spectrum, Charter Hall Group (5.6%) and Westfield Corporation (4.4%) both fell over the month, with the market taking a dim view of Charter Hall entering discussions to purchase Westpac’s global infrastructure business, Hastings Management.
Listed property markets were stronger globally, with the FTSE EPRA/NAREIT Developed Index (TR) rising 1.9% in USD terms. Singapore was the top-performing region (+5.2%) and New Zealand the worst in US dollar terms, with the US in the middle of the pack at +1.0%.
Global developed equity markets recorded another positive month, as market volatility measures continued to fall to record lows.
The VIX Index, a market estimate of future volatility, reached a new low, falling to 9.36 on 21 July. Stronger global growth, good company earnings, large cash volumes on the sidelines and strong guidance from central banks helped to reduce volatility concerns, despite elevated political uncertainty in the US.
The MSCI World Index was up 2.3% in US dollar terms over the month, but down 1.5% in Australian dollar terms as the currency strengthened. The US dollar was weak in July and was one of the biggest factors impacting country specific returns.
In the US, the S&P500 (+1.9%), Dow Jones (+2.5%) and the NASDAQ (+3.4%) produced strong returns. MSCI Materials (+4.6%) outperformed following a rise in commodity prices, while MSCI Healthcare was flat as political uncertainty continued.
Equity markets in Europe were weaker, with falls in France (0.5%) and Germany (1.7%) driven by a strong Euro. In the UK, the FTSE100 rose 0.8% on signs the Brexit negotiations were progressing better than some had feared.
Asian markets were mixed, with the Japanese Nikkei 225 down (-0.5%), but Singapore (+3.2%) and Hong Kong (+6.1%) both making strong gains. Hong Kong was propelled higher by some Chinese property companies.
Emerging market equities had another positive month, assisted by cyclical improvements in the global economy, commodity price gains and the weaker US dollar. The MSCI Emerging Market Index was up 5.5% in USD terms and 1.5% in AUD terms.
MSCI EM Latin America (+8.2%) rose strongly, helped by gains in oil and iron ore prices. MSCI EM Asia ex Japan gained 4.9% over the month, assisted by a 9% gain in MSCI China. The MSCI EM Europe, Middle East and Africa was up 5.3%, led higher once again by oil prices, with Russia recording positive gains after falls in June.
July was a relatively stable month for bond markets, with more hawkish central bank themes being offset by continued political and geopolitical headline risks. The relatively low volatility speaks to both the resilience of markets and increasing confidence that global growth is on a healthier trajectory.
Central banks were hawkish, with the Bank of Canada increasing official interest rates for the first time since 2010, plus ongoing tapering discussions from the US Federal Reserve and European Central Bank. Geopolitical tension was driven by continued missile testing in North Korea and the response from other countries, the US in particular. US political uncertainty continued, with no progress on healthcare and ongoing headlines around the US presidency.
European 10-year yields rose 8 bps to 0.54%, but the US and UK were slightly down (1 bp to 2.29% and 3 bps to 1.23% respectively). The equivalent Japanese yields were flat month-on-month at 0.08%. Australian government bond yields rose 8 bps to 2.68%. The rise was influenced by the release of minutes from the RBA’s Monetary Policy Board meeting, which were interpreted as overly hawkish.
Global investment grade credit spreads continued to tighten, but remain resilient despite wider market noise. While spreads are now the tightest since 2014, demand shows little sign of slowing down. Investment grade issuance in the US and Europe remained strong over the month.
The Bloomberg Barclays Global Aggregate Corporate Index average spread tightened by 7 bps to 1.02%. US credit also tightened, with the Bloomberg Barclays US Aggregate Corporate Index average spread closing 5 bps tighter at 0.98%. In Europe, the spread on the Bloomberg Barclays European Aggregate Corporate Index was 10 bps narrower at 0.92%, on the back of the ECB rhetoric.
US high yield credit spreads also tightened in July. The Bank of America Merrill Lynch Global High Yield index (BB-B) narrowed 16 bps over the month to 2.81%. The high yield market continues to be impacted by downgrades, particularly in the energy and mining sectors.
Australian credit spreads followed the global trend from recent months and moved tighter, with the average spread relative to swap on the Bloomberg Australian Corporate Index narrowing 5 bps 0.81%.
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