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Economic Overview

Economic Overview 

Global equities have started the New Year positively.  For the first six months of 2017 Global Equity markets have risen 8.3%.
Much of the increased optimism, and Sharemarket performance, has been attributed to the election of Donald Trump as President of the United States.  Global equity markets speculated that a Trump and Republican controlled Congress will pursue business friendly policies, lower taxes, and increase infrastructure spending.  All are seen as being positive for US and global economic growth. 
However, the positive start to the year cannot be entirely attributed to Trump.  The financial market enthusiasm built up around the Trump Presidential win has faded in recent months.
Underlying the positive environment has been an improvement in global economic activity.  Signs of a pickup in global economic activity started to emerge prior to the United States (US) elections.
Global economic activity is benefiting from a number of factors.  Falling unemployment and wage growth has seen an increase in household spending, particularly in the US.  Corporates have also increased investment spending.
Additionally, some of the head winds faced in early 2016 have abated.  For example, the negative impact on global growth from a reduction in spending and investment within the global energy sector, due to the sharp fall in oil price over 2015, is no longer having a negative impact. 
Similarly, the impact of China supporting their economy has been positive for global growth and commodity prices over the second half of 2016. 
Global economic growth has picked up over the last year.  In May it is estimated that global economic growth reached its highest level since 2012.
Based on forward looking indicators of economic activity, global economic growth is expected to remain solid for the remainder of 2017 and into 2018. 
As can be seen in the graph below, the index of Global Purchasing Managers Surveys (PMI) reached 5 year highs earlier in the year.  As can also be seen, the survey results have picked up since the middle of 2016 after declining over the previous 2 years.

 

globalmanu

 

At the individual country level, the US PMI recently reached a 3 year high and surprised on the upside. 
Similarly, manufacturing survey results in China and Europe have strengthened and have generally been better than anticipated over recent months. 
In addition, company profits are improving and have also been better than expected.  US corporate profits grew at their fastest pace in six years during the 1st quarter of 2017.  It is estimated that global corporate profits will increase by 12% over the course of 2017. 
Rising corporate profitability and improving economic activity has been supportive of global equity markets over the latter part of 2016 and into 2017.  Combined they have pushed the US equity market to historical highs.
Albeit, the Trump administration has dominated news headlines over the last 6 months. 
Trump’s victory reiterates the rise of the populist vote and a potentially changing political landscape.  The populist vote is centred on concerns around inequality, globalisation, trade and immigration.  Trump’s trade, immigration, foreign policy, and “Make America Great Again” and anti-Washington establishment rhetoric plays into this sentiment. 
The US election result came on the back of the surprise Brexit result.  In June 2016, the United Kingdom (UK) voted to leave the European Union (EU).
The UK Government gave formal notice of its intention to leave the EU to the European Council in March 2017.  Up to two years of protracted negotiations now lie ahead.  Although a complete breakup of the EU is not expected, Brexit negotiations will influence financial market sentiment as to the likely risk of further changes to EU membership. 
And the surprises in the UK kept coming with the outcome of the recent snap election.  UK Prime Minister Theresa May called a snap election with the view to strengthen her position going into the upcoming Brexit negotiations.  Unfortunately, the election to reduce uncertainty has only created more uncertainty.  May has lost her majority in the UK parliament and has had to form a minority Government with the backing of the Northern Irish party the Democratic Unionist Party.  Brexit negotiations commenced 10 days after the UK election. 
Global markets have largely seen the UK election and Brexit as a UK issue with little implications for the global economy.  The main financial market impact has been through wild swings in the value of the British Pound. 
Politics is likely to be an ongoing area of attention, uncertainty, and at times distraction for financial markets over the coming years. 
There will be the continued focus on the Trump administration as they try to roll out their policies.  There is room for disappointment in financial markets given the high level of expectations for Trump’s policies, such as a “phenomenal” tax package and expectations for trillions of dollars in infrastructure spending.
Political risk remains in Europe, with elections to be held in Germany and Italy.
The rise of the Populist vote and improving economic data has coincided with a change in a number of themes driving market sentiment.  For example, for much of 2016 expectations were for low inflation and low economic growth. 
However, global inflation expectations have risen over recent months. 
The initial inflation catalyst was signs of rising Producer Prices in China.  As can be seen in the graph below Chinese Producer Prices (PPI) climbed sharply last year.  The year on year increase in Chinese PPI turned positive in September 2016, the first positive annual increase since March 2012.


Chinappi
 

To reflect the sharp turnaround, Chinese PPI has increased from an annual decrease of -5.3% in early 2016 to annual increase of 6.5% in January 2017.
In addition, there were firmer inflation outcomes in the US and Germany earlier in the year. While jobs growth, (particularly in the US) and growing prospects for an increase in Government spending globally (given the rise of the populist vote) are also seen as inflationary.
Rising inflation expectations have been a key factor behind the increase in longer term global interest rates from the historical low levels experienced in the middle of 2016.
Against the backdrop of rising populism immigration reform and/or protectionist trade policies have also gained increasing support. 
The golden age of globalisation appears to be ending and with it the risk of trade disagreements has grown.  The US is likely to become more protectionist over 2017.  The response of China and impacts on other countries will be closely monitored by financial markets.
Lastly, one of the other big themes/trends to emerge over recent months is the expectations of an increase in Government spending and/or tax reform.  This partly reflects, after years of sluggish economic growth, a pushback against austerity (e.g. the reduction in government spending that has been undertaken across Europe over previous years).
It also reflects an acknowledgement that an extended period of very low interest rates has not delivered the desired economic outcomes.  Low interest rates have increased the level of inequality (those with financial assets have received outsized gains).  Furthermore, in many countries there is a need for infrastructure upgrades.
As a result, there is growing support for an increase in Government spending in the form of tax changes and infrastructure spending and less support for very low interest rates as the only policy to drive global economic growth.  
The US Federal Reserve (Fed) raised interest rates by 0.25% in June 2017, the third increase in six months.  The Fed Funds Rate range is between 1.0% and 1.25%.  The Fed previously raised interest rates by 0.25% in December 2015. This was the first increase in 10 years.  Prior to this the US Fed Fund Rate had been trading between 0.0% and 0.25% since December 2008.
The Fed is expected to raise the Fed Funds Rate another 1-2 times over the course of 2017.  This reflects the ongoing improvement in the US economy.  This includes strong employment growth (the US unemployment rate is 4.3%), a robust housing market (the average house price is up 5.7% over the last year), consumer confidence has risen to its highest level since December 2000) and rising incomes.
Although the Fed has emphasised a gradual increase in the Federal Funds rate, the likely impact of Trump’s economic policies, which will stimulate economic activity at a time the US economy is performing well, increases the odds that the Fed will raise interest rates more quickly than currently anticipated.


fedfunds
 

Elsewhere in the world, the European Central Bank (ECB) and Bank of Japan (BOJ) are likely to maintain low interest rate policies for the rest of 2017. 
Therefore, the divergence in interest rate settings between the US, Europe and Japan will increase over 2017.  The expectations of higher interest rates in the US relative to the rest of the world drove the US dollar to 14 year highs at the end of 2016.
With improving global economic activity, falling unemployment, and rising inflation pressures a number of other Central Banks are beginning to raise the prospect of having to increase interest rates.  Central Banks recently highlighting that the next move in the direction of interest rates is up include the Bank of England, Bank of Canada, and the Norwegian Central Bank.
Twelve months ago, China was a major source of uncertainty and concern for global financial markets.  Despite this, the Chinese economy has performed well over 2016 and economic growth has surprised on the upside.  The Chinese economy grew 6.8% in 2016.
More recently economic activity appears to be slowing from the fast pace set at the beginning of the year.  Nevertheless, the Chinese economy remains resilient and is expected to grow close to 6.5% in 2017. 
Measures of Chinese economic growth remain robust.  Exports have increased 8.7% over the last 12 months due to a weaker currency and stronger global economic growth, retail sales remain elevated, industrial profits are rebounding, up 16.7% over the last year, and house prices have grown 10.3% compared to last year.


ChinaGDP
 

The continued fall in commodity prices also contributed to financial market instability at the beginning of 2016.

Encouragingly, commodity markets have risen over recent months. Commodities such as Iron Ore and Copper have risen significantly over the last few months due to better than expected Chinese economic data, increasing optimism for the outlook for the global economy, and expectations for an increase in US infrastructure spending following the US election result.

Nevertheless most of the focus has been on the price of oil given its impact on economic activity and Consumer Price Indices (CPI). The price of oil had fallen from $115 a barrel in August 2014 to trade below $30 a barrel in January 2016. The current price is just under US$57 a barrel.

As can be seen in the graph below, the price of oil has recovered slightly since February 2016. In mid-February Saudi Arabia and Russia, two of the world’s largest oil producers, agreed to freeze oil production, albeit at near record high levels. Other oil producers followed suit. This was the first significant cooperation between OPEC and non-OPEC oil producers in 15 years. As a result, there was some upward movement in the price of oil, but the price of oil remains at historical low levels.

In a more recent development OPEC and 11 other oil producing countries have agreed to cut oil production for the first time in eight years, providing more support for the oil price. The price of oil rose 9.6% in December.


Dairy prices
 

The outlook for the Australian economy is finely balanced.  On the positive side the Australian economy is expected to grow more strongly over the next couple of years than it has recently.  The pick-up in the global economy, the mining sector being less of drag on the domestic economy, and historically low interest rates are expected to underpin the continued growth in the Australian economy.  There has been strong jobs growth and business confidence remains strong.
However there are some potential threats to Australia’s economic growth, these include unusually low wage growth, record levels of household debt, and overvalued property markets.  The risk being that this combination leads to a reduction in consumer spending and therefore softer economic activity than forecasted.
Amazingly, the Australian economy has recorded 25 years of uninterrupted economic growth.  Australia has not been in recession since June 1991 (a recession is defined as two consecutive quarters of negative economic growth).
The New Zealand Government in its recent budget was able to announce spending increases in a number of areas, including public and social services, as well on infrastructure.  The 2017 NZ Budget also introduced a Family Incomes Package to support lower and middle income earners.  This included an adjustment to tax thresholds, an increase in Working for Families, as well as increases in accommodation support.
Due to firming economic growth over the past years, and unlike most other countries around the world, New Zealand’s Government budget is in a healthy position to undertake these measures and still maintain a focus on long-term debt reduction.  Thereby continuing to improve New Zealand’s economic resilience.  The budget announcements will help support economic growth over the coming years.
New Zealand’s economy grew a disappointing 0.5% in the 1st quarter of 2017.  This compared to expectations of 0.7%.  The underlying strength in the New Zealand economy is probably stronger than the 1st quarter result.  The weaker than expected result can be attributed to some transitory factors such wet weather, earthquake related disruptions, and inventory cycle impacts.  Over the last 12 months the New Zealand economy has grown 2.5%.


 

Other measures of New Zealand’s economic strength remain high, such as business and consumer confidence.  New Zealand’s unemployment rate is currently 4.9%, the lowest level since December 2008.  Net migration, building activity, and tourist flows remain at elevated levels.  New Zealand’s terms of trade, the ratio of export prices to import prices, rose 5.1% in the March 2017 quarter.  The terms of trade are at their highest since 1973.  Export prices rose due to higher dairy prices, while imported prices fell due to lower petroleum prices.
 
New Zealand’s inflationary pressures were stronger than expected in the 1st quarter of 2017, the third consecutive quarter of stronger than expected inflation data.  Consumer Prices (CPI) rose 1.0% in the quarter, compared to 0.8% expected.  Annual CPI was 2.2%, a 5 year high and above the Reserve Bank of New Zealand’s (RBNZ) 2% target rate.