FX Daily: Australia’s austerity budget takes more steam out of property market

2nd June 2014

  • With expectations for ECB easing on Thursday near unanimous, the central bank is likely to shave rates and act to boost lending to the corporate sector. (The Times)
  • There is little to be expected from the Queen’s speech Wednesday on top of already announced changes in the budget, although there could be further details on pension reform. (The FT)
  • Spain PM Rajoy is expected to announce approval of a €6.3 billion euro economic stimulus package Friday, in an effort to “to keep sky-high unemployment and the risk of deflation from derailing the country’s recovery”. Rajoy signalled he would cut the corporate tax rate to 25% from 30%. (WSJ)
  • The latest State Council announcement of a selective deposit reserve ratio cut is not a change of monetary policy direction, said Ji Zhihong of the PBoC, but a better way of targeting certain industries and guiding financial resources to the agricultural sector and small business. ( Xinhua News Agency)
  • Australia RP Data/Rismark House Price fell -1.9% on the month in May, its first fall in a year. It follows a 0.3% gain in April.
  • Japan capital spending by non-financial companies rose 7.4% on the year in the three months ending March, marking the third straight annual rise after 4.0% in October –December.
  • Australia TD Securities Infaltion rose to 2.9% on the year in May, following 2.8% in April.
  • Australia Building Approvals declined 5,6% on the month in April, disappointing expectations for a 2.0% rise. The previous month’s decline was further downgraded to -4.8%, from -3.5%.
  • Japan Vehicle Sales fell -5.6% on the year in May versus -11.4% previous.
  • China Manufacturing PMI reported its highest reading in five months in May at 50.8. The reading just beat estimates of 50.7, up from 50.4 in April.

The S&P 500 reached yet another record close on Friday, up +0.18% on the day to 1,923.57. US 10 year Treasury yield, now a bell weather of overall market performance, continued to edge higher, extending Thursday’s rally. It was the rally in TIPs, inflation linked Treasuries, that provided the biggest insight into market psychology. US markets have moved from disinflationary concerns to inflation fears. In the second estimate of the US GDP report, the US contracting in Q1 stole the newspaper headlines, meaning the PCE Deflator was largely overlooked. The annual PCE Deflator jumped to 1.6%, with core up to 1.4%. The headline CPI was back at 2.0% in April, its highest in 10 months. With consumer demand driving US economic growth, demand pull inflation may be on course to make a nasty comeback. The Fed will have to balance inflationary risk with its desire to keep rates low for longer to try to stimulate the sluggish recovery.

There was a slew of negative reads on the Australian housing market this morning. Australia Building Approvals collapsed -5.6% on the month in April and revealed an even sharper contraction for the previous month of -4.8%. This forward looking indicator points to a slowdown to come but house price data suggests this may already be underway. Rismark House Prices data posted its first month-on-month fall in a year, down -1.9% in May. While this may be due to seasonal factors, the Australian Treasury’s recent austerity budget may have taken some of the heat out of bubbling market. Government spending cuts and higher taxes on high income earners will make affordability more challenging and the drop in consumer confidence points to less prolific residential investment. All this suggests what we have maintained for some time. At present the RBA is more likely to cut rates than hike. Though with TD Securities’ measure of inflation ticking higher to 2.9% annually in May, now just below the RBA’s 3.0% upper limit, the most likely scenario is the RBA remains on hold. The rebound in Australian growth into the new year caused market expectations for central bank policy to switch from further easing to tightening. We maintain this is extremely premature as the long-term growth story remains concerning. Australia needs to reinvent itself after the peaking mining investment boom.

The Aussie dollar dropped 70 pips this morning to $0.9248, short of the monthly low of $0.9209. While the long-term story for Australia remains concerning – two speed labour market, peaking mining investment boom, deteriorating terms of trade – we remain short term AUD bulls. Simply put we are in a carry trade environment and in the market’s relentless search for yield fundamentals matter little. The market learnt little from the EM rout of last year and Australia triple A rating gives investors another reason to be complacent to the long-term risks.  We advise buying AUD to dips towards the low $0.92’s with a target of $0.94, stop out $0.90.