Sticker shock?

It was another positive week for global equities, with sentiment particularly buoyed by a US-Mexico trade deal. Sentiment eased somewhat by week’s end, however, given America’s negotiations with both Canada and China remained unresolved. In fact, Trump ended the week threatening to impose tariffs on another $200 billion of Chinese imports. Chances are that a deal with Canada will be struck sometime soon (I suspect Canada will blink and need to bend to Trump’s tough demands), though China and the US will continue to kick their problems down the road for somewhat longer.

Meanwhile, US economic data remained upbeat, with consumer confidence pushing to its highest level in years, and already strong Q2 GDP enjoying a modest upward revision to 4.2% (from 4.1%).  In line with market expectations, annual growth in the Fed’s preferred inflation index – the core PCE – edged up to 2.0% in July from 1.9% in June. As seen in the chart below, US inflation is now around the top end of its range over the low inflation era of the past few decades – the Fed’s job is done!  My view is that core PCE inflation could edge up further, but start to level out at around 2.25% – if so, the Fed should continue to lift rates only gradually and even pause its hike timetable in mid-2019. Of course, should inflation rise faster, pushing through 2.5% within coming months, would be a much more worrisome outcome for markets!

Closer to home, bond yields dropped last week (10-year bond yields hitting their lows for the year) as the market reduced the probability of an RBA rate hike over the coming 12 months from around 40% to 20%. In turn, this reflected the out-of-cycle 0.14% mortgage rate hike from Westpac and a disappointing downgrade to FY’19 non-mining investment expectations in the Q2 CAPEX report. That said, reduced interest rate fears and a weaker $A seemed to help stocks, with the S&P/ASX 200 posting a solid 1.2% gain. Go figure.

Week Ahead

A key global focus this week will remain the “trade wars”, and particularly if the US and Canada are able to reach an agreement. The market will also remain sensitive to simmering US-China trade tensions given last week’s talks ended in a stalemate. That aside, another key focus will be US payrolls on Friday – and particularly whether average hourly earnings (AHE) remain fairly benign. As it stands, the market expects annual AHE growth to edge up only slightly to 2.8% from 2.7%. While I do expect AHE growth to push through 3% eventually (but not through 3.5% anytime soon), I don’t expect it to happen this week – though the market will probably suffer “sticker shock” if it did.

In Australia, Wednesday’s Q2 GDP will be a focus, with a rather mediocre gain of 0.7% (2.8% YoY) on the cards, following solid 1% QoQ growth in Q1. At this stage, partial indicators suggest business investment continued to cool in Q2 after solid growth last year, while choppy consumer spending should bounce back with decent growth. Public demand and exports will remain important contributors to growth, while home building is enjoying something of a last hurrah. Either way, the RBA will remain firmly on hold at Tuesday’s policy meeting, within interest focused on how it describes the recent lift in mortgage rates by some banks. Indeed, also of interest this week will be whether other major banks follow Westpac’s lead in lifting mortgage rates (hint: I suspect they will).

Have a Great Week!