Greece – Deadline Fast Approaching
Much to our surprise Greece managed to make a payment to the IMF of EUR 750m due on May 12th. However it was later revealed that Greece pulled off this feat by pulling EUR 650m from its own reserves with the IMF. This is a bit like writing a cheque to yourself to clear your bank overdraft, and the money needs to be replenished within a month. Meanwhile June is the end of the line for negotiations, with EUR 1.6bn of repayments to the IMF coming up, and the European support package coming to an end. Furthermore the deposit outflow continues apace, in the four months to March about 16% if the deposit base has been pulled out of Greek banks.
However progress in negotiations has been fraught. Greek Prime Minister Alexis Tsipras railed against demands being made by creditors, suggesting a referendum would be necessary if any agreement departed too far from election pledges. Though a new poll showed over three-quarters of Greeks feel Athens must strike a deal at any cost to stay in the euro. It is hard to see how this ends though we still believe some kind of muddle through as the most likely outcome. A plausible scenario might see some kind of compromise agreed at the eleventh hour, with the ECB stepping in to provide liquidity and facilitate repayments of the June debts, and a referendum on the package held shortly after. There are plenty of potential pitfalls between here and there.
U.K. Election Surprise
The pollsters were confounded by an unexpected majority for the Conservatives in the U.K. election, winning 331 seats out of 650. This saw the Labour opposition leader, the Lib-Dems leader, and the UKIP leader all resign. It means there will be a referendum on the United Kingdom’s membership of the EU in 2017, if not earlier, which would also likely trigger a second Scottish independence referendum. Does this, perhaps, make it more likely that the EU will fight harder to keep Greece in the club, so as not to have major fissures on two fronts? Up until this point European leaders had not taken the referendum too seriously given the likely messiness of governing the U.K. in coalition. Merkel has since come out and signalled a readiness to work with the U.K. to prevent the latter from exiting the EU, though EU treaty revisions have a bumpy history so it is unlikely Europe will embrace too large a divergence from the status quo.
The RBA Fires Again
The RBA cut its benchmark rate by a quarter point, the second cut in three months. The 2% cash rate is at its lowest since the 1950s. Bank Governor Glenn Stevens cited significant weaknesses in the economy, despite recent evidence of somewhat improved domestic demand and employment. Peter Arnold, banking analyst at RateCity.com, said typical borrowers would save around $1200 this year on their home loan repayments compared with what they paid the previous year. For a lot of people in the capital cities it will be around double that. The market was disappointed by the dropping of the easing bias language from the statement, but the RBA subsequently made it quite clear that they still have room to act. No doubt they were annoyed by the AUD rally after the last rate cut.
Australia’s Fantasy Budget
Australia’s unemployment rate rose slightly in April to 6.2%, up from 6.1% in March, with jobless rates jumping in Western Australia, South Australia, and Tasmania. Meanwhile we saw the release of the May budget which relied upon some heroic assumptions to keep the deficit under control, with expected growth of 3.5% in fiscal 2018 and 2019, a level unseen in six of the past seven years. This seems like an unrealistic trajectory. The projected deficit through June 2016 of 2.1% of GDP was also less than expected. Even so total debt is projected to hit a 21-year high. Meanwhile the RBA rate cut seemed to inspire consumers, with confidence rising 1.7% in the week following, and 3.6% the week after that. On the other hand the ABS reported a 4.4% fall in dwellings approvals between March and April. And with unemployment likely to trend higher we are not likely to see a large bump in consumer spending, we remain cautious on Australia.
Australian Banks Wobble
Reporting season saw underwhelming results for the Aussie banks, though no large misses. However other factors may have been more important for what has been a decent sell off in the majors. First was the decision by NAB and WBC to raise capital, which is a logical outcome of an increasingly stringent capital regime and elevated share prices. Second was the increasing concern over regulatory pressures. Data showed that in the year ended March 31st the banks expanded lending by 10.4%, more than the 10% designated by APRA as a threshold for greater regulation. In response to this the banks have been pulling back from their more aggressive efforts to boost their loan books. This coupled with profits driven by historically low bad debts, and dividend yields driven by historically high payout ratios, meant the banks were primed for a pullback. Rising bond yields have not helped. We believe that this may be approaching top of the current cycle for the banks, though they are likely to be supported by relatively attractive yields in the short to medium term.
United States – a Mixed Bag
In the U.S. we saw mixed data, but overall an improvement from Q1. Consumers had a soft patch with flat spending in April after a revised 1.1% rise in March, and the consumer sentiment gauge fell from 90.7 in May from 95.9 in April. Industrial output also declined 0.3% in April, however the more forward-looking manufacturing survey picked up in May for the first time in seven months, with the ISM rising to 52.8 from 51.5 in April. Sale of new homes were up an annualised 6.8% in April and construction spending was at a 6 ½ year high. Employment markets remain very positive with jobless claims remaining at a 15 year low, and wage growth ticking up a bit. Average hourly earnings increased 3 cents to $24.87 an hour. Over the past year, pay is up 2.2%, and a 0.3% rise in core U.S. prices last month brought the annual inflation rate to 1.8%. The annual rate is approaching the Federal Reserve’s target of 2%.
All this seems to point to an economy exiting its Q1 funk, where we saw GDP revised down to -0.7% from +0.2%. The biggest driver was the increase in the trade deficit, which was the largest amount since 1999. Economists have revised growth expectations for the calendar year down from more than 4% to less than 3%. However we still remain positive on the U.S.
