Merlea Macro Matters – February 2019

(Merlea Macro Matters)


The global economy continues to expand, but third-quarter growth reports disappointed in some economies. Idiosyncratic factors (new fuel emission standards in Germany, natural disasters in Japan) weighed on activity in large economies. But these developments occurred against a backdrop of weakening financial market sentiment, trade policy uncertainty, and concerns about China’s outlook. While the December 1 announcement that tariff hikes have been put on hold for 90 days in the US-China trade dispute is welcome, the possibility of tensions resurfacing in March casts a shadow over global economic prospects. Outside the United States, industrial production has decelerated, particularly of capital goods. Global trade growth has slowed to well below 2017 averages. The true underlying impetus could be even weaker than the data indicates, as the headline numbers may have been lifted by import front-loading ahead of tariff hikes, as well as by an uptick in tech exports with the launch of new products. Consistent with this interpretation, purchasing managers’ indices, notably in the category of new orders, point to less buoyant expectations of future activity.

The Federal Reserve concluded a two-day FOMC meeting where its pivot away from a tightening bias that began back in December last year, gathered momentum. The Fed not only held interest rates steady but said it would be patient in lifting borrowing costs further this year as it pointed to rising uncertainty about the US economic outlook. The Fed continues to be accommodative and sympathetic towards market volatility, which removes a significant headwind from last year.

In a statement, The Fed went on to say that continued economic and job growth were still “the most likely outcomes for 2019.” However, it removed language from its December policy statement that risks to the outlook were “roughly balanced” and struck out the statement that projected ‘some further rate hikes’ would be appropriate in 2019, and replaced it with ‘further adjustments’ – which could mean up or down. In a separate release from its policy statement, the Fed also said that while it was continuing its monthly balance sheet reduction, it was prepared to alter the pace “in light of economic and financial developments”. The Fed went on to say that it had decided to continue managing policy with a system of “ample” reserves, a signal that its balance sheet rundown may end sooner than expected. This was another major boost to sentiment today for equities, but also placed downward pressure on the US dollar.


US Bonds

The end of the 30 year plus bull market does not mean the start of the net bear market. Interest rates will remain low.  With long term rates well anchored, the current Fed reserve rate hike cycle will end earlier and at a lower level than is currently priced into the markets. Also controlling short term US rates is the ongoing accommodation from other central banks in response to low inflation. This will result in a nearly flat yield curve and a very small shift upwards in other yield curves around the world. We do not actually expect the curve to invert in 2019, not least because the Fed is itself likely to regard a flatter curve as a warning sign.

Credit spreads (both investment grade and high yield) will settle in at slightly higher levels than the lows seen in this cycle. The ongoing economic expansion and still low debt servicing costs continue to provide a foundation.

European Bonds

The outlook for European government debt will also be shaped by the European Central Bank’s decision to end the multitrillion euro bond-buying programme that it began in 2015. As the ECB’s purchases helped depress yields, the absence of such a large buyer should logically exert some upward pressure. But some are sceptical that yields for some Eurozone countries will climb significantly. For a start, the ECB will continue to reinvest the proceeds of maturing debt that it already owns — meaning its portfolio will remain at about the current €2.6trn ($4.3trn) level. The largely balanced fiscal position in some core Eurozone countries, notably Germany, offers another potential countervailing force to the ECB’s absence as there will be a limited new supply of debt for investors to digest. Overall the reinvestment programme will remain supportive for European bond yields because the scarcity issue is not going to disappear soon for core bonds.

Australian Bonds

A gap has opened between the markets and the RBA’s expectations for the path of the cash rate. While markets are now pricing in a 40% chance of an easing late 2019 to mid-2020, the RBA reiterated its view in the December Monetary Policy Meeting minutes that the next move in rates was most likely to be up rather than down and that there was no strong case for a near term move. We still hold on to our view that the RBA will be in a position to gradually remove policy accommodation and have responded to recent developments by pushing back the timing of the first tightening into the first half of 2020. Thereafter we look for a gradual and drawn-out removal of policy accommodation that eventually returns the cash rate to 2.50% by 2022. We see this rate as being close to the economy’s neutral rate given the added grip that monetary policy has at time of high household debt levels.

Markets beginning to factor in monetary easing seem premature given the prospect of fiscal easing in an election year, a large pipeline of public infrastructure spending and support from a lower exchange rate. Macro-prudential measures were again eased, with the Australian Prudential Regulation Authority (APRA) lifting restrictions on interest only lending. This comes on top of their April move to remove the “speed limit” on investor lending and in aggregate should remove a source of downside pressure on housing prices. At the time of writing, three and 10-year government bonds were yielding 1.8% and 2.29%, respectively. Both appear expensive, heavily discounting the downside risks to the growth and inflation outlook rather than the most likely path given current policy settings.

Listed Property

Australia continues to be an attractive destination to acquire property on the global stage. The dollar has fallen over the last year and the spread between property yields and interest rates is attractive when compared to other developed markets. Many global private equity players have significant amounts of capital to put to work after continuing to attract large scale funds in 2018. As a result, we expect to continue to see elevated levels of inbound commercial real estate acquisitions. Good REIT management teams will continue to adjust their portfolios to adapt to the changing supply and demand dynamics in each property sub-sector. Furthermore, there is still a disconnect between public and private market pricing across most (if not all) sectors. Offshore based groups were involved across the sector and in almost all M&A activity last year, demonstrated by transactions involving Westfield Corporation, Propertylink, Gateway, Investa Office Fund, Cromwell, Ingenia and Australian Unity Office Fund. We expect a number of successful offshore buyers will continue to look to build scale in their respective investments. For those who missed out, they may look to pursue alternative opportunities in the region in order to put their capital to work.

Australian Equities

The domestic economy looks to have lost some momentum towards the end of 2018 and confidence measures, which had held up through an earlier period of falling house prices and equity markets, fell sharply in December. On the activity side, there was a sharp fall in the business conditions index in the NAB survey from well above, to well below long run levels. While most likely reflecting some seasonal volatility, given that other PMI measures remained in expansion territory and capacity utilisation rates in the NAB survey were elevated, future moves in this series bear close monitoring. Building approvals declined a greater than expected 9.1% over November, to be down 33% from the peak levels of a year ago. Growth is likely to slow, albeit still above trend. The key focus for 2019 is going to be the housing market, given elevated prices are starting to slip, household indebtedness is high, and the tax regime for housing is likely to tighten. While this is a risk for the economy, there is a large pipeline of infrastructure work in place, the labour market is expected to remain strong, and support is expected to come from commodity prices.

Global markets


As 2019 begins, the U.S. economy could get an initial boost from what is expected to be a record-high tax-refund season. Nevertheless, many factors—including tighter labour markets, fading fiscal stimulus and the absence of monetary accommodation—likely mean reduced growth for the U.S. and other developed markets in 2019. U.S. corporate credit risks could run higher, as highly levered companies contend with rising rates and wages. For the U.S., the easing of trade tensions would have a more muted impact than for China and emerging markets; however, a positive resolution on trade would help lift business confidence and investment spending in the U.S.  These factors and risks, coupled with the tailwinds of fiscal stimulus and tax cuts fading, means the U.S. economy could swing from what was an exceptional performance in 2018—2.9% estimated GDP growth—to below trend.   Parts of the U.S. bond market are seeing short-dated yields push above their long-dated peers, a “warning sign” for the stock market as Wall Street’s economic expectations for 2019 deteriorate.


Eurozone growth should stabilise at low levels in 2019, helped by extra-easy ECB policy, fresh fiscal stimulus and the lifting of one-offs such as regulation-related disruptions to the auto industry. The ECB maintained its policy as we expected. We agree with its assessment that growth risks have shifted to the downside. This makes ECB growth and inflation estimates seem optimistic, we believe, and a 2019 rate rise unlikely. Medium-term threats to European unity, the European economy’s still-anaemic growth and its dependence on trade make us cautious toward European risk assets.


Investment will continue to be a key driver of growth next year, in our view, owing to demand for replacing aging capital stock, the need to address labour shortages and replace them with capital, and spending related to the 2020 Tokyo Olympics. All of these are supported by healthy corporate profits and high levels of business sentiment despite some moderation in recent months. Exports may contribute less to growth next year amid moderating global trade momentum, but consumption growth should pick up after a volatile 2018. Consumer fundamentals are strong, with a very low unemployment rate and steady income growth.

The October 2019 consumption tax hike will lead to swings in consumption in the ensuing quarters, in our view. As we’ve seen in the past, consumption growth accelerates before a tax hike, as consumers bring their purchases forward to avoid the coming higher tax rate. Consumption growth then declines for a while, until it stabilises at a new trend a couple of quarters later. But if we look past this volatility, the trend growth in overall GDP should remain intact, with Japan delivering above or near potential growth in the next two years, and gradually slowing down to its potential growth rate, which is estimated to be just below 1% growth. The BOJ will continue its aggressive stimulative monetary policy in 2019. The BOJ’s most recent formulation of its monetary policy framework is labelled “Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control (YCC).” Under this framework, the BOJ commits to Japanese government bond (JGB) purchases of 80 trillion yen, and targets the short-term policy rate at negative 0.1% and the 10-year JGB yield around zero percent. In practice though, the policy is really about controlling the yield curve.


The biggest headwind for China’s economy could be the unsettled trade war with the United States, analysts said. The two countries agreed on a 90-day truce in early December, but whether a ceasefire will be hammered out depends on the negotiations.  The tariff fight since July between the world’s two biggest economies will clearly take a toll on China’s exports, and the damage will become more visible next year, analysts continued.  China’s export growth will decline from 11% in 2018 to 5.6% next year, dragging down the country’s GDP growth by 0.8 percentage points.  Analysts predicted more-proactive fiscal policy, with a larger scale of tax and fee cuts and an increase in the issuance of special-purpose local government bonds to reduce the burden on business and support investment.

Policymakers will continue to fine-tune monetary policies to ensure increased credit supply to private and small businesses. Pushing forward structural reform is not only a long-term policy goal for China but also a key issue in trade negotiations with the U.S. More policy efforts can be expected in 2019 to promote market reform, opening-up, SOE reform, intellectual property rights protection and private sector support. With policies to expand local government bond issuance and ease borrowing controls on local government financing platforms, analysts expect to see a moderate rebound in infrastructure investment this year.

Increased spending on infrastructure is likely to widen China’s budget deficit next year, which has been held to no more than 3% of GDP for years Analysts said liquidity in the banking system will remain ample in 2019 as authorities have signalled further monetary easing. The central bank will further lower banks’ reserve requirement ratio and use various policy tools to manage market liquidity

Emerging Markets

Though they are more prone to extreme ups and downs, emerging markets typically grow at a faster pace than developed markets. In 2018, that pattern diverged, as U.S. economic growth picked up and emerging markets contended with rising U.S. interest rates and a strengthening dollar. “This, coupled with trade tensions, rendered emerging-market economies nearly defenceless against the barrage of negative external headwinds.” Most emerging markets maintained fiscal discipline and a prudent monetary policy in 2018, notable even in the face of external pressures, such as a higher dollar and energy prices.  “If anything, the harsher external environment in 2018 actually pushed emerging markets to build up more buffers.”  The recent agreement between the U.S. and China to postpone proposed tariff increases for 90 days could also impart modest upside to growth, particularly for China. Easing trade tensions could support China’s growth and momentum in global trade, both of which would benefit emerging markets.



Our model suggests that gold’s price is influenced by several key factors, including the value of the US dollar, inflation rates, changes in nominal yields, and investor sentiment towards the precious metal. Looking ahead, in our base-case scenario, we expect gold’s price to flatline out to June 2019, assuming an absence of sudden unexpected events that shock global financial markets. However, should events turn out differently and some of the geopolitical concerns crystallise into an adverse shock, gold could trade substantially higher. Thus, with gold currently trading at US$1294/oz at the time of writing, investors concerned about adverse geopolitical shocks may have found a good entry point.


Iran’s exports are expected to drop further heading into May, when sanctions waivers for several of the Islamic Republic’s biggest customers expire. The Trump administration granted the six-month exemptions in order to prevent a price spike. It stands that oil prices will play a major role in President Donald Trump’s calculus when the waivers expire. Even with the impending OPEC+ production cut (less than 2% of global supply) the only factor I see influencing prices in a meaningful way is geopolitical turmoil. And we may have our fair share of that in 2019. President Trump’s intent to withdraw all 2,000 U.S. troops from Syria and 7,000 from Afghanistan will have serious implications for security and stability in the region. The resulting power vacuum will lead to increased assertiveness from trouble-makers in the region (Russia, Iran,), and could even result in an Israel-Iran-Syria war. This would undoubtedly send oil prices skyrocketing, particularly if Iran follows through with its threats to blockade the critical Strait of Hormuz. Thus, 2019 oil markets should look a great deal like those of 2018: Volatile, cyclical, and unpredictable, with a downward trend if the global recession hits. The upshot is Wall Street expects a moderate recovery for oil in 2019. Investment banks see Brent crude, the international benchmark for oil prices, averaging about $68-$73 a barrel next year. Forecasts for U.S. crude mostly fall in a range between $59-$66 a barrel.

Sector 12 Month Forecast Economic and political predictions 2019





The Federal Reserve is expected to slow the pace at which it raises rates in 2019.  Speculators hold substantial net-short Australian dollar positions. If sentiment towards the Australian dollar would improve as a result of somewhat stronger than expected Australian macro-economic data, short covering will send the Australian dollar higher especially versus the US dollar.







Rising US interest rates and a strong US currency have continued to apply downward price pressure on gold, but resistance is growing. This has been helped by world stock market volatility, which has seen gold perform strongly over the past month due to its safe-haven status. A softening Fed outlook and increased global growth concerns have improved sentiment towards gold markedly over the last month.





Prefer Oil and Gas over bulk metals


A reversal of recent oversupply is likely to underpin oil prices. Any relaxation in trade tensions could signal upside to industrial metal prices. We are neutral on the U.S. dollar. It maintains “safe-haven” appeal but gains could be limited by a high valuation and a narrowing growth gap with the rest of the world.





Hold – value appearing

Have removed tactical tilts away from this sector.



Australian real estate investment trust (A-REIT) industry is stable, except for the retail segment, which faces a challenging operating environment.


The growth in operating income will remain strong, and they expect aggregate comparable net operating income growth of 3% to 4% during the next 12-18 months



Australian Equities


5500 – 6100


The local outlook is ok, but returns will be constrained.


On the one hand, there’s strength in infrastructure spending, business investment looks healthier, and export values should hold up; on the other hand, there’s the housing slowdown, which will constrain things, all of which should keep Australian interest rates on hold, or if, as some economist expect, ultimately drive a rate cut. So, the return outlook for bank deposits will remain very low as we go through 2019.





2.2% -3.5%


A subtle shift may also be underway in the outlook for Australian interest rates, with some economists now raising the prospect of rate cuts.


It also marks a broader move lower in Australian bond yields over the past month, in line with their US counterparts. Australian 10-year bond yields are now back below 2.22% for the first time since October 2016.


Cash Rates


On hold


The correction in property prices and tighter lending conditions are expected to continue over the next twelve months, pushing the central bank to leave the cash rate chilled at 1.5% — the way it has been for over two years already.


Global Markets





Very expensive. We’ve upgraded our valuation assessment by a notch with the selloff in October and November. But assuming a mean reversion lower in corporate profit margins over the next few years, maintain an underweight preference for U.S. equities primarily on the back of their expensive valuations.





Underweight / Sell


Relatively muted earnings growth, weak economic momentum and political risks are challenges. A value bias makes Europe less attractive without a clear catalyst for value outperformance. he ECB kept rates unchanged and noted risks to the growth outlook “moved to the downside.” Manufacturing Purchasing Managers’ Index (PMI) data for the eurozone and Germany disappointed, with German data signalling a manufacturing contraction.





Neutral/ hold


We see a weaker yen, solid corporate fundamentals and cheap valuations as supportive, but await a clear catalyst to propel sustained outperformance. Other positives include shareholder-friendly corporate behaviour, central bank stock buying and political stability.



Emerging markets








Attractive valuations and a backdrop of economic reforms and robust earnings growth support the case for EM stocks. We view financial contagion risks as low. Uncertainty around trade is likely to persist, though much has been priced in. We see the greatest opportunities in EM Asia.











The economic backdrop is encouraging, with near-term resilience in China and solid corporate earnings. We like selected Southeast Asian markets but recognise a worse-than-expected Chinese slowdown or disruptions in global trade would pose risks to the entire region.



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