The demand for easy money is a powerful one. Europe’s austerity drive (also known as living within one’s means) has hit a few road blocks — again. Portugal has had enough and the political situation there looks shaky. As a result, government bond yields shot up to 8% yesterday.
Germany has had to give Greece another clip around the ear for not adhering to its reform program, and is (once again) threatening to withhold the next tranche of bailout money unless Greece gets on with it.
And the situation in Egypt is volatile, with the army having just booted out the one-year old government of President Mursi following mass protests against his rule.
But that’s all happening on the other side of the world. There’s quite a bit going on here too. This week, a deluge of data on the Australian economy gave us a few big clues as to where we are headed.
Let’s start with retail sales, which came in at just 0.1% growth for May, versus expectations of a 0.3% increase. Earlier this week, a survey of manufacturing activity showed improvement in the industry but with a reading of 49.6, it’s still shrinking, just at a ‘less fast’ pace (anything below 50 reflects contraction).
Yesterday saw the release of the services sector survey, and it wasn’t pretty, coming in at 41.9. According to the release:
‘Businesses in most household-oriented sub-sectors are yet to report any signs that recent interest rate cuts have helped boost sales. Personal & recreational services was the only sub-sector in this group to expand in June. The activity indices of the retail and hospitality sub-sectors both suggest that activity declined further in June and, in three month moving average terms, are at their lowest levels this year.’
So both the services sector and the manufacturing sector are in recession, and have been for some time. And yesterday we got renewed confirmation that the mining construction boom has peaked, with the Australian Bureau of Statistics (ABS) reporting a 3% fall in the value of engineering construction work over the March quarter.
So what’s the good news? Well, new homes sales increased 1.6% in May after rising 3.2% in April. The growth is coming off a very low base so nothing to get excited about, but this could reflect a reengineering of the state government based first home owners grant.
Most states have, or soon will, only offer a first home owners grant on newly built homes. This should stimulate housing construction far more effectively than the old grant, which was on existing homes too. Moreover, the old grant was effectively a transfer of cash from taxpayers to home vendors and a completely useless stimulus measure.
By far the most intriguing release of the week was the trade data, which showed that Australia recorded a seasonally-adjusted trade surplus for May of $670 million, well above forecasts.
The driver of the surplus was a big increase in the export of iron ore and coal. And it all went to China, with exports to the country up a large $718 million. In fact, Australian exports to China hit a record high in May.
We are now more dependent on the Middle Kingdom than ever, with 35.6% of our exports heading to Chinese ports in May.
But isn’t China slowing down? Aren’t they supposed to be cutting back on steel production and debt-fuelled infrastructure spending?
Yes they are, but it’s not showing up in the data yet. While China’s growth may be slowing, that’s not to say its construction boom is too. Projects that got underway last year or earlier this year will still be completed. Despite the efforts of the central planners, property prices are still rising in China, which throws off the false signal to build still more.
So demand for iron ore remains strong, evidenced by the large export volumes and robust price (it’s still just under US$120 per tonne).
But this is a lagging indicator. The tight liquidity seen in China’s financial markets recently is a better indicator for what is to come. That is, financial markets are starting to allocate capital much more prudently and this will eventually work its way into the real economy.
The finance for an apartment block (no doubt approved by local bureaucrats for a tidy sum) will not be found so readily in the future now that the People’s Bank of China (PBoC) have made it clear they won’t be providing torrents of liquidity at the first sign of trouble.
The landscape has changed in China, and that is not yet reflected in the trade data. But we think it will be.
The stock market is a proven leading indicator and if you look at the performance of Rio Tinto this year, it perhaps provides a clearer sign of where the iron ore market is headed.
As you can see from the chart below, Rio (one of the world’s largest iron ore producers) rallied from $50 to $70 last year on hopes that a new stimulus program in China would keep the iron ore party going. It did that, but only for a few months.
During 2013, the share price has gone back to the $50 mark in anticipation of lower prices and/or weaker demand. At these levels Rio looks cheap if you think China’s demand for iron ore will remain strong.
But if you think that China’s economic rebalancing hasn’t even started yet, then Rio is a value trap.
And if that does turn out to be the case, then recession fears could well become reality towards the end of this year.
That’s because strong trade data boosts economic growth via a positive net export figure. If this positive influence on GDP fades as the year progresses (and we think it will) the economy will slip towards stall speed and unemployment will continue growing at a faster rate.
Which means the dollar, and interest rates, will continue to fall.
Unless of course you think low interest rates will lead to another house price boom and higher consumption via the ‘wealth effect’. That’s what Glenn Stevens’ is hoping for…but it’s all about confidence.
His speech yesterday was an interesting one, in which he talked about confidence being an ingredient of economic growth. For example:
‘Turning to the current conjuncture, it can be observed, in conventional expenditure accounting terms, that some key areas are well placed to expand once they have the confidence to do so…
‘The second thing to say is that much depends on ‘confidence’ – that intangible thing that is hard to measure and very hard to increase. We are talking here about confidence that the future will be characterised by growth, that there will be customers for products, that innovations are worth a try, and so on. That confidence seems pretty subdued right now.’
We would suggest that confidence is a symptom, not a cause, of current events. When people see squabbling children with giant egos running the country, central bankers experimenting with money and getting it wrong, and white collar crime on a grand scale with little to no consequences, no wonder confidence is low.
And the way things are heading, confidence won’t be improving anytime soon.
PS: Happy Independence Day to all our US readers!
for Markets and Money Australia
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