Beyond Bulls & Bears http://global.beyondbullsandbears.com Perspective From Franklin Templeton Investments Fri, 22 May 2015 20:17:03 +0000 en-US hourly 1 http://wordpress.org/?v=3.8.8 Global Economic Perspective: May http://global.beyondbullsandbears.com/2015/05/22/global-economic-perspective-may-2/ http://global.beyondbullsandbears.com/2015/05/22/global-economic-perspective-may-2/#comments Fri, 22 May 2015 20:17:03 +0000 http://global.beyondbullsandbears.com/?p=8588 GEP_Feature_NEWPerspective from the Franklin Templeton Fixed Income Group IN THIS ISSUE Federal Reserve Grapples with Mixed Data Multiple Central Banks Still in Easing Mode Europe Has Bond Market Hiccup Federal Reserve Grapples with Mixed Data Having come through 2015’s first quarter with virtually no growth, the US economy is generally expected to pick up during the rest of this year. Indeed, as we move into a new quarter and shake off the effects of a significant West Coast dock strike and severe winter weather, forward indicators have pointed towards better growth. The Institute for Supply Management’s (ISM’s) purchasing managers’ index for nonmanufacturing rose to 57.8 in April, well above the 50 mark that separates expansion from contraction, suggesting that activity in the US services sector—which accounts for the lion’s share of the American economy—has continued to march higher. At the same time, the ISM reading for the manufacturing sector has weakened somewhat, perhaps reflecting the adverse effects of a strong US dollar, which has also cut into exports and the first-quarter corporate earnings of big American multinationals. Meanwhile, global growth has continued to disappoint, US inflation has remained well below the Federal Reserve’s (Fed’s) medium-term target, and US productivity growth has stagnated, leaving the country’s growth potential in question. These competing forces continue to make the path towards interest-rate normalisation particularly tricky for the Fed. In an April statement, the Federal Open Market Committee (FOMC) said that it believed the first-quarter weakness seen in the United States was “transitory.” But with few signs that growth and inflation are likely to run out of control, the FOMC has, no doubt wisely, signaled that it would wait for further indications that job creation is picking up again and that inflation looks to be getting closer to its 2% target before making its anticipated move toward some gradual tightening of monetary policy. But circumstances may be changing somewhat. The dollar strength that had served as a brake on the US export economy gave way to dollar weakening in late April, while increases in oil prices have been much more rapid than many observers expected. By early May, the cost of Brent crude oil was approaching US$70 per barrel, over 50% higher than its low point in January. Not surprising, therefore, inflation expectations have also been rising. The rise in inflation expectations may also account for the rise in consumer spending. After a slump in retail sales in March, consumer spending showed signs of picking up again in April, according to the Bureau of Economic Analysis. Even more importantly, the April nonfarm payrolls figure showed a significant pickup in job creation, after a very soft March number. With 223,000 jobs created in April and the unemployment rate falling to 5.4%, according to the Bureau of Labor Statistics (BLS), the improvements in the US labor market seem well entrenched and indicate that the United States may soon reach “full employment.” In light of recent trends, we believe the United States should soon hit the Fed’s estimated level of the natural rate of unemployment (long term), which is approximately 5.0%–5.2%. The large-scale gains in US employment over the past two years have not been mirrored by wage increases, as employees’ bargaining power has waned. Those who want to work full time but can only find part-time jobs may also be pulling down wage growth. In the year to end-April, wages rose a modest 2.2%. This is a far cry from the 3.0%–3.5% rate that some Fed officials see as normal for a healthy economy. Nonetheless, with full employment in view, that may soon change, while the BLS’s employment cost index showed that compensation costs for civilian workers rose at an annualized rate of 2.6% in the first quarter, up from 2.2% in the previous two quarters. The index showed that private-sector pay rose at an annualized rate of 2.8% for the March-end period, the quickest upward pace since 2008. All in all, with the global outlook decidedly cloudy, the US outlook for the remainder of 2015 hinges importantly on how consumers respond to improving employment, including any signs that wages are moving higher, as well as savings produced by lower gasoline prices. In our estimation, therefore, any decision on rate normalisation by the Fed in the months ahead will remain “data dependent” under the leadership of a highly pragmatic chair, Janet Yellen, although we also believe that recent job data are bringing that decision closer. Multiple Central Banks Still in Easing Mode As the United States contemplates a tightening of monetary policy in the months ahead, interest rates continue to be cut in other parts of the world—a sign that the global economy is not by any means on a smooth growth path yet. Indeed, the extent of the growth slowdown in certain large economies has surprised some economic forecasters, given the boost to global growth that should have stemmed from lower oil prices, and the aggressively easy policy stance in all the advanced economies. Thailand, Australia and China all relaxed policy rates within days of each other in late April and early May, joining a long line of rate cutters in recent months. Thailand cut rates at the end of April, just six weeks after a previous reduction, reflecting a weaker-than-expected recovery and a steady decline in inflation. Some of the weakness seen in Thailand—and other Southeast Asian countries—stems from the slowdown in the Chinese economy, which has hit trade data in countries such as South Korea and Taiwan. The overall trade between China and the rest of world dropped almost 11% in April from a year earlier, according to the General Administration of Customs, while inflation data for the same month showed Chinese inflation coming in at well below the People’s Bank of China’s (PBOC’s) target of around 3%. The drop in imports was particularly acute. With China reporting annualised growth of 7% in the first quarter—the lowest rate since 2009—such data suggest that there is a lack of any real momentum in...]]> GEP_Feature_NEW

Perspective from the Franklin Templeton Fixed Income Group

GEP_PMs_Fixed_Income_Group

IN THIS ISSUE

  • Federal Reserve Grapples with Mixed Data
  • Multiple Central Banks Still in Easing Mode
  • Europe Has Bond Market Hiccup

Federal Reserve Grapples with Mixed Data

Having come through 2015’s first quarter with virtually no growth, the US economy is generally expected to pick up during the rest of this year. Indeed, as we move into a new quarter and shake off the effects of a significant West Coast dock strike and severe winter weather, forward indicators have pointed towards better growth. The Institute for Supply Management’s (ISM’s) purchasing managers’ index for nonmanufacturing rose to 57.8 in April, well above the 50 mark that separates expansion from contraction, suggesting that activity in the US services sector—which accounts for the lion’s share of the American economy—has continued to march higher.

At the same time, the ISM reading for the manufacturing sector has weakened somewhat, perhaps reflecting the adverse effects of a strong US dollar, which has also cut into exports and the first-quarter corporate earnings of big American multinationals. Meanwhile, global growth has continued to disappoint, US inflation has remained well below the Federal Reserve’s (Fed’s) medium-term target, and US productivity growth has stagnated, leaving the country’s growth potential in question.

These competing forces continue to make the path towards interest-rate normalisation particularly tricky for the Fed. In an April statement, the Federal Open Market Committee (FOMC) said that it believed the first-quarter weakness seen in the United States was “transitory.” But with few signs that growth and inflation are likely to run out of control, the FOMC has, no doubt wisely, signaled that it would wait for further indications that job creation is picking up again and that inflation looks to be getting closer to its 2% target before making its anticipated move toward some gradual tightening of monetary policy.

But circumstances may be changing somewhat. The dollar strength that had served as a brake on the US export economy gave way to dollar weakening in late April, while increases in oil prices have been much more rapid than many observers expected. By early May, the cost of Brent crude oil was approaching US$70 per barrel, over 50% higher than its low point in January. Not surprising, therefore, inflation expectations have also been rising. The rise in inflation expectations may also account for the rise in consumer spending. After a slump in retail sales in March, consumer spending showed signs of picking up again in April, according to the Bureau of Economic Analysis.

Even more importantly, the April nonfarm payrolls figure showed a significant pickup in job creation, after a very soft March number. With 223,000 jobs created in April and the unemployment rate falling to 5.4%, according to the Bureau of Labor Statistics (BLS), the improvements in the US labor market seem well entrenched and indicate that the United States may soon reach “full employment.” In light of recent trends, we believe the United States should soon hit the Fed’s estimated level of the natural rate of unemployment (long term), which is approximately 5.0%–5.2%.

The large-scale gains in US employment over the past two years have not been mirrored by wage increases, as employees’ bargaining power has waned. Those who want to work full time but can only find part-time jobs may also be pulling down wage growth. In the year to end-April, wages rose a modest 2.2%. This is a far cry from the 3.0%–3.5% rate that some Fed officials see as normal for a healthy economy. Nonetheless, with full employment in view, that may soon change, while the BLS’s employment cost index showed that compensation costs for civilian workers rose at an annualized rate of 2.6% in the first quarter, up from 2.2% in the previous two quarters. The index showed that private-sector pay rose at an annualized rate of 2.8% for the March-end period, the quickest upward pace since 2008.

All in all, with the global outlook decidedly cloudy, the US outlook for the remainder of 2015 hinges importantly on how consumers respond to improving employment, including any signs that wages are moving higher, as well as savings produced by lower gasoline prices. In our estimation, therefore, any decision on rate normalisation by the Fed in the months ahead will remain “data dependent” under the leadership of a highly pragmatic chair, Janet Yellen, although we also believe that recent job data are bringing that decision closer.

Multiple Central Banks Still in Easing Mode

As the United States contemplates a tightening of monetary policy in the months ahead, interest rates continue to be cut in other parts of the world—a sign that the global economy is not by any means on a smooth growth path yet. Indeed, the extent of the growth slowdown in certain large economies has surprised some economic forecasters, given the boost to global growth that should have stemmed from lower oil prices, and the aggressively easy policy stance in all the advanced economies.

0515_BBB_INTL_MayGEP_EMs

Thailand, Australia and China all relaxed policy rates within days of each other in late April and early May, joining a long line of rate cutters in recent months. Thailand cut rates at the end of April, just six weeks after a previous reduction, reflecting a weaker-than-expected recovery and a steady decline in inflation. Some of the weakness seen in Thailand—and other Southeast Asian countries—stems from the slowdown in the Chinese economy, which has hit trade data in countries such as South Korea and Taiwan. The overall trade between China and the rest of world dropped almost 11% in April from a year earlier, according to the General Administration of Customs, while inflation data for the same month showed Chinese inflation coming in at well below the People’s Bank of China’s (PBOC’s) target of around 3%. The drop in imports was particularly acute. With China reporting annualised growth of 7% in the first quarter—the lowest rate since 2009—such data suggest that there is a lack of any real momentum in the Chinese economy as we move into the second quarter. In response to the slowdown, on May 11 the PBOC cut both the benchmark one-year lending rate and the one-year benchmark deposit rate by 25 basis points—the third time policy has been eased in six months. The Reserve Bank of Australia has cut interest rates twice this year, with the second cut on May 5 bringing base rates down to 2%, their lowest level ever. Australia, like Thailand, has been feeling the effects of the Chinese slowdown, particularly in the demand for its commodities. Australia’s gross domestic product (GDP) growth came in at 2.5% in the final quarter of 2014, which is below long-term trends.

Overall, in Asia as in Europe, the dominant central banks are still in easing mode as they deal with an uncertain growth picture. The authorities in emerging markets will likely also soon have to deal with the end of cheap US money. Although liquidity from the European Central Bank (ECB) and the Bank of Japan will continue to seep into select markets, countries exposed to the US dollar could see bond yields—and hence debt service costs—rise as the Fed tightens policy. Countries with sizable private and public debt burdens denominated in US dollars can be expected to be the worst hit. Asian and Gulf countries with low debt levels and large currency reserves may be able to offset slower growth with lower taxes or increased spending. But this may not be the case everywhere, particularly in some Latin American countries, in spite of the recent respite they have been given thanks to a rise in commodity prices. And even in China, the PBOC warned in its latest monetary-policy report that the “rising debt size is forcing China to use a lot of resources in repaying and rolling over debt” while limiting the room for further fiscal expansion.

Europe Has Bond Market Hiccup

The European recovery appears to be well under way, with Eurostat announcing that quarter-over-quarter growth in the eurozone reached 0.4% in the first quarter, and the European Commission raising its growth forecast for the currency area this year from a previous estimate of 1.3% to 1.5%. The Commission credits low oil prices, the depreciation of the euro and loose monetary policy—including the ECB’s key refinancing rate of 0.05% and its €600 billion-per-month quantitative easing (QE) programme—for this progressive improvement in the economy.

0515_BBB_INTL_MayGEP_GDPEurozone

Yet, in recent weeks, the first two of these catalysts seemed to be going into reverse, with the euro beginning to rise against the US dollar and the price of Brent crude oil up over 50% from its January low point. There has been significant fallout on the region’s bond markets. European government bond yields, which had fallen to historic lows well before the ECB’s official launch of QE in March, rose again. The yield on German 10-year Bunds, which had fallen to as low as 0.05% in mid-April, were approaching 0.70% three weeks later. Spreads over Bunds for many other eurozone government bonds also rose.1 There is nothing necessarily sinister behind these sudden shifts: In the United States too, large declines in Treasury yields ahead of QE programs gave way to a rise in yields shortly after the Fed’s asset purchases actually started. It was far more unprecedented to see such a high portion of European bonds offer negative yields.

Some might argue more optimistically that the short-term rise in yields seen in late April and early May reflects Europe’s improved prospects, which, with the ECB’s help, have been pushing investors out of the perceived safety of government bonds—some of which have been offering negative yields—and into riskier assets. By contrast, the pessimists might see the short-term spike in European bond yields as heralding a period of heightened instability in markets as the United States heads towards monetary tightening and as negotiations between Greece and its creditors over bailout money reach a climax.

But the simplest explanation for the rise in bond yields would seem to us to be the impact of some investors exiting crowded positions, together with a rise in inflation expectations as oil prices have risen and growth has improved. Meanwhile, disappointing first-quarter data out of the United States have hit the US dollar and caused the euro to rise. But it may be too early to worry about a seismic sea change in the bond market that could eventually threaten Europe’s economic recovery. Already, the improved US jobs data for April served to curb some of the drop in European bond prices, while Europe, with an annualised inflation rate of zero in April (an improvement from -0.1% in March) remains far, far away from the ECB’s inflation target of below, but close to, 2%.

0515_BBB_INTL_MayGEP_Spreads

There remains the Greek problem. European finance ministers and negotiators for Greece continue to argue about the release of the final, much-needed €7.2 billion installment of Greece’s current €130 billion bailout. Both sides have taken a tough line: Greece’s partners say they will consider debt relief only after Athens commits to, and completes, the budgetary adjustments contained in its current bailout program, while the Greek government, led by the radical left Syriza party, has set down a series of “red lines” and is adamant it will not make further pension cuts or pass legislation to facilitate layoffs in the private sector. It could well be that the tough stance being taken by both sides is designed to assure their respective power bases—the Greek electorate in the case of Syriza and home country electorates in the case of European Union finance ministers. It is probably not in the interest of either side (at least in the short term) to see Greece tumble out of the eurozone. But accidents can happen—especially if decision makers in Brussels and Frankfurt begin to believe the rhetoric of an inexperienced government that has proven utterly incapable of fulfilling any of the promises that got it elected last January. Meanwhile, negotiations for another bailout program (the third) meant to aid Greece in honoring a heavy creditor repayment schedule over the coming months have not even begun.

One piece of good news for financial markets—at least in the short term—came with the unexpectedly clear victory of the Conservative Party in the British general election, with UK stocks and sterling both marching higher and Gilt yields falling. The Conservative victory may give hope to government parties that have similarly pushed through fiscal consolidation programs that have cost them support in opinion polls. But the possibility of a clash during the years ahead between a Conservative (and unionist) England and a Scotland dominated by secessionists is likely to be greeted less positively by market participants, as is a referendum on continued British membership in the European Union that the British prime minister, David Cameron, has promised by 2017. The race is on for mainland European leaders to come up with enough sweeteners to allow Cameron to present the case for a prolongation of Britain’s semi-detached relationship with the rest of the European Union.

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The comments, opinions and analyses are the personal views expressed by the investment manager(s) and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The information provided in this material is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding any country, region, market or investment.

Data from third-party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulation permits. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

 

What Are the Risks?

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity.

 

 


1. A credit spread is the difference in yield between two bonds of similar maturity but different credit quality.

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The Commonwealth & Commodities: Australia, Canada and New Zealand http://global.beyondbullsandbears.com/2015/05/19/commonwealth-commodities-australia-new-zealand-canada/ http://global.beyondbullsandbears.com/2015/05/19/commonwealth-commodities-australia-new-zealand-canada/#comments Tue, 19 May 2015 21:46:19 +0000 http://global.beyondbullsandbears.com/?p=8540 Commonwealth_Flags_FeatureIn addition to their common heritage as members of the British Commonwealth, Australia, New Zealand and Canada also share similar economic characteristics—and challenges. All are affected by commodity prices through their economic dependence on iron ore (Australia), dairy (New Zealand) or oil (Canada).  And, while commodity prices have come under pressure recently, all three countries—often thought of together as “commodity currencies” or part of the “dollar bloc”—also have continued to experience growth in other areas of the economy such as the housing market, leaving central banks having to offset weak external drivers, whilst being wary of overheating the economy. Chris Siniakov and Andrew Canobi of Franklin Templeton Investments’ Australian Fixed Income team provide an overview of the countries’ commodity conundrum and how each country’s central bank has reacted to a changing market environment. Chris Siniakov, Managing Director Andrew Canobi, CFA, Director Australian Fixed Income Franklin Templeton Investments Australia, New Zealand and Canada have been among the greatest beneficiaries of the commodity “supercycle,” where high rates of growth across several emerging economies, particularly China, led to a rise in commodity prices starting in the early 2000s. Australia’s terms of trade1 benefitted the most in the early stages of the commodity supercycle, as China’s fixed asset investment boom led to a sharp rise in the prices of key exports such as iron ore and coal. The benefits to New Zealand were smaller in the early stages but have proved longer lasting, as demand for agricultural exports grew in tandem with living standards in the developing markets. The benefits to Canada have largely been a function of oil prices; when oil prices increase, Canada’s terms of trade have usually risen along with them. In addition to lifting each economy’s terms of trade, the commodity supercycle also raised profit margins in certain commodity-oriented sectors and encouraged businesses to invest in order to expand the scale of their operations. Over this period, business investment in Australia and Canada closely mirrored the terms of trade, with a lag of one to two years. Business investment in New Zealand followed a similar pattern, though total investment had also been boosted by a boom in residential construction following the tragic Christchurch earthquake in 2011. Funding the Investment Boom Domestic savings bases have proven too small to fund such large increases in business investment, and this has resulted in deteriorating current account balances2—which effectively means an increase in borrowing from the rest of the world. But contrary to the belief that current account deficits lead to currency depreciation, the Australian, New Zealand and Canadian dollars each strengthened over this period. We attribute much of the relative strength of these currencies to the nature of the foreign liabilities being accumulated. Thus far, Australia, New Zealand and Canada have run what we consider to be relatively high-quality current account deficits, because a large portion of the borrowed funds has been channeled into profitable business investments rather than being used to fund domestic consumption. A relatively high portion of the liabilities that have been accumulated are in the form of direct investment, which tends to be of a longer-term nature than equity or debt portfolio flows. In addition, interest rates have been set at a higher level than those of most other developed markets to account for the ongoing funding requirements created by current account deficits. The Cycle Breaks In much the same way that elevated terms of trade benefitted past growth, however, the recent drop in commodity prices has acted as a strong headwind to future growth. We believe business investment in Australia likely peaked in mid-2013 and the outlook in New Zealand points towards a similar slowdown over the coming year. Thus far, policy responses to slowing growth in each country have been similar—lower interest rates to stimulate household consumption and non-commodity sector investment, and the introduction of risk controls to guard against a further buildup of household debt. Interest rates in Canada are currently lower than in Australia and New Zealand, and in the absence of a sharp correction in the current account balance, we believe the Bank of Canada has very little room for additional interest rate cuts. However, Canada’s proximity to a growing US economy will likely be a tailwind for growth. In contrast, interest rates in New Zealand are high relative to other developed markets, which we think affords the Reserve Bank of New Zealand more room to ease policy to stimulate domestic activity. We also believe the deteriorating New Zealand current account balance and its large stock of net international liabilities will likely lead to a very weak New Zealand dollar in an environment where monetary policy is being eased. In our view, the Reserve Bank of Australia (RBA) will likely continue to focus on the need for a lower exchange rate and, possibly lower cash rate, as the headwinds facing the Australian economy are amplified by the weak contribution of the government sector to growth. While it appears likely that future interest rate cuts will cause the Australian dollar to fall, the quality of Australia’s current account looks better than New Zealand’s, and hence a sharp depreciation of the Australian dollar seems less likely to us. We believe the RBA has further work to do around policy setting, but we believe the RBA will likely pause for the coming months to assess the impact of its policy easing implemented in February and May of this year. The comments, opinions and analyses are the personal views expressed by the investment managers and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The information provided in this material is rendered as at publication date and may change without notice, and it is not intended as a complete analysis of every material fact regarding any country, region, market or...]]> Commonwealth_Flags_Feature

In addition to their common heritage as members of the British Commonwealth, Australia, New Zealand and Canada also share similar economic characteristics—and challenges. All are affected by commodity prices through their economic dependence on iron ore (Australia), dairy (New Zealand) or oil (Canada).  And, while commodity prices have come under pressure recently, all three countries—often thought of together as “commodity currencies” or part of the “dollar bloc”—also have continued to experience growth in other areas of the economy such as the housing market, leaving central banks having to offset weak external drivers, whilst being wary of overheating the economy. Chris Siniakov and Andrew Canobi of Franklin Templeton Investments’ Australian Fixed Income team provide an overview of the countries’ commodity conundrum and how each country’s central bank has reacted to a changing market environment.

Andrew Canobi

Andrew Canobi

Chris Siniakov

Chris Siniakov

Chris Siniakov, Managing Director
Andrew Canobi, CFA, Director
Australian Fixed Income
Franklin Templeton Investments

Australia, New Zealand and Canada have been among the greatest beneficiaries of the commodity “supercycle,” where high rates of growth across several emerging economies, particularly China, led to a rise in commodity prices starting in the early 2000s.

Australia’s terms of trade1 benefitted the most in the early stages of the commodity supercycle, as China’s fixed asset investment boom led to a sharp rise in the prices of key exports such as iron ore and coal. The benefits to New Zealand were smaller in the early stages but have proved longer lasting, as demand for agricultural exports grew in tandem with living standards in the developing markets. The benefits to Canada have largely been a function of oil prices; when oil prices increase, Canada’s terms of trade have usually risen along with them.

In addition to lifting each economy’s terms of trade, the commodity supercycle also raised profit margins in certain commodity-oriented sectors and encouraged businesses to invest in order to expand the scale of their operations. Over this period, business investment in Australia and Canada closely mirrored the terms of trade, with a lag of one to two years. Business investment in New Zealand followed a similar pattern, though total investment had also been boosted by a boom in residential construction following the tragic Christchurch earthquake in 2011.

Terms of trade snip_5

Funding the Investment Boom

Domestic savings bases have proven too small to fund such large increases in business investment, and this has resulted in deteriorating current account balances2—which effectively means an increase in borrowing from the rest of the world. But contrary to the belief that current account deficits lead to currency depreciation, the Australian, New Zealand and Canadian dollars each strengthened over this period.

We attribute much of the relative strength of these currencies to the nature of the foreign liabilities being accumulated. Thus far, Australia, New Zealand and Canada have run what we consider to be relatively high-quality current account deficits, because a large portion of the borrowed funds has been channeled into profitable business investments rather than being used to fund domestic consumption. A relatively high portion of the liabilities that have been accumulated are in the form of direct investment, which tends to be of a longer-term nature than equity or debt portfolio flows. In addition, interest rates have been set at a higher level than those of most other developed markets to account for the ongoing funding requirements created by current account deficits.

The Cycle Breaks

In much the same way that elevated terms of trade benefitted past growth, however, the recent drop in commodity prices has acted as a strong headwind to future growth. We believe business investment in Australia likely peaked in mid-2013 and the outlook in New Zealand points towards a similar slowdown over the coming year. Thus far, policy responses to slowing growth in each country have been similar—lower interest rates to stimulate household consumption and non-commodity sector investment, and the introduction of risk controls to guard against a further buildup of household debt.

Interest rates in Canada are currently lower than in Australia and New Zealand, and in the absence of a sharp correction in the current account balance, we believe the Bank of Canada has very little room for additional interest rate cuts. However, Canada’s proximity to a growing US economy will likely be a tailwind for growth. In contrast, interest rates in New Zealand are high relative to other developed markets, which we think affords the Reserve Bank of New Zealand more room to ease policy to stimulate domestic activity. We also believe the deteriorating New Zealand current account balance and its large stock of net international liabilities will likely lead to a very weak New Zealand dollar in an environment where monetary policy is being eased.

In our view, the Reserve Bank of Australia (RBA) will likely continue to focus on the need for a lower exchange rate and, possibly lower cash rate, as the headwinds facing the Australian economy are amplified by the weak contribution of the government sector to growth. While it appears likely that future interest rate cuts will cause the Australian dollar to fall, the quality of Australia’s current account looks better than New Zealand’s, and hence a sharp depreciation of the Australian dollar seems less likely to us. We believe the RBA has further work to do around policy setting, but we believe the RBA will likely pause for the coming months to assess the impact of its policy easing implemented in February and May of this year.

The comments, opinions and analyses are the personal views expressed by the investment managers and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The information provided in this material is rendered as at publication date and may change without notice, and it is not intended as a complete analysis of every material fact regarding any country, region, market or investment.

Data from third-party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information, and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

Get more perspectives from Franklin Templeton Investments delivered to your inbox. Subscribe to the Beyond Bulls & Bears blog.

For timely investing tidbits, follow us on Twitter @FTI_Global and on LinkedIn.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

What Are the Risks?

All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Changes in interest rates will affect the value of a portfolio and its yield. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in a portfolio adjust to a rise in interest rates, the portfolio’s yield may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments.


1. Terms of trade measures the price of a country’s exports compared with their imports. It is calculated by dividing the price of exports by the price of imports.

2. A country’s current account balance is the sum of the balance of trade (exports minus imports), net income from abroad and net current transfers. A positive account balance means a country is a net lender to the rest of the world, while a negative account balance indicates that a country is a net borrower from the rest of the world. A country’s current account balance is considered an important indicator of its economy’s health.

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Notes From the Trading Desk – Europe http://global.beyondbullsandbears.com/2015/05/18/notes-trading-desk-europe-11/ http://global.beyondbullsandbears.com/2015/05/18/notes-trading-desk-europe-11/#comments Mon, 18 May 2015 15:47:53 +0000 http://global.beyondbullsandbears.com/?p=8493 Notes_from_the_Trading_Desk_LeadingFranklin Templeton’s Notes From The Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice. Monday, May 11, 2015 Europe underperformed global markets last week, as the ongoing Greece saga and the move in European sovereign bonds continued to attract attention. The data-watchers in the United States continue to closely scrutinise performance there, with some weaker points pushing back rate-hike expectations. China was the global outperformer over the week, benefitting from another lowering of rates as the government there does its best to fend off growth stagnation in the country. Equities Driven By Other Asset Classes It really looks to us as though European equities continue to be driven—on a day-to-day basis—by moves in other asset classes. The euro/dollar exchange rate, European Government Bond yields and oil prices have appeared especially influential and almost all recent moves in European equity markets in the last few weeks could be explained by developments and volatility in these asset classes. Let’s take a look at each in a little more detail: Oil Price Rebound: Inflation is back in the headlines in Europe and we’ve observed that inflation expectations appear to have tracked the oil price closely, with a lag of around 10 days. There are valid arguments on both sides of the debate whether the move higher in the oil price is demand- or supply-driven at the moment, but the market seems to be interpreting it as the former and thus indicative of stronger global growth. We are also hearing some analysts talk about a US$65 per barrel oil price as a relative sweet spot for the United States: the consumer gets a boost from a price lower than the historic average, but at the same time oil production for many companies becomes economic once again. So with a return to inflation in the eurozone on the cards at some point in the future, concerns have surfaced once again that the European Central Bank (ECB) might taper its programme of quantitative easing (QE). However ECB President Mario Draghi last week dismissed ‘transitory’ factors as contributing to any forthcoming rate rise or halt in bond buying. At an International Monetary Fund (IMF) lecture, he said the ECB’s non-standard measures have proven effective, and low interest rates haven’t yet led to financial imbalances. Nevertheless there is historical precedent for the ECB to react to volatile oil prices: in April 2011 it announced an interest rate rise, partly in response to high oil prices.  Rise in Bunds: Until mid-April, most of 2015 European government-bond yields had been heading lower, with the German 10-year yield heading to zero and shorter-term German bonds already offering negative rates, so those holding to maturity would effectively be losing money. Since then, we have seen a reversal. We would also suggest that QE programmes have not historically been consistent with bond yields falling. There has in many cases been a decline in bond yields in anticipation of the beginning of sovereign asset purchases (as was the case in the euro area this year), but once purchases actually begin, yields have historically tended to stabilise or rise. Based on historical precedence, we would expect bond yields to now stabilise somewhat, having appeared to have had their “big move” of the year. The Weaker Dollar/Stronger Euro: US economic data has been mixed over the last few months and last week was no different with a series of softer than expected figures. April retail sales and industrial production were among the data to miss estimates, pushing back expectation of a June increase in interest rates. Meanwhile the euro/dollar exchange rate was up on the week helping to raise US inflation expectations.   All Of These Moves Can Be Attributed In Part To….Subsiding Deflation Fears The second half of last year was characterised by falling oil prices and bond yields, slower growth and increased fears of deflation. This has started to change. Inflation outturns are now surprising on the upside: US core inflation is at 1.8% year-on-year and German inflation last week accelerated in April to 0.5% year-on-year. In fact, much of the recent consumer price index data in Europe continues to demonstrate that inflation is picking up.  We would also highlight the largely reassuring GDP data points from eurozone countries last week, which showed first quarter GDP for the eurozone as a whole up 0.4% quarter-on-quarter, in line with expectations. France accelerated to +0.6% Q/Q and Italy to +0.3%, both beating estimates. However Germany did slip a little compared with expectations and was up only 0.3%. Meanwhile, Discussions over Greece Continue to Drag On The Greek saga continues with fresh headlines and rumours over the past week. On Tuesday, Greece made its scheduled €750 million repayment to the International Monetary Fund (IMF), as expected. On Wednesday, the ECB bought Greek Prime Minister Alexis Tsipras some valuable time by extending its emergency liquidity assistance (ELA) programme yet again and not increasing collateral haircuts. This move clearly suggests to us that the central bank is intent on keeping the Greeks afloat. The Brussels Group—the informal name of the protagonists in the Greek negotiations: the European Commission, the European Central Bank the International Monetary Fund, the European Stability Mechanism (the eurozone bailout fund) and the Greek government—is to resume discussions today on Greece’s latest proposals. The aim is to reach an agreement before the European Union (EU) Eastern Partnership Summit on May 20-21. The Greek government is also reported to be aiming for a deal on a technical level this week, which will lead to the release of some funds. With things looking like they are coming to a head, it’s now time to ask the question: what will happen to markets if a deal is made? We...]]> Notes_from_the_Trading_Desk_Leading

Franklin Templeton’s Notes From The Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

Monday, May 11, 2015

Europe underperformed global markets last week, as the ongoing Greece saga and the move in European sovereign bonds continued to attract attention. The data-watchers in the United States continue to closely scrutinise performance there, with some weaker points pushing back rate-hike expectations. China was the global outperformer over the week, benefitting from another lowering of rates as the government there does its best to fend off growth stagnation in the country.

The Digest

Equities Driven By Other Asset Classes

It really looks to us as though European equities continue to be driven—on a day-to-day basis—by moves in other asset classes. The euro/dollar exchange rate, European Government Bond yields and oil prices have appeared especially influential and almost all recent moves in European equity markets in the last few weeks could be explained by developments and volatility in these asset classes.

Let’s take a look at each in a little more detail:

Oil_Barrels_LeadingOil Price Rebound: Inflation is back in the headlines in Europe and we’ve observed that inflation expectations appear to have tracked the oil price closely, with a lag of around 10 days. There are valid arguments on both sides of the debate whether the move higher in the oil price is demand- or supply-driven at the moment, but the market seems to be interpreting it as the former and thus indicative of stronger global growth.

We are also hearing some analysts talk about a US$65 per barrel oil price as a relative sweet spot for the United States: the consumer gets a boost from a price lower than the historic average, but at the same time oil production for many companies becomes economic once again.

So with a return to inflation in the eurozone on the cards at some point in the future, concerns have surfaced once again that the European Central Bank (ECB) might taper its programme of quantitative easing (QE). However ECB President Mario Draghi last week dismissed ‘transitory’ factors as contributing to any forthcoming rate rise or halt in bond buying. At an International Monetary Fund (IMF) lecture, he said the ECB’s non-standard measures have proven effective, and low interest rates haven’t yet led to financial imbalances. Nevertheless there is historical precedent for the ECB to react to volatile oil prices: in April 2011 it announced an interest rate rise, partly in response to high oil prices. 

Europe_Globe_Map_Magnifying_Glass_LeadingRise in Bunds: Until mid-April, most of 2015 European government-bond yields had been heading lower, with the German 10-year yield heading to zero and shorter-term German bonds already offering negative rates, so those holding to maturity would effectively be losing money.

Since then, we have seen a reversal. We would also suggest that QE programmes have not historically been consistent with bond yields falling. There has in many cases been a decline in bond yields in anticipation of the beginning of sovereign asset purchases (as was the case in the euro area this year), but once purchases actually begin, yields have historically tended to stabilise or rise.

Based on historical precedence, we would expect bond yields to now stabilise somewhat, having appeared to have had their “big move” of the year.

Money conceptThe Weaker Dollar/Stronger Euro: US economic data has been mixed over the last few months and last week was no different with a series of softer than expected figures.

April retail sales and industrial production were among the data to miss estimates, pushing back expectation of a June increase in interest rates.

Meanwhile the euro/dollar exchange rate was up on the week helping to raise US inflation expectations.

 

All Of These Moves Can Be Attributed In Part To….Subsiding Deflation Fears

The second half of last year was characterised by falling oil prices and bond yields, slower growth and increased fears of deflation. This has started to change. Inflation outturns are now surprising on the upside: US core inflation is at 1.8% year-on-year and German inflation last week accelerated in April to 0.5% year-on-year. In fact, much of the recent consumer price index data in Europe continues to demonstrate that inflation is picking up.  We would also highlight the largely reassuring GDP data points from eurozone countries last week, which showed first quarter GDP for the eurozone as a whole up 0.4% quarter-on-quarter, in line with expectations. France accelerated to +0.6% Q/Q and Italy to +0.3%, both beating estimates. However Germany did slip a little compared with expectations and was up only 0.3%.

Meanwhile, Discussions over Greece Continue to Drag On

Greece_Flag_LeadingThe Greek saga continues with fresh headlines and rumours over the past week. On Tuesday, Greece made its scheduled €750 million repayment to the International Monetary Fund (IMF), as expected.

On Wednesday, the ECB bought Greek Prime Minister Alexis Tsipras some valuable time by extending its emergency liquidity assistance (ELA) programme yet again and not increasing collateral haircuts. This move clearly suggests to us that the central bank is intent on keeping the Greeks afloat. The Brussels Group—the informal name of the protagonists in the Greek negotiations: the European Commission, the European Central Bank the International Monetary Fund, the European Stability Mechanism (the eurozone bailout fund) and the Greek government—is to resume discussions today on Greece’s latest proposals. The aim is to reach an agreement before the European Union (EU) Eastern Partnership Summit on May 20-21. The Greek government is also reported to be aiming for a deal on a technical level this week, which will lead to the release of some funds.

With things looking like they are coming to a head, it’s now time to ask the question: what will happen to markets if a deal is made? We would certainly expect the Greek market to rally and Greek bond yields to tighten significantly.

As for the rest of Europe, while we would expect a short-term pop in equities and a contraction of yields , we would think that this would be likely to fizzle out. Unlike the situation in Greece three years ago, this current scenario has not seen markets subject to a sell-off, so we would not expect a prolonged squeeze higher across broader European bourses in the event of a deal.

 

Around The World

Around_the_World

 

Last Week

Europe

The sell-off in European Government Bonds (EGB) continued to put pressure on equities in Europe last week, although here was some disparity between individual countries’ performance.

Greece was the worst performer, but the majority of major European countries—Spain, UK, France and Germany—also finished the week down. Italy was the outperformer, finishing the week higher as the country’s rating was affirmed by Standard & Poor’s.

The Bank of England decided, unsurprisingly, to leave interest rates unchanged. Its quarterly inflation report, also published last week, was dovish as it cut its growth forecasts for both 2015 and 2016. The report also showed weaker investment and consumption activity on 2015 and 2016 and the bank’s governor Mark Carney predicted that inflation would remain close to 0% in the near term but would likely pick up in the back half of the year.

Americas

Generally it was a quiet week in the United States, with the overall market trend flat to lower, although an outperformance on Thursday meant all three major US stock markets closed the week up. US domestic economic data did little to solidify a change in current policy normalisation consensus thinking: the data did fit with the notion of a later rate lift-off and there was a steepening of the US yield curve this week with the prospect for a rate hike pushed back.

Asia

In Asia, markets showed continuing confidence as investors welcomed last weekend’s decision by the Peoples Bank of China (PBoC) to cut one-year lending and deposit rates. Slowing retail sales and money supply growth are at record lows, and economists have alluded to expectations that second quarter GDP growth will come in well-below the 7% intended target by Beijing.

In Shanghai, foreign direct investment smashed expectations, rising 10.5% year-on-year in April. However, a fresh wave of initial public offering approvals was widely cited for this number. Australian equities ended their two week losing streak despite macro data aiming lower with consumer confidence falling.

 

Week Ahead

Monetary Policy: The Federal Open Market Committee minutes from their April meeting are released on Wednesday and are considered to be the week’s main monetary policy event. We will also see minutes from the last ECB and BoE policy rate meetings. The Bank of Japan holds another policy meeting this week with the decision announced and Kuroda press conference on Friday. We don’t expect any changes to current policy.

Economic Data: The flash May Purchasing Manager Indexes (PMIs) this week are the main data releases. This month’s eurozone CPI will be important for the bond market to see if inflation is picking up across the region. Relevant for Fed watchers and the bond market, we get US April CPI and April weekly earnings on Friday.

Politics: The negotiations between Greece and its creditors to conclude the second bailout programme will continue to make news headlines with the EU summit on the May 20 and 21. However, we reckon the market assumes/prices that there will be some kind of handshake ensuring that Greece doesn’t default before the end of the month.

 

Views You Can Use

Insight From Our Investment Professionals

Investor Sentiment Around the World

Mark Mobius

Mark Mobius

Franklin Templeton’s 2015 Global Investor Sentiment Survey (GISS) revealed a number of interesting observations about investor beliefs, misconceptions and biases—and a few surprises.

This year’s survey polled investors across 23 countries in developed and emerging markets.

Since the annual survey’s launch in 2011, the world’s investors have by and large been resiliently optimistic, but more so in certain markets than others. Read more

 

M&A in Technology Heats Up

J.P. Scandalios

J.P. Scandalios

The technology-heavy Nasdaq Composite Index finally hit a new record high in April, eclipsing the old record set 15 years ago in 2000. Naturally, when historic peaks are hit, bubble talk starts to circulate.

However, Franklin Equity Group’s J.P. Scandalios says the market and economic environment today are quite different from how it was in the late 1990s, when everyone seemed to be chasing anything “dot com” on pure speculation.

He believes the long-term outlook is positive for the tech sector (and related areas like biotech), and says valuations still appear reasonable. In fact, low valuations have contributed to a wave of merger and acquisition (M&A) activity in the space, which he expects could continue to fuel investor interest. Read more

Meet the Manager: Heather Arnold

Heather Arnold

Heather Arnold

Some experts say investing is more of an art than a science, and Heather Arnold, who earned degrees in both art and economics, would tend to agree.

She says studying art has given her a better understanding of the world and has impelled her to consider all possibilities when making investment decisions.

As director of research, research analyst and portfolio manager at Templeton Global Equity Group, Arnold has had many opportunities to assess, particularly in Europe, which is one of her areas of expertise.

But, as a long-time disciple of the late Sir John Templeton, she doesn’t take a broad-brushed approach to investing. Instead, she considers all the angles of a company before she decides to add it to her collection. Let’s get to know more about Heather Arnold and her approach to investment management. Read more

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This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of May 18, 2015, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton Investments. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security.

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