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News In Charts: Has the Lucky Country’s luck run out? | Alpha Now | Thomson Reuters
NEWS IN CHARTS: HAS THE LUCKY COUNTRY’S LUCK RUN OUT?
October 10th, 2014 by Fathom Consulting
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http://cdn1.alphanow.thomsonreuters.com/wp-content/uploads/2014/10/Alpha-Now-117.jpg
A booming natural resources industry has underpinned Australia’s relatively healthy macro-economic fundamentals over the past decade. Nicknamed ‘the Lucky Country’ after a book of the same name published in 1964, as the commodity super-cycle turns Australia’s good fortune may be at an end.
China’s slowdown is a game-changer for commodities, and for base metals in particular. The price of iron ore – which makes up around a quarter of Australia’s total exports – has halved since the end of 2012, and is now hovering at around $80 per metric tonne. Even if China’s policy makers manage to engineer a soft-landing, we expect growth in what, according to IMF estimates, is now the world’s largest economy to be weaker next year than this. And this has important implications for Australia, which has become increasingly reliant on Chinese demand, with exports to China rising from 1% to 6% of GDP over the past ten years.
Refresh Chart Edit Chart
Skyrocketing base metal prices in the past decade led to substantial overinvestment in the Australian mining industry, with iron ore production up more than 40% over the past four years. At the same time, the large producers seem prepared to engage in a price-war aimed at forcing their smaller, higher cost competitors into distress. BHP Billiton recently said that it plans to ramp up iron ore output, despite acknowledging that supply growth would exceed demand ‘in the short to medium term’, and Rio Tinto confirmed that it would go ahead with a planned expansion of mining production. So not only has global demand for Australia’s key natural resource fallen, that country’s ability to extract it has, with characteristic bad timing, risen too, putting further downward pressure on prices.
Refresh Chart Edit Chart
Refresh Chart Edit Chart
Further reductions in the price of Australia’s major export will, of course, put additional downward pressure on that country’s terms-of-trade, which had more than doubled since the turn of the century, and on the AUD. In addition, a rising dollar environment implies a further squeeze on commodity prices; and if the recent dollar uptrend evolves into a lasting bull market, akin to those witnessed in the early 1980s and late 1990s, then there could be a lot more downside. Taken together, these forces suggest residents of the Lucky Country are likely to feel distinctly less well off.
This backdrop suggests serious headwinds for Australia’s public finances. This week, Treasurer Hockey said that “there has been a hit to the budget” from lower iron ore and coal prices, frustrating the authorities’ effort to move public finances back into the black. As result, the government is likely to revisit its forecast of a A$30 billion deficit for the current fiscal year, following the shortfall of A$50 billion recorded in the twelve months to June. What is more worrying, in our view, is Mr Hockey’s conviction that the Chinese government will not “permit … a significant economic deterioration from what is near 7.5% growth”. This year, he may have a point. But next year is much harder to judge. We see around a one in three chance that China is already in a hard-landing scenario. If this risk materialises, growth next year is likely to be in the low single digits at best.
Refresh Chart Edit Chart
With the tailwind from the resource investment boom fading, and with limited scope for further fiscal loosening, the burden of cushioning the impact from China’s economic rebalancing has fallen on the central bank. The RBA has shifted to a progressively more accommodative stance. Governor Stevens has reduced the policy rate by 225 basis points to 2.5% since the end of 2011 – the real policy rate has been in negative territory for the last year or so – and has openly been talking the currency down.
Refresh Chart Edit Chart
The RBA expects below-trend GDP growth for a few quarters yet, and believes that “it will be some time before unemployment declines consistently”. There are indeed good reasons to be cautious. The decline in mining employment has gathered pace recently. Business investment remains subdued and it seems unlikely that other sectors will pick up the slack anytime soon. Despite current low rates of nominal wage growth, with what for now remains a strong currency Australian labour costs are among the highest in the world. In turn, sluggish economic conditions have dented consumer sentiment, as evidenced by weakness in the Westpac consumer confidence index and disappointing auto sales growth.
Australia’s easy money policy has not been without consequences. Home prices in major cities rose by 4.3% in the three months to August, the fastest pace in five years. Worryingly, this boom has a strong speculative element. Low interest rates and strong competition between domestic lenders have led to a marked increase in lending to property investors – not least from China – who now account for some 40% of total home loans. The RBA has repeatedly highlighted the risks to household finances and the banking sector from future price declines.
If China is to make the transition to an economic model that is less reliant on investment, then this inevitably will have profound implications for the composition of Australia’s economy. Net exports remain the main engine of expansion, having contributed around two-thirds to total economy growth over the past four quarters. However, as what Governor Stevens has called a “once in a century” rise in terms of trade reverses, Australian policymakers need to grapple with the structural weaknesses that lie beneath the surface.
Refresh Chart Edit Chart
The combination of Australia’s AAA rating with yields that are still relatively attractive among developed economies – the ten-year sovereign yield stands at 3.30% – means fixed income assets should stay well-supported. Foreign ownership of Australian government bonds remains high. And it may rise still further if the ECB and the Bank of Japan ramp up their asset purchase programmes. Equities have been on the back foot since September, down by more than 10% in dollar terms, and it remains to be seen whether a weak materials sector – which accounts for around one sixth of total market capitalisation – pulls the S&P/ASX 200 still lower. Our strongest conviction relates to the currency, which we expect to weaken substantially in the medium term, as demand for Australia’s major export declines still further. In the short-term, we see a weaker Australian dollar as the principal release valve during the economy’s transition away from a resources-driven growth model.
The long process of adjustment in Australia will be far from smooth, and investors would do well to recognise that the economy has to date felt nothing more than the initial tremors – China’s inevitable rebalancing has barely begun.
This research note is provided by Fathom Consulting. All of the charts below and many many more, covering a range of topics and countries on both the macroeconomy and financial markets are available in the Chartbook to Datastream users at www.datastream.com. Alternatively you can access Fathom’s Chartbook at www.fathom-consulting.com/TR.
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News In Charts: Has the Lucky Country’s luck run out? | Alpha Now | Thomson Reuters
NEWS IN CHARTS: HAS THE LUCKY COUNTRY’S LUCK RUN OUT?
October 10th, 2014 by Fathom Consulting
No Comments
http://cdn1.alphanow.thomsonreuters.com/wp-content/uploads/2014/10/Alpha-Now-117.jpg
A booming natural resources industry has underpinned Australia’s relatively healthy macro-economic fundamentals over the past decade. Nicknamed ‘the Lucky Country’ after a book of the same name published in 1964, as the commodity super-cycle turns Australia’s good fortune may be at an end.
China’s slowdown is a game-changer for commodities, and for base metals in particular. The price of iron ore – which makes up around a quarter of Australia’s total exports – has halved since the end of 2012, and is now hovering at around $80 per metric tonne. Even if China’s policy makers manage to engineer a soft-landing, we expect growth in what, according to IMF estimates, is now the world’s largest economy to be weaker next year than this. And this has important implications for Australia, which has become increasingly reliant on Chinese demand, with exports to China rising from 1% to 6% of GDP over the past ten years.
Refresh Chart Edit Chart
Skyrocketing base metal prices in the past decade led to substantial overinvestment in the Australian mining industry, with iron ore production up more than 40% over the past four years. At the same time, the large producers seem prepared to engage in a price-war aimed at forcing their smaller, higher cost competitors into distress. BHP Billiton recently said that it plans to ramp up iron ore output, despite acknowledging that supply growth would exceed demand ‘in the short to medium term’, and Rio Tinto confirmed that it would go ahead with a planned expansion of mining production. So not only has global demand for Australia’s key natural resource fallen, that country’s ability to extract it has, with characteristic bad timing, risen too, putting further downward pressure on prices.
Refresh Chart Edit Chart
Refresh Chart Edit Chart
Further reductions in the price of Australia’s major export will, of course, put additional downward pressure on that country’s terms-of-trade, which had more than doubled since the turn of the century, and on the AUD. In addition, a rising dollar environment implies a further squeeze on commodity prices; and if the recent dollar uptrend evolves into a lasting bull market, akin to those witnessed in the early 1980s and late 1990s, then there could be a lot more downside. Taken together, these forces suggest residents of the Lucky Country are likely to feel distinctly less well off.
This backdrop suggests serious headwinds for Australia’s public finances. This week, Treasurer Hockey said that “there has been a hit to the budget” from lower iron ore and coal prices, frustrating the authorities’ effort to move public finances back into the black. As result, the government is likely to revisit its forecast of a A$30 billion deficit for the current fiscal year, following the shortfall of A$50 billion recorded in the twelve months to June. What is more worrying, in our view, is Mr Hockey’s conviction that the Chinese government will not “permit … a significant economic deterioration from what is near 7.5% growth”. This year, he may have a point. But next year is much harder to judge. We see around a one in three chance that China is already in a hard-landing scenario. If this risk materialises, growth next year is likely to be in the low single digits at best.
Refresh Chart Edit Chart
With the tailwind from the resource investment boom fading, and with limited scope for further fiscal loosening, the burden of cushioning the impact from China’s economic rebalancing has fallen on the central bank. The RBA has shifted to a progressively more accommodative stance. Governor Stevens has reduced the policy rate by 225 basis points to 2.5% since the end of 2011 – the real policy rate has been in negative territory for the last year or so – and has openly been talking the currency down.
Refresh Chart Edit Chart
The RBA expects below-trend GDP growth for a few quarters yet, and believes that “it will be some time before unemployment declines consistently”. There are indeed good reasons to be cautious. The decline in mining employment has gathered pace recently. Business investment remains subdued and it seems unlikely that other sectors will pick up the slack anytime soon. Despite current low rates of nominal wage growth, with what for now remains a strong currency Australian labour costs are among the highest in the world. In turn, sluggish economic conditions have dented consumer sentiment, as evidenced by weakness in the Westpac consumer confidence index and disappointing auto sales growth.
Australia’s easy money policy has not been without consequences. Home prices in major cities rose by 4.3% in the three months to August, the fastest pace in five years. Worryingly, this boom has a strong speculative element. Low interest rates and strong competition between domestic lenders have led to a marked increase in lending to property investors – not least from China – who now account for some 40% of total home loans. The RBA has repeatedly highlighted the risks to household finances and the banking sector from future price declines.
If China is to make the transition to an economic model that is less reliant on investment, then this inevitably will have profound implications for the composition of Australia’s economy. Net exports remain the main engine of expansion, having contributed around two-thirds to total economy growth over the past four quarters. However, as what Governor Stevens has called a “once in a century” rise in terms of trade reverses, Australian policymakers need to grapple with the structural weaknesses that lie beneath the surface.
Refresh Chart Edit Chart
The combination of Australia’s AAA rating with yields that are still relatively attractive among developed economies – the ten-year sovereign yield stands at 3.30% – means fixed income assets should stay well-supported. Foreign ownership of Australian government bonds remains high. And it may rise still further if the ECB and the Bank of Japan ramp up their asset purchase programmes. Equities have been on the back foot since September, down by more than 10% in dollar terms, and it remains to be seen whether a weak materials sector – which accounts for around one sixth of total market capitalisation – pulls the S&P/ASX 200 still lower. Our strongest conviction relates to the currency, which we expect to weaken substantially in the medium term, as demand for Australia’s major export declines still further. In the short-term, we see a weaker Australian dollar as the principal release valve during the economy’s transition away from a resources-driven growth model.
The long process of adjustment in Australia will be far from smooth, and investors would do well to recognise that the economy has to date felt nothing more than the initial tremors – China’s inevitable rebalancing has barely begun.
This research note is provided by Fathom Consulting. All of the charts below and many many more, covering a range of topics and countries on both the macroeconomy and financial markets are available in the Chartbook to Datastream users at www.datastream.com. Alternatively you can access Fathom’s Chartbook at www.fathom-consulting.com/TR.
