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Licensee Economic Update – May 2014

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In summary

Latest data show renewed improvement in the US economy, including stronger than expected employment growth and higher levels of manufacturing activity. The United States Federal Reserve has reduced its asset purchases to $45 billion a month as it moves to end the stimulus programme known as Quantitative Easing [QE], but has indicated that interest rate increases before late 2015 seem unlikely.

In Europe, the ECB has reduced its forecasts of growth and inflation and has been discussing potential moves to relax monetary policy further in order to fend off deflation.  Pleasingly Spain seems to be slowly recovering from its devastation during the GFC and this is encouraging for its youth unemployment level.

China’s first-quarter GDP growth came in at 7.4%. Although recent data on industrial production and retail sales were robust, there have been reports of declining house prices in China.

Ukraine remains a major problem on Europe’s doorstep and a source of geopolitical tension for global financial markets. The situation there remains highly unstable with the risk of civil war escalating rather than diminishing. Russia continues to interfere as it seeks to promote a regime within Ukraine which is not pro-Western. Meanwhile, the US and Europe threaten escalated sanctions against Russian interests.

Australia is waiting for a harsh budget in May after the report of the National Commission of Audit offered a wide range of measures to reign in the nation’s deteriorating fiscal situation. At its meeting on 6 May, the Board of the Reserve Bank decided to leave the cash rate unchanged at 2.5%. This is the 8th time.

Figure 1: April saw REIT’s outperform while other equity markets were generally flat

Selected Market Returns April 2014


Recent better than expected economic data in Australia – including a surprise decline in the unemployment rate – surprisingly has not given much comfort to households. Expectations of unemployment are up and overall confidence is down according to statistics. In some respects politics could be partly to blame for this – the messages from Canberra are firmly skewed to the negative with repeated warnings of a horror budget and little in the way of positive reform announcements. This is understandably leaving households worried about job security. The RBA will continue to monitor this closely as a factor weighing against lifting interest rates too soon but given the fiscal situation has seen interest rates remain stable for 8 consecutive Reserve Bank meetings, a rise seems inevitable in the next 6-8 months to slow down property growth which remains incredibly buoyant – if not a bubble in the minds of some.

The forthcoming Budget and the report of the National Commission of Audit has been attracting much attention. At this stage it is still highly speculative to say what might or might not be in the budget, but it seems unavoidable that there will be a wide-ranging set of measures put in place to spread the net of fiscal adjustment. Exactly how contractionary this will be for the economy is yet to be seen, but the greater its impact and all other things being equal, the longer the Reserve Bank is likely to hold interest rates at current levels. At its meeting on 6 May the Board of the Reserve Bank decided to leave the cash rate unchanged at 2.5%. The Board noted that the $A “remains high by historical standards”. With the trading pattern still around the 0.93c level, a significant reduction over the year is still the majority verdict.

Headline inflation rose 0.6% in the first quarter of 2014 and was 2.9% over the year, compared with 2.7% in the year to the previous quarter. The underlying inflation rate was steady around 2.6%. Importantly, inflation is not yet a source of concern for the Reserve Bank and interest rates.

Figure 3: inflation remains in the top of the Reserve Bank’s range

Australia Measures of Inflation

Deloitte’s released the results of their CFO survey for March a couple of weeks ago. It was very interesting as a barometer and showed a generally positive outlook across a number of fronts. For example, business sentiment and risk appetite were seen to be higher, supported by the stronger share market, the lower dollar and interest rates and the change of Federal government. The majority of CFO’s expect the $A to depreciate further to between US$0.90 and US$0.85 by year-end. It also went on to show that the recent trend in business optimism is continuing, with concerns around economic uncertainty at their lowest level in almost three years. All of the key measures surveyed supported the improving positive outlook, with 43% of CFOs indicating that they are more optimistic than three months ago. With greater confidence, 55% of CFO’s believe now is a good time to take on more risk – the most positive result in the survey’s history.   Global factors continue to have a large impact on the optimism of Australian CFOs – with positive views on the US and European economics continuing to contribute to the increased optimism.

United States

After weeks of disappointing economic data there are signs the US economy is picking up steam once again. Some of the most important statistics showing better than expected results in April were:

  • payroll employment rose by 288,000 in April, comfortably exceeding the consensus expectation of 218,000 employment gains were well-distributed across a number of industries;
  • the unemployment rate fell to 6.3% in April, well below the market forecast of 6.6%, although the decline in the unemployment rate is still being heavily influenced by a falling labour market participation rate (down under 0.4% in April).

Figure 2: Payroll employment was much stronger than expected in April

USA Payroll Employment

Other statistics on the US economy released over the past month include:

  • first-quarter GDP growth came in at a seasonally adjusted annual rate of 0.1% which was much weaker than expected due to the impact of poor weather;
  • consumer sentiment rose;
  • retail sales rose 1.1% in March and the best result in 18 months;
  • the CPI rose 0.2% in March and 1.5% over a year earlier;
  • various housing market statistics posted softer than expected readings than in March;

The Federal Reserve said that it sees the economy picking up after a weak first quarter and noted the improvement in both the job market and household spending. This gives the Fed further room to scale back its QE programme, which has been cut by another $10 billion a month to $45 billion. This puts the Fed well on track to end QE in 2014 as planned. The Fed also reported that there had been a special secret meeting of the Federal Open Market Committee in early March at which it was decided to abandon a target level for the unemployment rate as a trigger for raising interest rates. Markets reacted well to this more flexible approach, especially given the speed with which the unemployment rate has been declining. The previously stated threshold for the unemployment rate was 6.5% which has just been surpassed with the data from April. Although the economy is improving conditions are not yet robust enough to justify interest rate increases any time soon. Instead, Fed officials are signalling that the first interest rate increase won’t happen until late 2015 at the earliest.


Data from Europe shows that inflation remains generally weak. Consumer prices rose 0.7% in the year to April compared with 0.5% in the year to March. In some countries the rate of inflation is even lower than this. This is one reason why the ECB has said it is ready to provide further stimulus to the Eurozone. The cash rate in Europe currently stands at 0.25% and reducing this to 0% would probably have little impact. However, the ECB has floated the idea of a negative interest rate on bank deposits held at ECB in order to encourage banks to lend further, as well as the possibility of asset purchases by the ECB. However, the ECB cannot do as much with QE as other central banks have. The ECB really needs to get the Euro down, but as we have seen with the $A this is not always easy to do. Greece took a bond auction to the market for the first time in four years. The €3 billion issue of five-year bonds at 4.95% attracted bids of nearly €20 billion.

The UK economy continues to improve and recorded a 0.8% increase in GDP growth in the first quarter. Although slightly less than expected, this was the fifth straight quarter of growth in the UK. However, inflation remains weak around 1.6%.

Ukraine remains a major problem on Europe’s doorstep and a source of geopolitical tension for global financial markets. The situation there remains highly unstable with the risk of civil war escalating rather than diminishing. Russia continues to interfere as it seeks to promote a regime within the Ukraine which is not pro-Western. Meanwhile, the US and Europe threaten escalated sanctions against Russian interests.


In China real GDP growth came in at 7.4% in the first quarter which was generally above expectations. Industrial production and retail sales were both quite strong in March, however there have been reports of some softening of real estate prices. Growth of the money supply has been weak in recent months. Figure 4 on the next page compares the rate of growth of M1 with banks’ reserve requirements (inverted on the right scale).

This shows that the current soft pace of money supply growth is consistent with where the authorities have set reserve requirements and can be expected to continue for some months yet. The central bank has indicated that it will cut the reserve requirements of rural banks to provide some assistance to that part of the economy.

Figure 4: Soft Chinese money supply growth reflects relatively tight reserve requirements

China - Money Supply & Reserve Requirements

NEW CONTENT :  Forecast summary – markets

Although snapshot does not attempt to forecast or create predicative outcomes, this month we thought it may interest readers to see the outlook of asset classes through the eyes of a boutique professional asset consulting firm that assists fund managers and wholesale investors establish investment portfolios. The firm, Caravel Consulting, uses dynamic asset allocation for the broad determinant of performance outcome. In other words they believe that investing a portfolio with the right weighting into the right asset class at the right time determines returns more than stock selection.  Diversification remains a fundamental key.

Caravel believe  the broad flavour of their latest set of expected returns is much in line with views they have held for some time now – which is that equities still look set to beat bonds as long as their views about global growth – and the US in particular – come to pass [i.e. reasonable growth outlook with the USA leading].

Forecast summary – markets

A footnote from Caravel: Note that large expected returns for unhedged international equities mainly reflect currency movements – expected local currency returns are relatively modest. This reflects the important point that global equity markets have priced much of the growth likely to be seen in this cycle. Further good economic news is needed from here not only to see markets realise the rest of the gains to be made, but also just to hold onto the gains that have already been made.

Our kindest thanks to Caravel for the above …… However, we also observe Snapshot readers would do well to remember that dynamic asset allocation means just that:  Adjusting views in a dynamic manner to capture changing outlooks.  Whilst the trend above may be accurate, the actual weightings will no doubt change in line with new observations and it is important to match individual risk profiles – volatility isn’t shown in the above and it can get rocky…….. This means sleeping well at night is an important aspect of risk management. The above chart is based on economic likelihood using statistics, cycles and a professional economic opinion- as such it is of a general nature only and subject to the usual  uncertainties associated with forecasting.

This has been prepared by Paragem Pty Ltd [AFSL 297276] and is intended to be a general overview of the subject matter.  The above is not intended to be comprehensive and should not be relied upon as such. We have not taken into account the individual objectives or circumstances of any person.  Legal, financial and other professional advice should be sought prior to applying the information contained above. Advice is required before any content can be applied at personal level. No responsibility is accepted by Paragem or its officers

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