Wealth Managed - 22 September 2016

By David Lane - September 22, 2016

As expected, the US Federal Reserve left rates unchanged at today’s meeting.

The Fed Statement noted that economic activity has picked up from the modest pace seen in first half of the year, and said that “near-term risks to the economic outlook appear roughly balanced”.  As has been the case for some time, the Fed did leave the door open for a future increase in stating that the case for a rate increase has strengthened, though Committee decided, for the time being, to wait for further evidence of continued progress toward its objectives.  In discussing the decision not to move, Janet Yellen highlighted asymmetric risks and said economy has a bit more "running room".  She also noted that asset prices are not out of line with historical norms.

Financial market participants will continue with ‘Fed Watch’ until rates do rise – most likely to be in the December meeting – in spite of the minor impact that any move will have at the current levels of interest rates. Despite all of the apprehension and volatility in markets leading into this meeting, the US markets rallied, with both the S&P500; and NASDAQ indices up over 1%.

Yesterday, the Bank of Japan announced a change in its policy framework, with a shift in focus away from monetary base/quantity target to the yield curve.  The two main components include yield curve control and an inflation-overshooting commitment. The Bank of Japan is now targeting a 10-year yield of around 0% (they were around -0.30% not too long ago), and left the short-term rate target unchanged at -0.10%, despite expectations for a push deeper into negative territory.

What does all this mean for investors?  Global interest rates remain at unprecedented low levels, with short and long term rates in the US, Japan, UK, Germany, Switzerland and other major countries hovering around 0% (or below). Without any inflation, and muted economic growth, it seems that rates will remain near zero for some time.  For investors, this means that conditions remain challenging for generating a return from cash and fixed interest investments, encouraging further moves up the risk spectrum to assets that provide healthier income. Hence, asset prices in “risk assets” will continue to be supported due to the superior yields on offer.

While it is likely that volatility will continue, as traders attempt to benefit from predicting the next Fed rate rise, we should see equity and bond markets stabilise for the foreseeable future. The rally that has occurred overnight in the US could be the beginning of an improvement in markets over the coming months.

News in Review

  • Australia's seasonally adjusted unemployment rate unexpectedly fell to 5.6% in August from 5.7% in July. This beat market consensus of 5.7%. It was the lowest jobless rate since July 2013 as the number of unemployed decreased by 10,500. The participation rate fell from 64.9% in July to 64.7%.
  • Australian consumer confidence rose fractionally in September, according to the latest Westpac-MI consumer sentiment survey. The survey’s headline index rose by 0.3% to 101.4, indicating that optimists outnumber pessimists, albeit by a small margin.
  • Broad measures of Chinese economic activity improved in August, with industrial production, a broad gauge of factory activity, rising 6.3% from a year earlier. Industrial production slowed to 6% annually the month before. Retail sales, a measure of private and government spending, climbed 10.6% year-on-year, following a 10.2% increase the previous month.
  • According to the banking industry’s global watchdog, the Bank of International Settlements (BIS), the risks for a Chinese banking crisis are mounting with China’s credit-to-GDP (borrowing in relation to the size of the economy) gap more than three times above the danger level. 
  • The UK Consumer Prices Index (CPI) rose by 0.6% in the year to August 2016, unchanged from July. The rate is still relatively low in the historic context although it is above the rates experienced in 2015 and early 2016. The main upward contributors to change in the rate were rising food prices and air fares, and a smaller fall in the price of motor fuels than a year ago. These upward pressures were offset by falls in hotel accommodation prices, in addition to smaller rises in the prices of alcohol, and clothing and footwear than a year ago.
  • UK unemployment rate fell to 4.9% in July, down from 5.5% a year earlier. The last time it was lower was in 2005. The participation rate (the proportion of people aged from 16 to 64 who were in work) was 74.5%, the joint highest since comparable records began in 1971.
  • The Bank of England left the main interest rate on hold at 0.25% but did say that another cut is still possible.
  • Oil discoveries have slumped to the lowest level since 1952 and the global economy is becoming dangerously reliant on crude supply from political hotspots, the International Energy Agency has warned. Annual investment in oil and gas projects has fallen from US$780bn to US$450bn over the last two years in an unprecedented collapse, and there is no sign yet of a recovery next year.

Company News

  • Fortescue Metals (FMG) says it will repay $US700m ($925m) of its debt, generating annual interest savings of about $US26m. CFO Stephen Pearce said the $US700m repayment added to the $US2.9bn the company repaid in fiscal 2016 and further reduced the company's cost base. FMG shares closed 0.9% up at $4.74.
  • Myer Holdings Ltd (MYR) has reported earnings in line with company guidance and analyst expectations with net profits after tax of $69.3m, meeting the $66m to $72m guidance put forward by the company.
  • Vale SA, the world’s top iron-ore miner, is more optimistic on prices for the steel-making material than BHP Billiton Ltd. even after its rival anticipated this month’s market tumble.  Iron ore, down almost 5% in September and 20% since peaking in April, will trade at $50 to $60 a dry ton next year, said Peter Poppinga, Vale’s head of ferrous minerals.
  • JB Hi-Fi (JBH) announced it has snapped up fridges and washing machines giant The Good Guys for $870m to eclipse Harvey Norman's share of the consumer electronics and home appliances markets. The acquisition will drive JB Hi-Fi's 19% share of the consumer electronics market up to 24%, beating Harvey Norman's 15% share.  JB Hi-Fi has announced a rights issue that will raise equity to assist the purchase.  Shareholders will receive 1 new JB Hi-Fi share at $26.20 for every 6.6 shares they currently hold.

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