Brenton Saunders: What’s driving the ASX this week?

Here are the main factors driving the ASX this week, according to Pendal portfolio manager BRENTON SAUNDERS. Reported by portfolio specialist Chris Adams

• RBA board “not ruling anything out” on interest rates
• Market-implied pricing suggests a rate cut before 2025 looks unlikely
• Find out about Pendal MidCap Fund

THE artificial intelligence revolution marches on, with Nvidia touching a US$3.2 trillion market cap last week – second only to Microsoft – and the broader S&P 500 gaining another 0.63%.

Markets look technically extended on momentum indicators, but corporates continue to trade reasonably well – with economies remaining resilient in the face of high interest rates.

Labour markets have weakened at the margin, but slower than anticipated, and remain in good shape.

Strong interest income and asset price strength has supported the top end of the consumption cohort. 

The fixed interest market continues to contemplate the potential for rate cuts in the US, while many emerging markets and some developed markets have already started easing.

The Swiss National Bank cut interest rates by 25 basis points (bps), while the Bank of England said it was close to cuts, with inflation having reached the target range in May.

The RBA, on the other hand, delivered what was seen by some as a hawkish pivot in its comments around the decision to hold rates steady.

It implied that the potential for one or possibly two rates hikes before year’s end was firmly back on the table, much to the dismay of the Federal Government.

The S&P/ASX 300 gained 0.93% for the week.

Elsewhere, US bond markets were largely unchanged, with ten-year treasury yields rising 5bps to 4.25%.

Brent crude oil rose 3.2%, base metals and gold were down between 0.5% and 1.5%, and iron ore was flat.

Lithium marched lower on weak auto sales and continued share gains from plug-in hybrids – which require less lithium – at the expense of battery electric and internal combustion engine vehicles.

US economy and policy

Data points last week tended to underpin the view of an economy softening at the margin, but holding up reasonably well:

• Industrial production beat expectations, with manufacturing output up 0.9 per cent in May – recouping all the declines of the previous two months.
• The March quarter current account deficit widened by $15.9 billion (7.2%), largely reflecting an expansion in the goods deficit. The deficit represents 3.4 % of nominal GDP, up from 3.2% in the previous quarter.
• Advance retail sales for May came in at 0.1% versus the 0.3% forecast. April was revised 0.2% lower to -0.2%. Sales excluding auto and gas rose 0.1% versus the 0.4% expected. April was also revised down on this measure, from -0.1% to -0.3%. 
• Initial Jobless claims declined 5,000 to 238,000. Continuing claims decreased 10,000 to 1.81 million.
• Housing starts fell 5.5% in May (the lowest level since June 2020) and permits fell by 3.8%, the third consecutive monthly decline. The weather is having some impact, but new home construction is now at a four-year low.
• The NAHB Housing market indicator slipped to 43, with weakness across the sub-indices and against the expectation for some improvement.
• The Composite Purchasing Managers Index (PMI) was 54.6, moderately ahead of the 53.5 forecast. The Manufacturing PMI was 51.7 (51 forecast) and Service PMI was 55.1 (54 forecast).

Several comments from US Federal Reserve policymakers noted recent encouraging trends on inflation.

Find out about

Pendal Midcap Fund

Read more

New York Fed President John Williams noted that the labour market is slowing to more sustainable levels and that he expects rates to come down over the course of the year.

Thomas Barkin and Susan Collins, Presidents of the Richmond and Boston Feds respectively, both noted the encouraging inflation figures and said that, while patience was required, there were scenarios where rates were cut once or twice this year.

Dallas Fed President Lorie Logan also saw recent indicators of colling inflation as “welcome news”, but said that several more months of data is required to confirm the trend.

The net effect was very little change over the week in market-implied expectations around rate cuts.

China

May’s retail sales surprised to the upside, rising 3.7% year-on-year – the first monthly reading to beat expectations after six misses.

That said, sales – in part – reflected strength in spending on electronic and communications devices as several new products were launched in the month.

Despite this, the dynamics in China remain weak.

Infrastructure investment is slowing, the housing sector is yet to bottom, and the consumer is losing some tailwinds.

Industrial production was weaker than expected and slowed to 5.6% year-on-year in May, from 6.7% the previous month.

Electricity output also slowed from 3.1% to 2.3%.

Australia

The most interesting thing domestically last week was the debate around the RBA following the Tuesday meeting where it left rates on hold at 4.35%, as expected.

There are a lot of “known unknowns” facing the RBA, including the lagged effect of previous hikes, the impact of tax cuts and the wealth effect of higher home prices and lower inflation on consumption, the effect of tighter labour markets and slowing demand on prices, as well as an improving outlook for the US and possibly China, and higher commodity prices.

At the end of its minutes, the RBA noted: “Inflation is easing but has been doing so more slowly than previously expected and it remains high. The Board expects that it will be some time yet before inflation is sustainably in the target range.”

The Board is also not ruling anything in or out in terms of interest rates.

Some economists have a hawkish take on the statement and Governor Bullock’s press conference.

This view is that the RBA and Federal Government’s views are diverging, and that the central bank may be positioning for a potential hike depending on inflation data from Q2 2024.

Key points for this argument are that inflation remains persistent and above target and that the pace of decline has slowed, while data suggests continued excess demand and elevated costs in the economy.

Real disposable incomes have also stabilised and may be bolstered by lower inflation and tax cuts.

This view was reinforced by Governor Bullock’s comments that the case for a hike was discussed at Tuesday’s meeting, while the case for a cut was not considered.

Market-implied pricing suggests that an interest rate cuts before 2025 looks highly unlikely.

All of this suggests the Australian economy is six-to-nine months behind the US in terms of its economic and interest rate trajectory.

Elsewhere, job ads on the Indeed platform declined 2.1% in May and are down 8.2% year-on-year. Demand for labour continues to weaken and, with population growth supporting an expanding workforce, the unemployment rate should continue to trend higher.

Despite weaker consumer sentiment, higher-for-longer interest rates and the threat of more rate rises, consumption data remains resilient in nominal terms, which is supportive for corporate Australia.

Price inflation has materially offset volume weakness in most categories and, so far, corporate margins have been maintained by the ability to pass on price.

The question is whether margins come under pressure the longer interest rates remain high.

We are seeing signs of pressure on margins in the consumer electronics space, which was reinforced by feedback during the week and suggests risk are building for retailers in this space.

Aggregate household spending remains strong and rose in April versus March, but is slowing in a number of discretionary categories.

Aggregate household expenditure is buoyed by high wage increases, resilient employment data and population growth.

The resulting inflation remains resilient at levels above RBA targets, with few inflation categories showing much decline.