McNaughton report Economic

May 2018


Key data was mixed, in line with recent trends. The NAB business survey showed business conditions are at their best on record. The labour market data pointed to broad stability in the unemployment rate and wages growth. Employment in April rose 23k m/m (consensus: +20k, previous: -1k), but the y/y slowed to a still strong 2.7%. Hours worked surged 5.4% y/y, the fastest since 2000. The unemployment rate rose to 5.6% (consensus: 5.5%, previous: 5.5%).House prices, finance approvals, credit and retail sales all disappointed, as did Q1-18 capex data. On 8th May, Treasurer Scott Morrison handed down the Federal Budget which saw the government announce a number of tax and spending measures paid for by improvements in economic parameters.

United States

US activity indicators for April were more mixed. The manufacturing ISM retraced to 57.3 (consensus: 58.5, previous: 59.3), while the composite non-manufacturing ISM fell further to a still high 56.8 (consensus: 58.0, previous: 58.8). Non-farm payrolls missed expectations again, rising 164k in April (consensus: +193k, previous: +135k), while the unemployment rate dropped to 3.9% (consensus: 4.0%, previous: 4.1%). Average hourly earnings also missed expectations, holding 2.6% y/y (consensus: 2.7%). Retail sales were in-line with expectations, rising a decent 0.3% m/m (consensus: +0.3%, previous: +0.7%). April core PCE rose a higher than expected 0.2% m/m (consensus: +0.1%, previous: +0.2%), seeing the y/y hold 1.8% (consensus: +1.8%). April housing starts retraced more than expected, down 3.7% m/m (consensus: -0.7%, previous: +3.6%) to a 1,287k annualised rate. Conference Board consumer confidence rose in May to a booming 128.0 (consensus: 128.0, previous: 125.6).


China’s economy remained resilient in May, despite trade uncertainty and a slowdown in infrastructure investment. Earlier in the month, China's Caixin manufacturing PMI rose to 51.1 in April (consensus: 50.9, previous: 51.0), while CPI also missed expectations, rising 1.8% y/y (consensus: +1.9%, previous: +2.1%). The April trade balance was a $28.8bn surplus (consensus: $27.8bn, previous: -$5.1bn). Total social financing rose a more than expected 1,560bn RMB (consensus: 1,350bn RMB, previous: 1,355bn RMB).


Activity indicators in Europe remained at strong levels but suggest growth has likely peaked: the flash Eurozone manufacturing PMI for April moderated to a still booming 55.5 (consensus: 56.1, previous: 56.2), while the composite PMI dropped to 54.1 (consensus: 55.1, previous: 55.1). April CPI also slowed to 1.2% y/y (consensus: 1.2%, previous: 1.3%).

Other news

Italian President Mattarella rejected PM-designate Conte’s proposal for Italy’s new finance minister, raising fears that a new election was looming and potentially boosting the standing of the two main populist parties, the Five Star and the League, even more. An alternative candidate was eventually accepted easing market concerns.

According to Dealogic, there has been a record $US1.7tn in M&A activity YTD 2018 surpassing the previous pre-GFC record.

On 8 May, US President Trump officially decided to scrap the 2015 Iran nuclear pact and institute the ``highest level'' of sanctions on the country. The Treasury Department said sanctions would be implemented after “wind-down periods” of 90 or 180 days. Equities wobbled -- the S&P 500 dipped as much as 0.7% -- but recovered to leave the benchmark index little changed for the day. The announced sanctions against Iran has the potential to sideline 0.5-1.0% of global oil supply.

China offered to import more US goods, but agreements fell short of US President Trump's demand that China reduce its bilateral trade surplus by $200bn. China also announced a cut in tariffs on passenger cars from 25% to 15% from 1 July. On 29 May, the White House announced that the final list of imports subject to a 25% tariff will be announced by 15 June, and "tariffs will be imposed on those imports shortly thereafter". Moreover, the United States will "implement specific investment restrictions and enhanced export controls for Chinese persons and entities related to the acquisition of industrially significant technology".


Bonds and Credit

The first two-thirds of May were relatively quiet, but saw yields push higher. The risk of trade wars appeared to recede early in May and the North Korean situation appeared to be progressing tolerably well. However, another crisis in Italian politics caused a very large risk-off move towards the end of May. The fundamental question was whether a populist, but inexperienced, set of political players should be allowed to form an explicitly high debt and anti-Euro Government.

The fears over political instability caused massive sell-offs in Italian bonds and contagion sell-offs in other peripheral European Sovereigns. Italian 10-year yields rose from 1.79% to a high of 3.44% on 29- May, but closed the month at 2.77%. Italian 2Y yields rose from -0.30% to an intra-day peak of 2.84% on 30 May, but closed at 0.99%.

The higher rated sovereigns, like Germany, US and Australia all rallied sharply in the risk-off move. The German move was particularly sharp. The 10-year Bund began the month at 0.55% and rose slowly to 0.65% only to rally nearly 40bp as the Italian problems came to the fore. Bunds closed May at 0.34%, a rally of 22bp on the month. The risk-off rally took US 10-year yields down to a low of 2.76% finishing the month at 2.86%, which was a 9bp rally.

Meanwhile, the RBA kept the cash rate at 1.50% as was widely expected. Pricing for the first 25bp increase in the cash rate drifted out further during May, from Aug-2019 to Nov-2019. The statement released by the RBA Board post the May meeting largely repeated that of April, concluding with “further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual.”

That stance was supported by the quarterly Statement of Monetary Policy issued a few days later. The forecasts broadly showed GDP marginally above trend, the unemployment rate trending sideways and CPI moving back into the bottom of the range, but no higher. Those numbers reflect RBA assumptions that the cash rate will remain unchanged until next year.Equities The 10-year spread to the US was unchanged over the month sitting at -19bpts.

Credit spreads widened again in May. We started the month with earnings season providing some stability to the fundamental backdrop but by month end geopolitical concerns re-emerged in the form of trade tariffs and Italian politics.


Global sharemarkets ended mixed in May. The key influences were the US-China trade dispute, proposed US-North Korea summit, oil price fluctuations and earnings results in the US and Europe. Political instability in Italy and Spain were influences late in the month together with fears of a global trade war.

After a strong run early in the month, oil prices eased in late May, weighing on shares of energy producers. Saudi Arabia and Russia began talks about boosting supplies of crude on the global market.

Over May the S&P 500 index increased by 2.2% and the Nasdaq lifted 5.3%. Across Europe the German Dax fell by 0.1% but the London FTSE lifted by 2.2%. In Japan, the Nikkei fell by 1.2%. In Australia, the ASX 200 rose by 0.5%.

Overall the MSCI EM index fell 3.8% while the MSCI World closed 0.3% higher.

Commodities and Currencies

The main currency story was the collapse in the euro which fell 3.6% against the USD and 3.9% against the AUD. Crude oil prices spent the first three weeks of the month pushing higher but later in the month, prices corrected on talks of OPEC/Russian supply responses.

Tracey McNaughton

Tracey McNaughton

Executive Director
Head of Investment Strategy