Monthly economic commentary: October 2015

Market insights

Aaron Lewis, Research Analyst, Macquarie
Wednesday 11 November 2015

Economic and market highlights


The US Federal Reserve left the federal funds rate unchanged in October but adopted a more hawkish tone in its press release, removing references to global financial and economic risks. The implication being that the chances of a December rate rise have increased. The target band remains 0 to 25 basis points. Macquarie forecasts that the first Federal Reserve interest rate rise for the new tightening cycle will occur in December 2015, which is in line with market consensus.

The Chinese Caixin Flash Purchasing Managers Index (PMI) shows manufacturing activity continues to slow, although the reading was fractionally stronger than anticipated at 48.3, up from 47.2 the previous month. In the eurozone, PMI readings have been relatively robust for most of the year, with October’s registering at 52.3 while after some strong data in the US over the past year, things are looking a little more subdued with the PMI at 50.1 with purchasing managers surveyed citing the strong dollar and energy markets as headwinds.

Source: MWM Research, Caixin, ISM, Markit, November 2015

Deflation in Europe remains a concern with Germany's Harmonised Index of Consumer Prices (HICP) registering a 0.2% fall year-on-year, while import prices fell 3.1%. The Euro area HICP is -0.1% year-on-year with core inflation running at 0.9%.

The latest real GDP figures from China show a 6.9% growth year-on-year, with the announcement after the 5th Plenum reiterating the goal to double China's GDP between 2010 and 2020, implying an average growth rate of 6.5% per year over the next five years.

Canada entered a technical recession in the first half of the year but is expected to return to growth in the third quarter. Australia was sailing close to the wind with a 0.2% quarter-on-quarter growth rate in the June quarter, although we expect a rebound for the third and fourth quarters of 2015 with a pickup in manufacturing output and strong retail trade.

The Reserve Bank of Australia (RBA) Board left rates unchanged at 2% in November, but has shifted to a clear easing bias implying that it is a matter of "when", not "if". Inflation data was weaker than anticipated, which is consistent with low growth in labour costs and spare capacity in the economy.


The downward trajectory of US 10-year note yields over the last few months looks to be reversing with the latest statements from the Federal Reserve conspicuously removing warnings about global financial and economic risks. Fixed income markets are pricing in a greater chance of a December rate hike after what was perceived to be relatively more hawkish statements. Yields in the United Kingdom, also close to a new rate hike cycle, followed suit. In Europe, while 10-year rates moved, there was very little response at the short end, which remain relatively stable near or below zero due to quantitative easing.

Australian 10-year yields were unchanged in October but rallied strongly in early November after markets digested the Federal Reserve's latest monetary policy statement, while Canadian yields were up 11 basis points.


Equities were broadly stronger in October as they began to shrug off the volatility of August and September. In local currency terms, the strongest developed markets were Germany and Japan, up 11.8 and 10.9% respectively. The US gained 8.1% while Australia lagged, adding only 4.2%. Emerging market equities underperformed developed markets with China rallying 9.1% while the MSCI Emerging Market Index recovered 5.3 percent, dragged down by Brazil, India and Russia.

The S&P500 has staged a dramatic recovery, rallying 11.6% from its September lows and now rests just 1.4% away from new highs. The S&P/ASX200 has only rallied 5.6% from its recent low but is 13.2% below the late April high.


The Australian dollar has strengthened 1.6% over the course of October. The Canadian dollar and Swiss franc gained 2.4% while the British pound was up a fraction less at 2.0%. The Quantitative Easing currencies euro and yen lost 1.0 and 0.8% respectively. The Australian dollar has continued to strengthen in the wake of the RBA decision to leave rates unchanged and will likely oscillate with expectations of a US interest rate rise. As expectations of a US rate rise increase, the Australian dollar should weaken, and vice versa. The US dollar index rose 0.6%.

It's not "location, location, location". It's "population, population, population".

Australia's population growth has slowed and is likely to slow further over the coming quarters. Net migration, a major driver of population growth, is at its weakest level since 2010 and well below Department of Immigration and Border Protection projections made last year. While the population growth remains positive, it is insufficient to absorb a surge in housing supply that will be hitting the market in 2016, based on building approvals and housing commencements data which are running well in excess of underlying demand.

Source: MWM Research, FactSet, November 2015

Australia faces a confluence of factors which we believe will have an effect on house prices: diminishing population growth, an increase in housing supply, and macroprudential policy tools designed to remove risk from the real estate market and curb foreign investment. These forces act in concert to deliver a challenging phase of adjustment. There are a number of paths this can take: lower house prices; a decline in dwelling construction; or interest rate cuts.

Over the past several years, demand has exceeded supply and this has applied upward pressure to prices, reducing housing affordability. Reversing this process requires stronger household income growth, lower interest rates or lower house prices. At present, Australia does not have robust household income growth, with real measures of household income and income per capita flagging for a number of years.

Source: MWM Research, Macquarie Securities, November 2015

In previous housing cycles, large negative house price corrections have been avoided and policy has been used to support prices while a long, slow price adjustment takes place. For example, in Sydney, real house prices peaked in the first quarter of 1989 and with the ensuing correction, it took almost a decade for prices to regain the previous high. However, the nominal adjustment was minimal and the 1989 level was surpassed after only two years while in real terms, it was not until the second quarter of 1998 that the Australian Bureau of Statistics measure of Sydney dwelling values finally exceeded the 1989 level.

This cycle, Macquarie forecasts a 7.5% peak to trough decline in house prices over 2016 and 2017, with a recovery beginning in the second half of 2017. Unfortunately, the wealth effect, which is the tendency people have to spend more as their wealth rises, works both ways. The decline in household wealth as a percentage of incomes, due to the expected decline in house prices, represents a downside risk to consumer spending. It is likely that this dynamic will exist until the labour market begins to deliver employment that is sufficient in both speed and composition for real household income growth to resume. Based on Macquarie labour market, wages and dwelling forecasts, we estimate that this will not occur until the latter half of 2017.

Source: MWM Research, Macquarie Securities, November 2015

The broader impacts of slowing population growth will be felt even more strongly in Australia due to the structural headwinds faced by an economy in transition from mining-driven growth to non-mining.


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