Expect a mixed bag ahead

We’re in for more months of frustration and inspiration, says Hans Kunnen

Hans Kunnen

JOHN TIEDEMANN

THE WORLD IS NOT A DULL PLACE. As May and June unfold there will be plenty to tease, frustrate and inspire investors. Top of the list will be the federal and state budgets, followed closely by labour market statistics and Reserve Bank board meetings. Then there is the rest of the world. Will the US continue on its path of recovery or will its debts hold it back? How far will the financial fallout from Cyprus spread or was it really a “special case”?

The RBA has been sounding more upbeat of late. The phrase “the global backdrop has improved” is ringing in my ears as Europe deals with the fallout from its handling of the Cypriot banking crisis. It is true that equity markets have improved. It is true that China is expanding at a healthy pace – but it is also true that confidence in Europe is fragile.

While the European Central Bank has a large war chest to deal with banking issues, prising open that war chest proved difficult for Cyprus. Is there another Cyprus waiting in the wings? I hope not, but the crisis did catch markets somewhat by surprise.

The global backdrop has improved, but that doesn’t necessarily mean smooth sailing from here.

Back to the RBA. It is being patient. It wants to wait and see what the full impact of its previous rate cuts is. The signs are that parts of the economy are beginning to stir. The sharemarket is up, house prices have edged higher, superannuation balances are being repaired, household financial conditions are lifting and consumer sentiment has risen. So would the RBA bother cutting the cash rate still further?

The RBA has left the door open for a rate cut if demand in the economy softens. We fear that it might. If investment in the resources sector tails off, it will require a huge boost in other investment to fill the gap. If the gap is not filled, the economy could slow and elicit the need for a slightly lower cash rate. There is some chance for a rate cut around September if retail sales are weak and if the February leap in job growth is completely reversed.

May is budget month. This year the outcome is clouded by elections in September. It may transpire that a fresh budget will come out later in the year, but this will depend on the outcome at the ballot box.

Whoever is in government after September, their focus is likely to be on getting the books to balance. That can be done by asset sales, tax hikes or spending cuts. It can also happen if economic growth picks up. Asset sales were used to move the budget into balance in the previous decade and most of the big-ticket items have already been sold. That leaves tax hikes or spending cuts, neither of which will excite investors. More robust economic growth would help, but this seems unlikely in the next 12 months.

Looking overseas, we need to keep an eye open for when the US will ease back on its money-printing program, otherwise known as “quantitative easing”. It would be good to see signs of recovery in Europe and the reignition of economic growth in Japan.

So what do I expect? The $A to firm a touch over the next few months, equity markets to at least hold on to recent gains, a budget that will try to move towards balance (but which could become redundant in September), state budgets that will continue to squeeze their populations, and a US recovery that takes two steps forward and one step back. Happy investing!

Hans Kunnen is chief economist at St.George Banking Group.

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