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The Most Important Numbers

Over the (Australian) weekend, the representatives of the US Federal Reserve spoke on the outlook for US interest rates. Both chair Yellen and vice chair Fischer made it clear interest rate rises were nearer than market pricing indicated. BUT, any decisions from the Fed Board are dependent on economic data continuing to support the Fed’s view.

There are many reasons why Australian investors care about Fed actions. The US remains the largest external investor in Australia, and the third largest trade partner. The health and performance of the US economy is therefore important to Australian investors.  Many Australian companies have operations in the US. And naturally, US interest rate settings also affect the US share market, which in turn has influence on local share prospects.  

None of the above explains the initial reaction of Australian investors when they sold shares on Monday morning. Instead, two key factors weighed on local shares.

The first is the view that a lift in US interest rates does some of the RBA’s work for them. Higher US rates not only help close the gap with Australian rates, they should strengthen the USD. This means the AUD/USD should sink, easing concerns at RBA headquarters that a higher AUD would choke off the transition to a post mining boom economy. Of course, if the Fed does the work, there’s no need for the RBA to ease. This reality help sparked the sell-off. Tighter US monetary policy most likely leads to tighter Australian monetary policy, and lower share prices.

The other factor driving shares lower was the impact of a stronger USD on commodity prices. The energy sector was hit hardest, but gold stocks weren’t far behind. This may be a knee jerk reaction. Yes, a higher USD usually means a hit to gold, copper and oil prices. However, it also usually results in a lower AUD/USD, delivering a benefit to miners who report in AUD. Major stocks that report in USD should be affected, but many of the minor miners were caught in the downdraft.

However analysts cut it, the first blush reaction to US rate rises is a sell off. This pushed the Australian share market index down and out of the narrow trading band just above 5500. The timing is poor, given the end of the semi-annual company reporting season.

The Fed is clear. The numbers will determine the policy. The key reads are jobs, inflation and growth. This makes Friday’s non-farm payrolls report a major driver of short term direction for markets, with a possible focus on any gains in average hourly earnings, as well as the headline number of jobs created (f/c 164 k). The other important read before the September 22 Fed meeting is CPI inflation data due on September 16 (core f/c +2.2% yoy).

 Reporting Season – Conclusions

The potential for large institutional investors to come off the sidelines this week is high. Fund managers tend to wait for all the company reports to drop, before making any portfolio changes. This could see a big pick up in volumes and volatility this week.

Unfortunately, the news is not all good. Across the corporate landscape, growth remains low (with some notable and expensive exceptions). The constrained environment over the last few years drove much cost cutting, resulting in little further room to move. The combination of these two elements saw an average half year fall in earnings across the top 200 companies of 8-9%.

Although there are a number of impressive individual reports, the average is not supportive of a higher market overall, at least in the short term. While I stick to my call that the index will reach 5,900 by year end, there may be some stormy weather over the next two months as investors around the globe adjust to higher interest rates.

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