2012 will start and probably end with clear problems in the Eurozone economy and its markets. This will remain the major negative offshore risk to Australia. The US has had more than a few encouraging signs of growth coming through in recent times which could suggest a reasonable year in headline terms for the economy. Its structural problems run deep which will act as a handbrake on longer run optimism in the US. China is slowing with authorities there are now responding with the start of a policy easing campaign. China will keep growing it seems. There is a mixed picture throughout the rest of the world, but overall activity will be below trend.
For Australia, 2011 ends with the economy growing below trend, there is the start of a monetary policy easing cycle, a quite severe fiscal tightening is still unfolding and an over-valued Australian dollar persists.
Below is a list, in no particular order, of 12 economic, market and political issues for 2012 that I suspect will attract attention.
1. Despite the RBA cutting official interest rates aggressively in 2012, perhaps to a low of 3.5%, government bond yields will be higher by end 2012 than now. The market is pricing in a 3.0% cash rate, a move that has dragged the 3 year government bond yield down to just above 3%. The 3 year bond yield is forecast to trend higher - towards 4% or more through the course of 2012. I will be getting short the short end of the government bond market at some stage in 2012, at levels around 3.1% to 3.3%, on the view these will hit 4%.
2. Based on the growth outlook below, towards the end of 2012, the market could well be starting to price in interest rate hikes for 2013 – a strong case can be made for paying the September 2012 to June 2013 OIS strip at levels around 3.0%.
3. For the economy, GDP growth will hover below and above 3% until late 2012. The drag from fiscal policy, plus on-going caution from consumers will dampen growth. The mining boom will support growth. The falls in household wealth from falling house prices and a faltering stock market will not help. Late in 2012, under the influence of easier monetary policy, perhaps that elusive upturn in the US and with China setting its sails for growth, Australian GDP growth could well start to have a 3.5% or even 4% tone to it.
4. Inflation will fall sharply through to about the middle of 2012 – the headline CPI is likely to be as low as 1.5%; with underlying inflation likely to ease towards 2%. The pick up in growth in late 2012 will probably be too late to have a material impact on the CPI in the second half of 2012, but (aside from the one-off effect of the carbon price) inflation is likely to edge up towards 2.5% by the end of 2012.
5. The unemployment rate will get to the “high-fives” during 2012 – topping out at 6% or a few ticks lower. The current below trend growth rate is still impacting the jobs market and will do so through most of 2012. The pre-emptive rate cutting action of the RBA will ensure unemployment does not become a major problem.
6. The Australian dollar (AUD) remains a perplexing beast. It is supported by Australia’s across-the-board triple-A credit rating; record trade surpluses; relative economic strength and for the moment high commodity prices. My hunch and it is a low conviction hunch, is that the AUD will be more inclined towards US$0.90 or lower through 2012 as market positioning, flat of falling commodity prices and perhaps some relative economic improvement elsewhere in the world sees outflows from Australia.
7. Australian stocks are likely to move higher – maybe a lot higher. As one who has never really been positive on the Australian stock market (and have benefitted from that view), I reckon we are getting close to a turning point in stocks given the change in growth momentum through the course of 2012. Also aiding the stock outlook is the unfashionable nature of stocks for investors burnt so badly in recent years meaning many will feel the need to get in once the upswing beings.
8. House prices remain a problem for early 2012. There is a clear glut of property on the market which can be cleared either by a pick up in demand – which will be helped by lower interest rates – but also by falling prices. The price falls are unlikely to be huge - perhaps down 10% from peak to trough – but there might be some negative chatter as these numbers unfold. By late 2012, with more favourable economic conditions and relatively low interest rates, prices should start to bottom out.
9. The mining boom will keep chugging along. The investment boom in that sector will continue to unfold at a rapid pace with benefits for related sectors. There is a hint of risk that a fall in commodity prices will lead some to question whether there will be an investment / capacity overhang in mining over the longer run. If this talk gets traction, the AUD could fall sharply.
10. The 2012-13 Budget in May will announce a surplus well above the MYEFO estimate of $1.5 billion as the government sticks to its commitment of having every new policy fully funded by offsets elsewhere and as the parameters turn a little more positive. By the time of the MYEFO in November, the 2012-13 surplus projection (and those in the out-years) could well approach $10 billion per annum as Treasury factors in the economic upswing into its numbers. The challenge for the Government will be to hold onto the cash until the 2013 Budget.
11. Prime Minister Julia Gillard will still be PM and Opposition Leader Tony Abbott will still be Opposition leader through 2012. There will not be an election in 2012 as the focus will move to an October 2013 poll.
12. Banks will adjust retail interest rates relatively frequently and often away from moves in RBA official rates. The RBA will be even more explicit suggesting its official rate moves are directed at retail rates.
I will try to revisit this outlook every 3 months during 2012.
Happy New Year!
NOTE: None of the above is intended as investment advice. The views above are mine only and are published for the purpose of discussion and information only.