As is normal at this time of the year, economists are pretty much compelled to outline their main themes for the economy and markets in the year ahead.
I am not different so here we go.
1. Economic Growth
The economy is accelerating into the end of 2013 and with very easy monetary policy, a competitive Australian dollar, more favourable conditions in the global economy and fiscal policy moving to neutral, GDP growth is poised to accelerate to around 3.5% by the end of 2014. It might even be stronger than that as the world economy grows at an above trend pace. While every Joe, Glenn and Martin know that mining investment will be a significant drag of GDP, a pick up in household consumption, a housing construction boom and solid export gains will swamp the mining downturn.
2. Labour market
With the economy on a clear upswing, jobs growth is likely to follow to a stronger phase, of course allowing for the usual 6 to 9 months lag. In the near term, the unemployment rate is likely to nudge 6% before it starts to tick lower from around the June quarter. Around 225,000 jobs are likely to be created in 2014 which will see the unemployment rate around 5.25% at the end of the year.
There are some tentative signs that inflation is now less benign than it was a year ago. The surge in asset prices (housing and shares) is underscoring a huge gain in wealth which is spilling over to higher spending and possibly consumer prices. The lower Australian dollar is adding some stimulus to the economy which is also likely to see inflation edge up into the upper half of the RBA’s 2 to 3% target band. Headline inflation to hit 3% by end 2014, but underlying inflation will lift to around 2.75%.
4. Monetary policy
The RBA will be hiking interest rates during 2014, perhaps aggressively. The growth, labour market and inflation dynamics suggest the current 2.5% official cash rate is just too low. The best bet for now is to expect the RBA to snug and tap interest rates up by around 25 basis points each quarter in 2014 with the cash rate ending 2014 at 3.5%.
5. Fiscal policy
By the time the government brings down the MYEFO for 2014-15 in the final months of 2014, there will be a clear trajectory to budget surplus for 2016-17 and beyond, largely because the budget’s automatic stabilisers will be super-charging revenue but also as some of the money shuffling from the government pays back the current out-years from the smoke and mirror budgeting that will see the 2013-14 deficit hit something close to $50 billion. In net terms, the government is unlikely to do much to deliver a structural fiscal policy tightening. Most savings measures announced to date have been fully offset to a ramp up of spending elsewhere. The infrastructure spending program is likely to be captured in the budget figuring which will mean the path to surplus will be not much different to that proposed by the previous government.
6. House prices
Having risen a solid 10% or so in 2013, house price growth is likely to taper somewhat in 2014. A rise of less than 5% for the year is more likely as tighter monetary policy, a rebound in supply and some satisfaction of pent up demand works to take some house price heat out of the market. Indeed, if the RBA hikes a little more than I expect, house prices may be dead flat in the second half of 2014.
7. The Australian dollar
The AUD is ending 2013 about 15% lower than the peak reached during the first half of 2013. There is a very hearty debate being driven by the RBA about fair value for the currency with the RBA judging that the AUD is overvalued. This assessment has some substance although with a lift in the global economy, strong domestic activity and probably wider interest rate differentials all AUD supportive. The recent fall in the AUD has seen a lot of international investors lighten what were very overweight positions. They and others may be tempted to re-enter the AUD market, especially when interest rates rise. All up, it is a scenario where the AUD could easily lift through 95 US cents or regain parity during 2014. Range for the year, 84 US cents to 97 US cents with more time in a 90 to 95 range, especially in the second half of 2014.
The favourable growth and earning story is likely to be offset by monetary policy tightening not only in Australia, but in the US and some other major countries around the world. The ASX200 is likely to record a decent gain and should hit 5,750 points during the year although it is likely to be biased nearer 5,500 over the latter part of 2014. The risk to this forecast is to the high side – that the more positive conditions spark a more solid increase in the ASX200 to above 6,000. In other words, buying stocks now, around 5,150 points is a good trade.
9. Bond yields
The bear market for bonds that unfolded in 2013 is likely to continue into 2014. The 10 year government bond is likely to break above 5% with the rate hikes skewing short end yields higher, meaning a flatter yield curve. The higher inflation rate that is likely to be printed over 2014 will be critical in driving yields higher, as will a reallocation of cash to stocks and away from bonds.
There will be a plethora of political matters that will be important in 2014. There will be, in no particular order, the by election for Kevin Rudd’s old seat of Griffith, the new Senate election for Western Australian and then the State elections in South Australia, Tasmania and Victoria. All will be interesting but largely irrelevant for those looking for clues for implications for Federal politics given the next Federal election will not be held until the end of 2016.
I will, as always, revist these calls during 2014.
Happy new year.