The election economy

Neither the ‘election budget’ nor the Reserve Bank of Australia (RBA) dropping cash rates to their all-time low recently offers huge scope to be optimistic about the Australian economy. And with the election taking centre stage over the coming weeks, it is important to recognise that before any of the ideas in the budget become concrete, we will have to wait and see how the result plays out.

In fact, the election has prompted both the ratings agencies and the market to react in very muted fashion to the Treasurer’s announcements. Standard & Poor’s (S&P) made the following comment worth noting: "... improving budget balances remain important to the rating [Australia’s AAA credit rating] to offset Australia’s high vulnerability to shifts in offshore financial market sentiment.” Australia is a small economy with little ability to withstand global market shocks in our opinion.

Who is really driving our economy?

Regardless of whether the proposed changes in the budget come to fruition, it is interesting to review the forecasts Treasury used to model its impact. The view of our Investment Committee is that their forecast global economic growth numbers are optimistic (3.25 per cent in 2016 rising to 3.75 per cent in 2018), and consequently the projected iron ore price (one of the key numbers in calculating revenues for Australia) is high at US$55 a tonne. This poses risks to the forecasts the budget is built on.

The impending election plus bitter leadership politics mean that yet another budget misses opportunities for structural reform and fiscal policy, which leaves the RBA as the key player to try to keep our economy moving. At the beginning of May, they duly dropped the cash rate in response to weakening tailwinds supporting the economy – interest rates are not at all-time lows because the economy is booming. A bright spot seems to be a weakening Australian dollar following months of steady climb, particularly against the US dollar. The magnitude of the fall in the Australian dollar indicates the interest rate cut took the market by surprise, and the lower dollar should help smooth the transition away from mining-led growth.

What do the cash rate cut and election mean for investors?

In summary, it has become even harder for investors to hold cash given the likely levels of deposit rates, but this must not deter us from doing so. Overall we are still cautious about commodity prices and the Australian economy. We believe the Australian dollar has a bias to being weaker, but the risks remain more balanced at 70-75 cents than they are at higher levels. Maintaining international exposures in specific markets and sectors including Asian and emerging market equities, US residential property and private investments, and global infrastructure is the approach that our Investment Committee is continuing for now.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.

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Patrick Broughton

Investment Committee Member

Patrick has 32 years of investment banking experience spanning over a broad range of financial markets, including equities, fixed income, hybrids and convertibles and foreign exchange.

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