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Australia – A growth outperformer
Strong policy traction, leverage to China/Asia
But global recession yet to fully impact
RBA on hold, easing bias to linger
Fixed income opportunities - yield appeal, low govt debt, strong AAA
A$ heading higher
Su-Lin Ong
Director, Senior Economist & Fixed Income Strategist +612 9033 3088
July 2009
Global growth outlook subdued as structural recessions dominate
75.0
ISM signalling a return to positive growth by Q4
18
70.0
16
65.0
14
60.0
12
55.0
10
50.0
8
45.0
6
40.0
4
ISM (Index, LHS)
UST10 (%, RHS)
35.0
30.0
Jun-80
Jun-83
Jun-86
Jun-89
2
Jun-92
Jun-95
Jun-98
Jun-01
Jun-04
0
Jun-09
Jun-07
 Maximum pace of contraction is behind us but outlook is subdued.
 Aftermath of asset price collapse, credit crunch, further deleveraging and synchronicity = deeper and longer
recession. We note the structural nature of the US, UK, JPN and (to a lesser extent) EU recessions.
2
Australia: A growth outperformer
GDP (% q/q Q1)
1
GDP (% y/y Q1)
8
6
0
4
2
-1
0
-2
-2
-4
-3
-6
-8
-4
-10
-5
-12
Australia
US
UK
Europe
Japan
South
Korea
India
Taiwan
Singapore
Australia
US
UK
Europe
Japan
South
Korea
India
Taiwan
Singapore
 Growth in Q1 was the strongest in the developed world.
 By international standards, this is mild slowdown as we debate whether we are in recession or not.
 Recent upward revisions to IMF and OECD forecasts for AU (-0.5%, -0.4%, respectively) for 2009. They
may still be too pessimistic (RBC -0.2%). Both suggest a return to positive growth in 2010 (1.2%, 1.5%,
respectively), well above that anticipated for developed nations.
3
China
Although activity has moderated as the economy skirts with recession
4
8
3
6
2
4
1
2
0
0
-1
-2
Mar-80
-2
Domestic Demand (% q/q LHS)
Domestic Demand (% y/y RHS)
-4
Mar-84
Mar-88
Mar-92
Mar-96
Mar-00
Mar-04
Mar-08
 Momentum turned 12 months ago fuelled by high interest rates and petrol prices. The intensification of the
global financial crisis in Q3 drove much weaker domestic demand in H2 2008.
4
With domestic demand turning negative
Business Confidence (Index)
Business Conditions (Index)
40
40
Consumer borrowing (% y/y RHS)
Retail sales (% y/y LHS)
12.0
20.0
30
30
10.0
15.0
8.0
10.0
6.0
5.0
4.0
0.0
2.0
-5.0
20
20
10
10
0
0
-10
-10
-20
-20
-30
-30
-40
-40
Mar-90
-50
Mar-93
Mar-96
Mar-99
Mar-02
Mar-05
0.0
May-03
Mar-08
May-04
May-05
May-06
May-07
May-08
 Business and consumer confidence have fallen. Borrowing has been pared back. Consumption has
weakened but helped by fiscal stimulus.
5
-10.0
May-09
But policy is tempering the depth and likely duration of this slowdown
Cash Rates & Housing Finance Approvals
30
First Home Owners Step Up
3
25
30
3.5
28
20
4
26
15
4.5
24
10
5
5
0
5.5
-5
22
20
6
18
-10
6.5
16
-15
7
-20
7.5
Cash Rate (% inverted, RHS)
-25
-30
Jun-95
14
Housing Finance Approvals (% y/y, trend, LHS)
Jun-97
Jun-99
Jun-01
Jun-03
Jun-05
Jun-07
Housing starting to bottom?
17,000
12
8
Jun-09
10
Mar-92
26.0
First home owners housing finance approvals/total approvals (%)
Mar-94
Mar-96
Mar-98
Mar-00
Mar-02
Mar-04
Mar-06
Consumers Get A Boost
5.0
Mar-08
Mar-09
2.5
24.0
16,000
4.0
22.0
15,000
Fiscal Package I
2.0
3.0
20.0
14,000
2.0
18.0
1.5
13,000
16.0
1.0
14.0
0.0
Fiscal Package 2
12,000
1.0
11,000
12.0
-1.0
10,000
0.5
10.0
-2.0
Building Approvals (Number, LHS)
9,000
8.0
Retail sales (% m/m LHS)
Housing borrowing (% m/m RHS)
RBA Housing Credit (% y/y RHS)
8,000
May-85
May-88
May-91
May-94
May-97
May-00
May-03
May-06
-3.0
May-03
6.0
May-09
6
May-04
May-05
May-06
May-07
May-08
0.0
May-09
With considerable traction
Mortgage Rates Drop to a Generational Low
18.0
Fiscal Policy Turns Historically Stimulatory
18.0
30
16.0
2009-10 Budget
3
16.0
2
28
14.0
1
14.0
Variable Mortgage Rate (% LHS)
12.0
26
12.0
0
Cash Rate (% LHS)
-1
10.0
10.0
24
-2
8.0
8.0
22
6.0
-3
6.0
-4
Outlays (LHS)
Underlying Balance (RHS)
Revenues (LHS)
20
4.0
4.0
2.0
Jun-90
2.0
Jun-09
Jun-92
Jun-94
Jun-96
Jun-98
Jun-00
Jun-02
Jun-04
Jun-06
Jun-08
18
1983/84
-6
1987/88
1991/92
1995/96
1999/00
2003/04
2007-08
 425bp of easing of which the bulk has been passed through to mortgage rates (~ 385bp on average)
 Historically stimulatory fiscal policy ~ 2½% of GDP in CY2009, within the top 5 global pump primers.
7
-5
2011-12
And there are encouraging signs in China/Asia
Chinese commodity imports
Chinese bank lending, money supply and investment
4000
CNYbn
%y/y
new lending (LHS)
new investment (RHS)
money supply (RHS)
3500
3000
40
volumes
Index: Oct-
300
values
35
250
30
200
2500
25
2000
20
1500
15
1000
10
500
5
0
0
150
50
Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Apr-09
May-09
Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Apr-09
May-09
Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Apr-09
May-09
Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Apr-09
May-09
0
May-09
Apr-09
Mar-08
Jan/Feb-09
Dec-08
Nov-08
Oct-08
Sep-08
Aug-08
Jul-08
Jun-08
May-08
Apr-08
Mar-08
100
Iron Ore
Copper
Coal
Crude Oil
China activity indicators
index
%y/y
25
30
20
20
40
15
10
30
10
0
70
60
Annual Chinese Electricity Production y/y %)
50
20
industrial production (RHS)
retail sales (RHS)
10
5
-10
0
-20
May-09
Apr-09
Mar-08
Dec-08
Nov-08
Oct-08
Sep-08
Aug-08
Jul-08
Jun-08
May-08
Apr-08
Mar-08
0
Jan/Feb-09
PMI (LHS)
May -01
8
May -03
May -05
May -07
May -09
Which take the bulk of AU’s exports
The rise of China and emergence of India
30
(% of Total Australian Exports)
25
1998
2008
20
15
10
5
0
China
Japan
Korea
NZ
Singapore
Taiwan
UK
US
Germany
HK
India
Composition of Merchandise Exports
(top 10 exports)
Destination of Merchandise Exports
(top 10 destinations)
Coal (17%)
Iron Ore (11%)
Gold (5%)
Crude Petroleum (4%)
Natural Gas (4%)
Aluminium Ores (includes Alumina) 3%
Aluminium (3%)
Meat (3%)
Other Ores (Zn, Lead, Mg) 3%
Copper (2%)
Japan (23)
China (15%)
Republic of Korea (8%)
India (6%)
US (6%)
NZ (5%)
UK (5%
Taiwan (4%)
Indonesia (2)
Thailand (2%)
9
However, the global recession is only just starting to impact
Terms of Trade and the A$
130.0
Terms of Trade (Index, LHS)
120.0
The Trade Balance
RBC
Forecasts
2000
0.95
1000
AUDUSD (RHS)
0.85
110.0
100.0
45
Trade Balance (A$m, LHS)
Exports (% y/y, RHS)
Imports (% y/y, RHS)
35
0
25
0.75 -1000
15
0.65 -2000
5
0.55 -3000
-5
90.0
80.0
70.0
60.0
Dec-93
Dec-97
Dec-01
Dec-05
0.45 -4000
May-96
Dec-09
May-98
May-00
May-02
May-04
May-06
May-08
-15
May-09
 Export income is starting to ease. Lower annual contract prices for coal and iron ore from April are evident
in the trade data.
 Terms of trade will fall further. We estimate a 25% decline for FY2009.
10
The impact is yet to be felt on output and employment
Business investment near record share of GDP
20
Credit growth slows rapidly
130
25.0
25.0
20.0
20.0
15.0
15.0
10.0
10.0
5.0
5.0
120
18
110
16
100
14
Business Investment/GDP (%, LHS)
90
Terms of Trade (Index, RHS)
12
80
10
0.0
70
8
0.0
Housing
Other personal
-5.0
60
-5.0
Other mostly business
Total Credit
6
Mar-86
Mar-89
A$m
Mar-92
Mar-95
Mar-98
Mar-01
-10.0
May-91
50
Mar-07 Mar-09
Mar-04
-10.0
May-94
May-97
May-00
May-03
May-06
May-09
Capital spending plans are being pared back
110000
90000
 Business investment has just started to decline.
70000
 Sharp paring back of investment plans.
 Tighter credit conditions also hampering capital
expenditure.
50000
30000
10000
2000-01
2002-03
2004-05
2006-07
2008-09
-10000
11
With the leading indicators pointing to further job losses
Trend ANZ Vacancies and Employment
60
8
50
40
6
30
20
4
10
0
2
-10
-20
0
-30
-40
ANZ Job Vacancies (% y/y, +6 mnths,LRHS)
-50
Employment (% y/y RHS)
-60
Oct-89
Oct-93
Oct-97
Oct-01
Oct-05
-2
-4
Oct-09
 The key leading indexes point to further job losses ahead with the unemployment rate heading to 7¾% in
Q2 2010.
 This is likely to weigh upon consumption and confidence as fiscal stimulus and 1 July tax cuts fade.
12
Watch the labour market, risk of sticky participation
Trend Unemployment Rate & Participation Rate
66.0
4.0
5.0
65.0
6.0
64.0
7.0
63.0
8.0
9.0
62.0
10.0
61.0
Unemployment Rate (%, inverse, RHS)
Participation Rate (%, LHS)
60.0
May-78
May-85
May-92
May-99
May-06
11.0
12.0
May-09
 Participation may prove more sticky compared with last slowdown in 2001 and recessions of early 1990s
and 1980s.
13
Given the wealth destruction and level of household debt
350.0
Household Finances
Heavily indebteded households
180
850.0
140
160
330.0
120
750.0
310.0
140
100
650.0
290.0
270.0
120
550.0
100
80
80
60
250.0
450.0
230.0
60
210.0
190.0
170.0
40
350.0
40
Financial assets to disposable income (% RHS)
Household debt/disposable income (% LHS)
250.0
20
20
Total assets to disposable income (% LHS)
0
Mar-79
150.0
150.0
Dec-88 Dec-90 Dec-92 Dec-94 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08
House Prices (Index RHS)
Mar-85
Mar-91
 Total assets/disposable income have fallen by twice as much as the 1990-91 recession.
 Primarily driven by the fall in equity markets but increasingly, lower house prices.
14
Mar-97
Mar-03
0
Mar-09
And repair of household balance sheets
Household Savings Rate (%)
20
15
10
5
0
-5
Mar-61
Mar-67
Mar-73
Mar-79
Mar-85
 Near term negative impact on growth, long term positive.
15
Mar-91
Mar-97
Mar-03
Mar-09
RBA’s easing cycle is probably over but no hikes on the horizon
Watch the unemployment rate
11.75
3.00
10.75
5.00
9.75
7.00
8.75
9.00
7.75
11.00
6.75
13.00
5.75
15.00
4.75
3.75
Jan-90
Unemployment Rate (% LHS)
Cash Rate (% inverse RHS)
17.00
19.00
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
 Hurdle to cut further is high. It will likely demand a deterioration in global data and renewed financial market
weakness.
 Key domestic risk – further independent increases in key variable mortgages rates.
 Easing bias likely to linger. Rate hikes remain unlikely until H2 2010. Global risks remain and, the RBA
historically does not raise rates until the unemployment rate is declining.
16
Especially with inflation heading lower
Core inflation to move lower over the medium term
Pipeline costs easing
16.0
16.0
14.0
RBC's
Forecasts
86.0
Headline CPI (% y/y LHS)
RBA's Core Measures (% y/y LHS)
Capacity Utilisation (+4qtrs % RHS)
14.0
Intermediate Prices
Final
Preliminary
12.0
6.0
5.0
12.0
84.0
10.0
10.0
8.0
8.0
6.0
6.0
4.0
4.0
2.0
2.0
0.0
0.0
-2.0
-2.0
4.0
3.0
82.0
RBA's inflation target range
2.0
1.0
80.0
0.0
-4.0
Mar-05
Mar-06
Mar-07
Mar-08
-1.0
Dec-94
-4.0
Mar-09
Dec-96
Dec-98
Dec-00
Dec-02
Dec-04
Dec-06
Dec-08
 Headline inflation is set to fall sharply assisted by base effect. Core inflation will prove more sticky but
increasing slack in both goods and labour markets should see core inflation back in the target range in 2010.
 Global excess capacity will prove supportive.
17
78.0
Dec-10
AU bonds face a number of challenges
Outstanding Commonwealth Government Bonds & Semis (A$bn)
300
Fixed Rate A$ Government-Guaranteed Issuance
AOFM, May 2009
Forecasts, RBC Forecasts
250
Date
200
Oustanding ACGBs
Outstanding Semis
150
100
50
Issuer
Coupon
Amount
Maturity
New Issue Spread
Swap
Swap
10-Dec-08
CBA
5.750%
300
17-Dec-13
206
120
35
12-Dec-08
NAB
5.750%
1,800
19-Dec-13
206.5
120
35
12-Dec-08
Suncorp
5.750%
1,100
18-Apr-12
186.5
140
50
7-Jan-09
NAB
5.750%
500
19-Dec-13
174
110
35
9-Jan-09
ANZ
5.250%
1,500
16-Jan-14
172
110
35
22-Jan-09
NAB
5.750%
300
19-Dec-13
158
82.5
35
2-Feb-09
Investec
4.500%
200
9-Feb-12
173
125
70
3-Feb-09
AMP
4.750%
100
10-Feb-14
146.5
107
55
3-Feb-09
AMP
4.500%
76
13-Feb-13
174
95
50
10-Feb-09
NAB
4.750%
500
12-Feb-14
115
75
35
12-Feb-09
CBA
4.500%
2,000
20-Feb-14
120
70
35
18-Feb-09
Investec
5.000%
200
22-Feb-14
228
130
75
20-Feb-09
Macquarie
5.000%
1,100
25-Feb-14
201
100
60
26-Feb-09
Westpac
4.750%
975
5-Mar-14
172
70
35
11-Mar-09
Westpac
4.000%
1,795
19-Mar-12
100
60
30
18-Mar-09
Westpac
4.000%
1,000
19-Mar-12
105
60
30
20-Mar-09
RBS
4.375%
225
27-Mar-12
135.5
90
60
17-Jun-09
ING
5.750%
800
24-Jun-14
108
65
60
14,970
0
1998/99
2000/01
2002/03
2004/05
2006/07
2008-09
2010-11
2012-13
 ACGB issuance has stepped up sharply ~ A$5-5.5bn per month compared with A$5bn per year for most of
the last decade.
 Alternative cheaper quasi sovereign fixed income product – government guaranteed bank paper,
government guarantee semi paper, and AAA.
18
Current Spread
Bond
We favour medium term underperformance and a flatter curve
Fed Funds
US 2 yrs
US 10 yrs
AU Cash Rate
AU 2 yrs
AU 10 yrs
10 yr AU-US spread
10 yr AU-US spread range
A$
NZ$
AUDJPY
NZDJPY
Q1 2008
2.25
1.58
3.41
Q2
2.00
2.64
4.10
Q3
2.00
1.87
3.70
Q4
0.00
0.72
2.05
Q1 2009
0.00
1.02
2.01
Q2
0.00
1.11
3.55
Q3
0.00
0.90
3.00
Q4
0.00
0.85
2.75
Q1 2010
0.00
1.10
3.00
Q2
0.00
1.25
3.25
Q3
0.00
1.35
3.35
Q4
0.50
1.50
3.50
7.25
6.20
6.04
263
7.25
6.81
6.46
235.5
7.00
5.10
5.70
200
4.25
2.75
3.99
194
3.25
2.84
4.40
239
3.00
4.00
5.50
195
3.00
3.75
5.00
200
200-225
3.00
3.80
4.95
220
200-225
3.00
4.00
5.30
230
200-225
3.00
4.25
5.65
240
225-250
3.50
4.50
5.85
250
225-250
4.50
4.75
6.00
250
225-250
0.9400
0.7895
91.03
78.36
0.9606
0.7720
101.6
80.50
0.80
0.67
84.7
71.00
0.70
0.58
62.5
52.10
0.69
0.56
68.5
56.40
0.81
0.63
76.7
59.90
0.80
0.60
75.2
56.40
0.81
0.59
75.3
54.90
0.83
0.61
77.2
56.70
0.84
0.63
78.9
59.20
0.85
0.63
80.8
29.90
0.85
0.64
81.6
61.40
 Receive AU 1yr/1yr forward @ 4.95%-5.0%
 Receive 10 year EFP @ 50-55
 Sell 10 year AU-US @ 175-180bp
 AU flattener vs UK steepener @ 70bp
19
But there is value near term given the recent sell off
Redemption profile
20,000
18,000
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
Jun-09
Aug-09
Oct-09
Dec-09
CGS
Feb-10
Semi
Apr-10
SSA
FI
Jun-10
Aug-10
Oct-10
Dec-10
Corporate
 Offshore appetite has stepped up in recent months, yields are at 8 month highs, A$ outlook is positive,
diversification is supportive
 Domestic investors – overweight cash, net buyers, extending duration, appetite for credit.
20
Especially in semis and AAA
180
180
Announcement of govt guarantee for semis
160
160
140
Queensland downgraded to AA+
120
140
Semi bill passes
120
First guaranteed bank issue (CBA)
Intro of govt guarantee for banks
100
100
NSW's put on negative
80
80
60
60
NSW's back to stable
40
20
40
QTC 17 to bond (bp)
20
NSWTC 17 to bond (bp)
0
1/06/07
0
1/09/07
1/12/07
1/03/08
1/06/08
1/09/08
1/12/08
1/03/09
1/06/09
 Semis have performed well in recent months assisted by a number of key developments – announcement of
a Commonwealth government guarantee, return to stable outlook for NSW, and an improved credit
environment.
 Semi curve remains steep and we expect further outperformance of long semis to bond.
21
A$ outperformance against rest of G10
Net Debt/GDP (2010)
140
120
100
80
60
40
20
0
US
Europe
Japan
UK
Canada
Source: IMF World Economic Outlook and AU Commonwealth Treasury
Australia
 Yield appeal, strong AAA sovereign, a growth outperformer, and low net government debt by international
standards. Diversification will benefit the A$.
22
With A$/JPY heading back above 80
3
350
Currency denomination of uridashi issues, JPY bn
Other
U.S. dollar
300
Australian dollar
June
New Zealand dollar
105
2
pro-rata
95
1
250
200
0
150
-1
100
-2
50
85
75
-3
0
Jan-04
Oct 07
Apr 08
Oct 08
Apr 09
180
Net AUDJPY longs, JPYbn
160
Long term av erage (AUDJPY)
140
Net NZDJPY longs, JPYbn
120
Long term av erage (NZDJPY)
12
9
6
3
0
-3
-6
-9
-12
-15
-18
80
60
40
20
Jan 07
Jul 07
Jan 08
Jul 08
Jan 09
65
55
Jan-09
Oct 09
100
Jul 06
Net AUD Issuance A$bn LHS
Upcoming redemptions A$bn LHS
AUD/JPY, RHS
Jan-05
Jan-06
Jan-07
Jan-08
Jul 09
23
Jan 05
Net AUD/NZD issuance, 3m rolling sum, A$bn, LHS
Upcoming redemptions, 3m rolling sum, A$bn, LHS
AU-NZ 2 y ear sw ap spread, %, RHS
0.5
0.0
-0.5
-1.0
-1.5
-2.0
Jan 06
Jan 07
Jan 08
Jan 09
Key Macro Forecasts
Australia (%)
Consumption
Dwelling
Business Investment
Domestic Demand
Stocks (ppc)
Net Exports (ppc)
GDP
CY2008
2.2
2.5
13.6
4.4
-0.6
-1.5
2.3
CY2009 F
1.2
-8.5
-8.3
-0.5
-1.0
2.3
-0.2
CY2010 F
1.1
1.2
-6.5
1.1
0.7
-0.1
1.6
3.9
4.5
4.1
4.4
4.3
3.2
6.8
3.8
1.7
3.6
4.5
7.0
3.7
1.9
2.2
Current Account Deficit/GDP
Unemployment Rate
Wages (Wage Cost Index)
Headline CPI
Core CPI
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