Morgan Stanley Expects Sharp Australian Slowdown

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Includes: EWA, FXA, IAF
by: Evelyn Rubin

Morgan Stanley economist Gerard Minack expects a sharp slowdown of the Australian domestic economy in 2007, resulting in rate cuts from the RBA, weakening of the Australian dollar, and increased earnings risk in the domestic equity market. Excerpts from his argument:

First, the RBA wants growth to slow. Whether the RBA has to tighten much more to achieve its aim is unclear, but what doesn’t seem at issue is that the RBA will do what it takes to slow activity.

As it is, I do not have another rate hike in my forecasts. But that’s a low-conviction call, based largely on my view that employment data will soften in the near term (as the unbelievable strength of the past four months is partly reversed). If employment stays strong or if the other indicators that the RBA is watching — notably consumer borrowing — remain robust, then there will be another rate hike before year-end, in my view.

Second, the windfall from the commodity boom is starting to fade. The boom has supported the domestic economy in two important ways. First, it triggered an investment surge. Business investment spending has accounted for the lion’s share of GDP growth over the past 18 months, accelerating just as consumer spending softened.

But the signs now point to investment spending leveling out next year. The most recent ABS survey of businesses’ investment spending plans points to no growth in investment spending in FY2007. This is not a bad outcome: after the stellar growth contribution of the past four years, businesses are planning to maintain the same high level of investment spending next year as they achieved this year.

The simple point is that in terms of contributing to growth, maintaining investment spending at a constant level implies zero contribution to GDP growth. That will put a big dent in next year’s outlook. [...]

The third factor likely to act as a drag on growth is softer employment. Leading employment indicators are mixed, but the simple point is that softer GDP growth — in four-quarter change terms, seven consecutive quarters of sub-3% growth — suggests that labor demand will moderate.

Related on Seeking Alpha: There is one CEF that covers Australia: the Aberdeen Australia Equity Fund (NYSEMKT:IAF). Two relevant ETFs are iShares Australia (NYSEARCA:EWA) and CurrencyShares Australian Dollar Trust (NYSEARCA:FXA). Roger Nusbaum recently looked at capturing Australia with ETFs, ADRs or CEFs.

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