Given the wide ranging implications that the budget has on all parts of the economy and the subsequent follow-through into the AUD and equity markets, there was very little reaction to the release. Most of the policies were leaked and the government had done a good job of conveying them to the population, resulting in no real surprises.
The overall budget deficit for 2010-11 came in around expectations of $49.4b or 3.6% of GDP, with the budget balance expected to narrow to $22.6b or 1.5% of GDP in 2011-12. Importantly, and as thoroughly expected, the budget projects a surplus of 0.2% in 2013-14.
The 2011-12 budget has $22.2b in savings, with most of these coming from spending cuts. As long as growth continues with current projections, and given the strength we are seeing in the mining sector, meeting this surplus is achievable. Interestingly though, whilst this figure has received a lot of attention, the savings are largely to pay for $19b of new programs.
How will the AUD fare?
In terms of short-term implications on the AUD, one has to look at whether the RBA sees this as overly restrictive and therefore limiting the need for further interest rate hikes. Looking at the reaction in the AUD and the credit market, it clearly suggests that the market does not see this as altering their train of thought. If anything, given public opinion was expecting a more stringent budget, it could provide a slight uplift to sentiment. The Federal budget has done little to address the inflationary risks and as such economists have not altered their assumption of when the RBA will next hike.
The market's reaction
There has also been little reaction in the stock market, with the likes of Credit Suisse maintaining their year-end target of 5000; Macquarie suggests that the budget may actually exacerbate existing pressures. The already weak domestic consumer related stocks are likely to see further pressures on spending, suggesting little prospect of a recovery in retail spending and subsequent profit growth. In the healthcare space the budget saw a funding increase in pathology, which is a minor positive for Sonic Healthcare and Primary Healthcare; however this was offset by funding cuts for GPs. In media, Seven West Media and Ten Networks are the winners as the government is spending $377m on digital set-top boxes. In the infrastructure and property sectors, the headline spend of $36b on infrastructure over 5 years, according to Merrill Lynch, has fewer implications than would appear at first glance. It should however be a small positive for Australian Infrastructure Fund, Transurban, Lend Lease and FKP property.
All in all, most of the policies included were already known by the market and as a consequence caused little reaction. There have been suggestions that the budget has been politically motivated and set out in such a way that it will keep the support of the government's Independent members by funding education and health spending in rural areas which they were very much in favour of. However, many would see this budget as a non-event for the markets and with little to deter the RBA from raising rates, traders will continue to ask whether the economy can handle another rate hike given the domestic economy is weak and retail spending low.
The key risks that could have caused a strong reaction to the AUD and Australian equity market were a removal of the benefit of negative gearing on investment properties and an introduction of the much talked about carbon tax, however neither came to fruition. The carbon tax debate has still not gone away so this could still prove to be a headwind for certain stocks until we get more clarity.
What are traders thinking?
The government feels that in order to avoid further rate hikes by the RBA (which could pile on the misery to an already depressed consumer and housing market), it has proposed a budget which, according to Goldman Sach's, represents the biggest fiscal contraction since 1970. However, looking at the appreciation in the AUD/USD, one could say that the currency market has not been deterred and still expects between one or two interest rate hikes this year.
Could this mean further downside for consumer related stocks? Whilst the AUD/USD is rallying on risk appetite, are currency traders pricing in too high rate expectations, and as a result see downside pressure in the near term?
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Updated: 11/05/11
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