Risk assets mostly traded weaker in October, breaking the rallying run set over the previous few months. While there were signs in October that major economies such as the US economy and even the Australian economy were performing better than expected, that news came with the sting that progress reducing inflation could slow limiting the extent of future rate cuts by central banks and in the case of the RBA delaying the first rate cut further into 2025. Government bond yields rose substantially in October, partly reflecting the changing outlook for rates set by central banks, but also by increasing realisation that governments in the US (regardless of who wins the presidency this week), Europe and Australia are increasing real government spending making reduction of large government borrowings at best a slow affair and in some cases a non-existent prospect.
In the US, the advance reading of Q3 GDP showing annualised growth at 2.8% and strongly supported by real consumer spending at 3.7% means the economy is continuing to grow at a higher than long-term trend pace. Notwithstanding two devastating hurricanes through the southern states most September and October monthly reports and surveys point to the economy still growing at above 2% annualised pace in Q4. Relatively firm US growth is coming at the cost of cutting back progress reducing inflation which on all measures looked stickier in mid-2% territory in September.
The Federal Reserve meets this week but is unlikely to be able to deliver a second 50bps rate cut settling in the changing economic environment for a 25bps cut in the Funds Rate to 4.75% and a warning that the pace of rate cuts may be slower over the next few meetings.
The US government bond market in October moved bond yields higher reflecting firmer economic readings, stickier inflation reports, less room for the Fed to cut rates and lack of indication by either candidate in the presidential race that they see any need to prioritise reducing high US government debt.
The US 2-year bond yield rose by 53 basis points (bps) to 4.17% in October, while the 10-year yield rose 50bps to 4.28% and the 30-year Treasury yield rose by 35bps to 4.47%. Given that the Federal Reserve will still cut the Funds rate, albeit, at slower pace than expected previously, the combination of easing monetary policy and loose fiscal policy with the economy growing above trend implies that US bond yields may push up higher over the next few months, particularly longer-term bond yields.
Australian government bond yields also moved materially higher in October with the 2-year bond yield up 43bps to 4.07% and the 10-year bond yield up 53bps to 4.54%. During the month market expectations concerning when the RBA might start cutting cash rate from the current peak of 4.35% moved out from late 2024 towards mid-2025. The re-assessment was driven by evidence of a still very tight labour market with employment still growing fast in September and the unemployment rate low at 4.1% as well as inflation readings showing that while headline CPI readings have fallen below 3% y-o-y underlying inflation is still in mid-to-high 3% y-o-y territory and a harbinger of where headline CPI inflation could return to once the impact of government energy rebates and recently low petrol prices pass through.
The next RBA Monetary Policy Statement out this week is likely to show that returning inflation consistently inside 2-3% target band is unlikely to occur before mid-2026. This inflation forecast means no RBA rate cut before May next year at earliest and Australian bond yields staying above 4% mostly over the next few months.
Turning to risk assets, the changing interest rate outlook in October presented a head wind to share markets. Most lost ground in October with falls ranging between 1.0% for the US S&P 500 and 3.9% for Hong Kong’s Hang Seng. Australia’s ASX 200 fell by 1.3%. One exception to the falls in October was Japan’s Nikkei, up 1.1%.
Credit markets were mostly a little firmer in October, going against the trend of weaker share markets. Strong employment growth and low unemployment are helping Australian households to cope with high interest rates on their high borrowings. Default rates are starting to climb but modestly compared with previous cycles. Most households remain well placed to meet their high debt-servicing commitments.
While the bump up in bond yields caused some deterioration in risk asset values in October, it is worth noting that the more resilient economic readings that caused the lift in bond yields should also return to favouring risk assets over coming months. Risk assets would be most at risk of losing substantial value if recession is in prospect. If anything, the risk of recession ahead has lessened materially over the past month both for the US and here in Australia. That means less need for central banks to keep cutting (or in Australia’s case start cutting) interest rates but it could also mean that inflation stops moderating over coming months and starts to lift again maybe not next year, but in 2026 and 2027.