Risk assets mostly strengthened in December capping a good year. Among major share markets gains in December ranged from 0.1% for the German Dax to 2.9% for the US S&P 500. A notable exception to the gains in December was the Australian ASX 200 which fell 2.4% in the month concentrated towards month-end and driven mostly by weakness in bank shares. 2019 marked strong gains across the board for major share markets ranging from 12.1% for Britain’s FTSE 100 despite Brexit turmoil to 28.9% for the US S&P 500 assisted mostly by the Fed’s turn from lifting interest rates in 2018 to cutting rates in 2019. Australia’s ASX 200, notwithstanding the fall in December was up 18.4% in 2019 even with a series of setbacks for the banking sector emanating initially from the Banking Royal Commission findings and later from revelations of poor banking practices.
The main driver of strong share market performance globally in 2019 including December was that central banks were working to ease monetary conditions. In the case of the US Federal Reserve this was distinctly different from its policy course in 2018 when it had accelerated the process of lifting interest rates towards more normal settings. The three interest rate cuts by the Fed in 2019 opened the prospect that the long US economic expansion would not slip into recession in 2020 but might instead extend and even strengthen.
Another driver of share market gains later in 2019 was diminishing threats to global growth prospects from political disruption. The tariff war between the US and China that was started and periodically fanned by President Trump moved to a phase of de-escalation late in 2019 and the promise of a “first-stage” trade agreement in mid-January.
The disruptive political influence, Brexit, also moved in December from an outlook of no clear way ahead to a set of steps to deliver Britain’s exit. The breakthrough came first with the unexpectedly big Conservative election victory followed quickly by the Brexit legislation setting January 31st2020 as the definite date when Britain will exit the EU and start negotiations of new trade arrangements with Europe. The negotiating period will generate more challenges, but uncertainty about Brexit has been dialled down considerably.
2020 is starting on a promising note for many of the world’s bigger economies assisted by central banks maintaining easy monetary conditions and perhaps easing further. Most likely global economic growth will pick up pace. Usually stronger growth generates higher inflation which in turn ends the period of central bank monetary accommodation. Yet there are few signs of inflation making a quick return. Although wages growth has lifted in some economies it remains comparatively low in most. It seems that the link between low unemployment (a sign of strained labour market capacity) and rising wages has slipped. It requires lower rates of unemployment than in the past in current more flexible labour markets with rising participation rates to place upward pressure on wages and inflation.
Even in the US, where the unemployment rate is at a 50-year low 3.5% and wages are rising above 3% y-o-y, unit labour costs are rising not much above 2%. There is no pressure on central banks, even the US Fed operating in an economy with the most promising growth prospects, to worry about inflation prospects.
Promising global growth prospects combined with easy monetary conditions are helping to sustain the rally in Australian credit and notwithstanding the management issues in the local banking sector. In terms of Government bond yields, brighter global growth prospects in December combined with diminishing political risks caused longer term bond yields to rise. The US 10-year bond yield rose by 14 basis points (bps) to 1.92%, while the 30-year yield lifted 18bps to 2.39%. The Australian 10-year bond yield rose more than its US counterpart by 34bps to 1.37% with better than expected November labour force data (employment up 39,900 and unemployment rate edging down to 5.2%) plus brightening global growth prospects briefly made it less likely that the RBA will ease monetary policy again soon.
Bond market conditions have changed again in the first few days of 2020. The lift in government bond yields through December has part-retraced in early January amid flaring tension between the US and Iran causing some flight to safe-haven assets and locally the worsening bushfire crisis in Eastern Australia adding to existing factors such as weak household spending subduing Australian growth prospects. Recent events have probably pushed the RBA closer to considering another cash rate cut when it meets next in early February and we expect another 25bps cut to 0.50%.
The bushfire crisis will have detracted from Australian growth in Q4 2019 and in Q1 2020, but beyond that the lagged positive growth impact from easier monetary conditions plus bushfire recovery spending (denting the government’s budget balance plans but adding to growth prospects) should see stronger GDP growth from mid-2020. Even with stronger growth in the second half of 2020 the RBA is unlikely to need to consider changing monetary policy course. After the next rate cut we see the cash rate at 0.50% or lower through the rest of 2020 and extending to the first half of 2021.