Risk assets weakened again in October amid the possibilty of an escalating war in the Middle East as well as concern that central banks may need to hike rates further. The rate hike concerns were alleviated to some extent late in the month as several major central banks, including the US Federal Reserve, Bank of Canada, European Central Bank and Bank of England at their various policy meetings all left rates unchanged. The RBA could prove to be an exception after high Australian inflation reports for September month and Q3 increased the likelihood of a November rate hike.
Most major share markets extended their August and September falls in October, although towards month-end share markets lifted on rekindling hope that interest rates might have peaked. The late-month rally in shares pared back losses in October that ranged from -2.2% for the US S&P 500 to -3.9% for Hong Kong’s Hang Seng index. Europe’s Eurostoxx 50 index fell 2.7% in October, Japan’s Nikkei was down 3.1% and Australia’s ASX 200 fell 3.8%.
Government bond yields rose again in October, although by month-end were starting to fall on hope that central banks might have finished hiking official interest rates. The US 2-year bond yield rose only 5 basis points (bps) to 5.09% while longer-dated bond yields rose by much more, by 36bps to 4.93% for the US 10-year bond yield and by 39bps to 5.09% for the 30-year Treasury yield. The early-November Fed policy meeting that left the Funds rate on hold at 5.50% and where Fed Chairman Powell hinted that the Fed may have finished hiking rates helped US bonds rally sharply. At the end of the first week of November the US 2-year bond yield had fallen 25bps from end-October and the 10-year and 30-year yields had fallen more than 30bps from end-October.
Australian Government bond yields suffered a bigger increase than bond yields in most other markets in October. The 2-year bond yield rose by 37bps to 4.45% while the 10-year bond yield lifted 46bps to 4.92%. Also, the rally in the first week of November has been less than elsewhere with the 2-year yield down 11bps from end-October and the 10-year yield down 20bps. The main reason why Australian performed differently to US bonds is that the RBA, unlike its central bank peers overseas, appears to be on the brink of hiking the cash rate again. During October, it became clear that Australian inflation is sitting higher than it is overseas and that the RBA has done less with rate hikes than its peers overseas to tame inflation.
Turning to credit markets, rising interest rates and weakening equity markets in October saw credit spreads widen. There were also specific concerns swirling around US commercial property risk and China’s problem-plagued property market. Australian credit risk remained comparatively strong by comparison with only relatively small lift in problem loans. By the end of October, even though Australia faces the prospect of another official rate hike, credit spreads were stabilising.
On the economic front in October, the US showed more signs of resilient economic activity in the face of the large rise in interest rates since early 2022. The advance reading of Q3 GDP came in stronger-than-expected at 4.9% annualised growth, up from 2.1% in Q2. Real consumer spending was up 4.0% annualised compared with 0.8% in Q2. However, the labour market is showing signs of softening. October non-farm payrolls rose 150,000, half the pace of the downwardly revised 297,000 increase in September and with the unemployment rate edging up to 3.9% in October from 3.8% in September. Annual CPI inflation was unchanged at 3.7% y-o-y in October with core inflation excluding food and energy prices moderating to 4.1% y-o-y from 4.3% in September. The Fed is indicating that on balance the likelihood is that the economy will slow enough to bring inflation down to target over time.
In China, while GDP rose 1.0% q-o-q in Q3 annual GDP growth slowed to 4.4% y-o-y from 6.3% y-o-y in Q2. It is increasingly unlikely that China will make its 5% growth target for 2023. October economic readings show still soft fixed asset investment spending, up 3.1% y-o-y and industrial production, up 4.5% y-o-y. Retail sales are showing stronger growth, up 5.5% y-o-y but much faster growth is needed to offset softer growth in other parts of the economy. The Peoples’ Bank of China has been easing monetary policy at glacial pace given that inflation is sitting at zero and the Government appears to be struggling to put together an effective stimulus package because of the over-supply issues and credit problems in the property sector.
Europe appears to be in recession. Real GDP fell 0.1% q-o-q in Q3 reducing annual growth to only 0.1% y-o-y. Leading economic indicators are pointing to weaker growth ahead with both the October manufacturing purchasing managers’ index (PMI) at 43.0 and the services sector PMI at 49.2 sitting below the 50 expansion/contraction marker. Europe’s unemployment rate edged up one notch to 6.5% in September. Weak European economic growth is helping to push inflation down more sharply than elsewhere and the preliminary October CPI rose only 0.1% m-o-m reducing annual inflation to 2.9% y-o-y from 4.3% in September. Core inflation was a touch higher, but up only 0.2% m-o-m, reducing the annual rate to 4.2% y-o-y from 4.5% in September. The ECB left official interest rates unchanged (deposit rate 4.00%) at its late-October policy meeting and is becoming more concerned about the weak economic growth outlook.
In Australia, economic readings in October showed some resilience in economic activity – September house prices and housing finance commitments up, September retail sales up a surprisingly strong 0.9% m-o-m with Q3 real retail sales up 0.2% q-o-q – plus a possible easing in very tight labour market conditions. Employment rose only 6,700 in September and while the unemployment rate edged down to 3.6% it was driven by a weaker labour force participation rate, down to 66.7% from 67.0% in August. The September and Q3 CPI reports, however, were disturbingly high. The monthly report showed annual inflation rising to 5.6% y-o-y from 5.2% in August. The Q3 CPI showed a higher-than-expected quarterly change, +1.2% q-o-q resulting in less reduction in annual inflation than hoped, to 5.4% y-o-y from 6.0% in Q2.
The most worrying parts of the CPI reports were too high contribution to inflation from service prices and domestic production pointing to the need for the RBA to revise upwards its inflation forecasts when it delivers the November Monetary Policy Statement this Friday. Those forecasts are likely to show inflation staying too high for too long and a need for even tighter monetary conditions. Australia, against the prevailing trend overseas, seems likely to suffer another 25bps rate hike tomorrow taking the cash rate up to 4.35%.