Risk assets mostly weakened through December weighed down by the first rate hike by the US Federal Reserve in nearly a decade and further softening in industrial commodity prices. Risk assets were weakest ahead of the Fed’s mid-month decision lifting the Funds rate by 25bps to 0.25% to 0.50% range, but trimmed earlier losses after the event as Fed Chairman Janet Yellen made it plain that the US rate tightening process was likely to be a much slower-paced affair than previous rate hiking phases. Major sharemarkets lost ground through December with falls ranging from 1.8% for both the US S&P 500 and British FTSE 100 to 6.8% for the Eurostoxx 50 index. The Australian sharemarket was a notable positive exception with the ASX 200 lifting by 0.6% in the month.
Australian credit weakened early in December, but recovered much of the ground lost later in the month finishing December only slightly down on its end-November level. The first US interest rate hike was a very well telegraphed event and came as no surprise. As a consequence the reaction of longer-term US government bond yields was comparatively small. The US 10-year bond yield rose in December by 6bps to 2.27%, while the 30-year treasury yield rose by only 4bps to 3.02%. The Australian 10-year bond yield barely moved, lifting by 2bps in the month to 2.88%. In early December, the RBA again left the cash rate unchanged at 2.00% and indicated that it was content to leave the cash rate unchanged awaiting more information relevant to Australia’s economic outlook.
On the US economic data front, non-farm payrolls took a stronger turn in October – up by 298,000 – and consolidated the strength with a follow-up rise of 211,000 in November. Retail sales took a firmer turn in November too, lifting by 0.4%, excluding automobile sales, after a 0.1% gain in October. US housing construction also improved substantially in November with housing starts lifting by 10.5% and housing permits lifting much more than expected, by 11.0% and pointing to starts remaining strong over the next few months. The soft spot in the US economy remains manufacturing. Industrial production fell by 0.6% in November after falling by 0.4% in October and regional manufacturing PMI readings remain soft pointing to further weakness in industrial production over coming months. The final reading of Q3 GDP showed annualized growth of 2.0% and Q4 GDP seems to be running at similar pace. While the US economy is growing the pace is not strong enough to promote aggressive reduction in monetary accommodation by the Fed. We see 25bps rate hikes every second policy meeting (every three months) through 2016.
In China, annual GDP growth appears to be basing near to 7.0% y-o-y pace on the basis of the run of November monthly economic readings. Exports, -5.3% y-o-y in November; industrial production, 6.2% y-o-y; retail sales, 11.2% y-o-y; and urban fixed asset investment spending, 10.2% y-o-y all equaled or improved on the respective October readings and all were stronger than analysts’ expectations. China’s authorities remain prepared to prime growth further and very weak and falling producer prices, down 5.9% y-o-y in November, imply that the authorities are more likely to err on the side of greater-than-expected policy accommodation to guard against deflationary pressure becoming entrenched.
In Europe, the European Central Bank’s policy meeting early in December disappointed by not easing policy as aggressively as the guidance in several speeches given earlier by ECB President Mario Draghi seemed to imply. The ECB deposit rate paid to banks was cut by 10bps to -0.30%, but the size of the monthly asset purchase program was left unchanged at 60 billion euro although the possible end date of the program was extended to at earliest March 2017 from September 2016 previously announced. The failure to ease monetary policy more aggressively in the face of economic readings pointing to modest European growth at best weighed particularly heavily on sentiment in European sharemarkets through December.
In Australia, household spending may have taken a stronger turn. Retail sales rose by 0.5% in November after lifting by 0.4% in October. Employment growth was particularly strong in October, up 56,100 and again in November, up 71.400. Unexpectedly, the unemployment rate fell to 5.8% in November the lowest level in more than a year. The RBA has turned cautiously optimistic about Australia’s economic outlook to the point where RBA Governor Glenn Stevens indicated that it unlikely that the RBA will be downgrading its economic growth forecasts any further in the near term. In contrast, Commonwealth Treasury, downgraded its growth forecasts in its Mid-Year Economic and Fiscal outlook at the same time revising higher its forecasts of budget deficits over the next few years and the expected peak in Commonwealth Government debt outstanding as a percentage of GDP by more than five percentage points to 33.3% of GDP in March 2019. International credit ratings agencies have already indicated that the changes to budget and debt forecasts will not affect Australia’s AAA sovereign debt rating.
Looking ahead, we still see downside risks to Australia’s growth outlook through 2016 although in the immediate-term rather better economic readings may predominate. The topping out of home building activity, persistent weakness in industrial commodity prices and accelerating rundown in parts of Australian manufacturing – notably automobile manufacturing point to a challenging year ahead. It is likely to take a few months for these downside risks to growth to become more evident. We see a strong likelihood that the RBA will start to consider that easier monetary conditions are necessary before the middle of the year. We pencil in two 25bps cash rate cuts in May and June taking the cash rate down to 1.50% in the second half of the year. Low interest rates are likely to persist in Australia throughout 2016 and probably through much of 2017 as well.