Risk asset were more volatile in June coming to terms with the firming prospect of the US Fed starting to taper its bond buying (QE) later this year as well as the prospect of a period of softer growth in China as the authorities work to tame residential property speculation and cap growth in so-called “shadow” banking activities. In sharemarkets, the US S&P 500 was down by 2.3% and European sharemarkets weakened over the month too, with the Stoxx 50 down by 4.3% and the FTSE 100 down by 2.9%. On the positive side, despite the volatility during the month, Japan’s Nikkei was up by 2.3%, while the local ASX 200 was up by 1.0%. A feature of financial markets in June was the continuing increases in government bond yields with the US 10-year Treasury yield up by another 36bp to 2.49% and the Australian 10-year bond yield up by 40bp to 3.75%. Credit markets were also weaker over the course of the month with credit spreads widening, including Australian credit spreads.
Returning to influences on US financial markets in June, the key event was the two-day Fed policy meeting on 18-19th June which confirmed a slightly brighter Fed view of US economic prospects in 2014 and with the better economic forecasts an indication that the Fed could taper its $US85 billion a month bond/mortgage paper buying program later in 2013 and end purchases mid-2014. Risk asset markets reacted negatively to the confirmation that QE may start to taper later in 2013, even though Fed Chairman Bernanke assured that the Fed’s plans were flexible, depended upon the economy strengthening as forecast and involved no lift in the zero Fed funds rate for the foreseeable future.
The run of economic data in the US in the month was consistent with an economy entering a self-sustaining recovery, with particularly strong indicators of April and May housing activity (mostly the strongest levels since 2008), and better than expected June readings of consumer confidence and sentiment both at or near their best levels in more than five years. The improving US economy however, is no longer unambiguously good news for risk markets, as it tended to be before the Fed raised the issue of starting to taper its bond purchases.
Almost coinciding with the Fed’s June policy meeting, the Peoples’ Bank of China presided over a brief but sharp credit squeeze which saw its overnight repurchase rate spike more than six percentage points to 12.85% on June 20th. The squeeze was aimed at excessive credit growth in China, especially the activities of wealth management groups boosting non-bank credit. China’s authorities indicated that they are prepared to sacrifice some near-term growth for the sake of more sustainable long-term growth. The moves in China, Australia’s single biggest trading partner, added to pressures pushing down the Australian dollar.
In Australia, the RBA left its cash rate unchanged at a record low 2.75% at its early June Board meeting, but kept an easing bias in the statement accompanying the decision. Interestingly, most economic readings were a touch firmer than expected through the month, notably April home building approvals rising more than 9% and May employment rising slightly against expectations of a sizeable fall. Slightly firmer economic readings combined with now a relatively big depreciation in the Australian dollar imply to us that the RBA is unlikely to consider further cuts to the cash rate over coming months, although it will continue to indicate that low inflation provides the capacity for the cash rate to be cut further. Particularly given the much weaker Australian dollar (down 3.5% on trade-weighted basis in June, after a 5.6% fall in May), prospects for local growth and local risk assets have brightened in our view.