Risk assets mostly weakened again through February as financial markets focused on downside risks to the global economic growth outlook seemingly validated by further weakness in oil prices. By month-end market sentiment started to take a brighter turn on a view that earlier concerns may have been exaggerated about the risk of global recession. Major sharemarkets mostly lost ground through February with falls ranging from 0.4% for the US S&P 500 to 8.5% for Japan’s Nikkei. One notable exception to the falls was the British FTSE 100 that rose by 0.2% after the government announced that a referendum would be held in June on whether the United Kingdom should leave the European Union. The Australian ASX 200 fell by 1.8% in the month as banks and resource stocks both came under selling pressure.
Australian credit weakened through February hurt by a brief but intense push wider in Banks’ credit spreads driven mostly by offshore sellers. The selling pressure subsided late in the month and early in March on recognition that negative stories swirling around Australian banks and related to home lending were unfounded. Relatively strong Australian economic growth data confirmed that Australian banks’ fundamentals were strong. On the interest rate front, the weakness in risk assets in February promoted safe-haven buying of government bonds. The US 10-year bond yield fell in February by 19bps to 1.73%, while the 30-year treasury yield fell by 12bps to 2.62%. The Australian 10-year bond yield rallied more than its US counterpart falling by 23bps in the month to 2.40% even though the RBA at its first policy meeting for 2016 in early February again left the cash rate unchanged at 2.00%. The latest policy meeting held on the 1st March also left the cash rate at 2.00% and the RBA remained comparatively upbeat on Australia’s economic outlook.
On the US economic data front, non-farm payrolls took a stronger turn in February – up by 242,000 – and the January reading was revised up to 172,000 from an initial print of 151,000. The unemployment rate remained at an 8-year low of 4.9% in February but earlier concern that capacity in the US labour market may be becoming strained promoting upward wage pressure was alleviated by average hourly earnings showing a 0.2% fall in the month. Housing indicators in the US have been mixed-strength in January and February, but personal consumption spending firmed in January, up by 0.5% m-o-m and previously weak US manufacturing activity showed signs of improvement with January industrial production lifting 0.9% m-o-m and durable goods orders rising 4.9% m-o-m. Q4 GDP was a touch soft, up on second estimate by 0.9% annualized from 2.0% in Q3. After a first 25bps rate hike by the Fed back in December and then a pass at its January policy meeting it is unclear whether economic activity is strong enough to permit the Fed to lift rates again in the near term. We see the Fed leaving its funds rate unchanged again in mid-March, although it is a close call.
In China, the lunar New Year celebrations limited the range of data issued during February, but the data released was mostly comparatively soft. January international trade data were surprisingly weak showing exports down by 11.2% y-o-y and imports down by 18.8%. February purchasing manager survey data relating to both the manufacturing sector and the services sector were both softer than expected. The authorities continued to struggle to contain large-scale capital outflow from China and apart from imposing stricter capital controls the authorities have acted to open up China’s government bond market to overseas investors. In terms of stimulating flagging economic activity, the Peoples’ Bank of China eased monetary policy again reducing banks’ reserve ratio requirement another 50bps to 17.0%. China’s economic planners also announced that they are aiming to see the economy grow between 6.5% and 7.0% over the next five years a sign that they recognise that even if China’s economic growth drivers re-balance as planned, China’s potential growth rate will inevitably be much lower than it was when runaway (and unsustainable) growth in investment spending pushed GDP growth along at double-digit pace.
In Europe, GDP growth ran at 1.5% y-o-y in Q4 2015 about the same as in Q3 and the unemployment rate, although still very high, continues to fall, down to 10.3% in January, from 10.4% in December. European retail sales look a touch firmer, up 0.4% m-o-m in January after an upwardly revised 0.6% gain in December. Inflation, however turned to deflation again with the flash estimate for February showing a -0.2% y-o-y change. Europe’s weak banks periodically come under intense selling pressure and are challenged by negative interest rates and flat yield curves. The Middle-East refugee crisis is challenging Europe’s internal open borders policy and the political fabric of Europe. Another challenge for Europe is the British exit referendum coming in June. ECB President, Mario Draghi has reaffirmed in February that the ECB will do whatever it takes to support Europe’s banks and earlier indicated that monetary policy will be reviewed at the policy meeting later this week. The ECB will need to at least match market expectations of some easing in monetary policy
In Australia, GDP growth proved to be surprisingly strong through the second half of 2015 supported mostly by firm growth in household consumption expenditure. Real GDP rose by 0.6% q-o-q in Q4, and by 3.0% y-o-y and Q3 GDP was revised higher to 1.1% q-o-q, 2.7% y-o-y. Notwithstanding very weak wages growth – up only 2.2% y-o-y in Q4 the lowest reading in more than 20 years – real household consumption lifted by 0.8% q-o-q in Q4 after increasing 0.9% in Q3. Households seem to have been confident enough to run down their savings in order to spend helped by relative job security – the unemployment rate lifted to 6.0% in January from 5.8% in December but is still quite low – , rising household wealth, and probably the tax-cut like effect of lower petrol prices. All of these confidence supporting factors are showing signs of not staying as strong as they were through much of the second half of 2015 pointing to some risk of GDP growth strength fading through the first half of 2016.
The RBA’s view expressed in its detailed quarterly monetary policy statement released in February is that the Australian economy is showing signs of stronger activity in the non-resources parts of the economy more than countering the weakness in national income, mostly from lower export commodity prices, and the continuing downturn in mining investment. However, persistently low inflation still provides the RBA with the capacity to lower interest rates further if demand does not stay firm. We still think it likely that demand will falter over coming months and we continue to 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.