Risk Assets were mixed in December; starting the month on a very weak note amid tumbling oil prices, but rallying strongly towards Christmas on evidence of US economic strength. The Australian equity market enjoyed one of the stronger rebounds later in the month, but mostly because it suffered the sharpest fall in November and early December. Over the month, the ASX 200 rose by 1.8% but recovered less than half of its 3.9% fall in November. The US equity market touched a record high in December, but faded towards month end with the S&P 500 lifting in December by only 0.1%. Other major equity markets were mostly weaker ranging from a fall of 0.1% for Japan’s Nikkei to a fall of 3.2% for the Eurostoxx 50. Problems in Greece again became a central focus with the risk of an election likely to be dominated by parties keen on withdrawing from the euro and ending austerity policies.

The Australian credit market was softer through the month, not rebounding quite as strongly as the local equity market towards Christmas and month end. In interest rate markets more generally, longer term bond yields fell over the month although short-term US Treasury yield edged higher after the last Federal Reserve policy meeting of the year indicated both patience before the Fed starts lifting its funds rate but also that it will happen at some point in the first half of 2015. The Reserve Bank of Australia again left the cash rate on hold at 2.50% at its early December policy meeting. They indicated again that rates would be stable for some months ahead, despite mounting market speculation that the next move in rates might be down. US 10 year and 30 year treasury yields finished December at 2.17% and 2.75%, respectively 1 basis point (bp) higher and 14bps lower than at the end of November. The Australian 10 year bond yield fell during the month by 29bps and finishing December at 2.73%.

On the economic data front, US indicators showed a second consecutive quarter of strong growth, revised upwards on the third report to 5.0% annualized GDP growth in Q3 after 4.6% in Q2, the strongest two-quarter growth in eleven years. The November non-farm payrolls report was much stronger than expected at +321,000, but the unemployment rate was unchanged at a six-year low reading of 5.8%. US consumer sentiment and confidence were both close to a seven year high in December an indication of continuing robust household spending.
In contrast to the strength in the US, economic readings in China were mixed in November and indications of manufacturing activity were soft adding to downward pressure on industrial commodity prices. In Europe, economic readings were mixed but still indicated very soft growth and no inflation pressure. In Australia, monthly economic readings were mostly stronger than expected, notably October home building approvals, up by 11.4% and November employment, up by 42,700 (although the unemployment rate still edged up to 6.3% from 6.2% in October). Q3 GDP in contrast, was disappointingly weak, up only 0.3% q-o-q and keeping annual growth at a sub-trend 2.7% y-o-y.

Looking ahead, global economic growth looks set to improve further late in 2014 and in the first half of 2015. Growth in China and Europe look like needing assistance from easier policy settings but there are improving signs that this will be forthcoming.

In Australia, the headwind to growth from weakness in national income looks set to intensify as collapsing energy prices in the wake of the late November OPEC meeting, reinforce the downward pressure on Australian income from falling iron ore prices. Weak income growth will probably add to factors keeping annual inflation very well contained. The RBA is very firmly on monetary policy hold, but the weakness in Australian national income implies some risk that the RBA may cut the cash rate further. Housing is the one strong part of the Australian economy, but even that may soon take a softer turn on falling rental yields and less accommodating loan conditions on offer from lenders. Any rate hike is further away than we thought likely previously and it is possible that the cash rate may be cut at some point in 2015 if commodity prices continue to decline potentially causing Australian national income to fall.