Risk assets again charted a mixed and bumpy course in May buffeted by a range of conflicting influences. The US Federal Reserve (Fed) was still signaling a potential first rate hike later in the year, but amid very mixed-strength US economic readings through the month. China’s economic readings remained relatively soft. European growth was a fraction better, but the Greek sovereign debt problem continued to fester. Australian economic readings ranged from very strong relating to housing to exceptionally weak business investment spending, but in total seemed to show economic growth still losing momentum and causing the RBA to deliver another cash rate cut. Among the major share markets Japan’s Nikkei was one of the strongest in May, up by 5.3. After a volatile trading month most other equity markets ended within a percentage point or so from where they ended April. The US S&P 500 was up by 1.1% in the month and the British FTSE 100 was up by 0.3%. On the weak side, the Eurostoxx 50 was down by 1.2% and the Australian ASX 200 fell by 0.2% in with banks again under selling pressure through much of the month in part offset by improving fortunes for resource stocks on better commodity prices.
Australian credit gave up a little more ground in May but movements within the month were much more modest than the quite big swings at times in the fortunes of Australian shares. In government bond markets, yields rose again, but by less than in April. The US 10 and 30-year bond yields rose in May respectively by 7bps to 2.12% and 12bps to 2.88%. Unlike in April when the Australian bond market sold off by more than the US market, Australian bonds performed in line with the US market in May assisted by the RBA cutting the cash rate by 25bps to 2.00% at its May policy meeting and a relatively well-received Budget delivered by the Federal Government the following week. The Australian 10-year bond yield rose in May by 8bps to 2.72%.
On the US economic data front revised Q1 GDP data showed that US growth contracted in Q1 2015 declining 0.7% in annualized terms, and compared with growth of 2.2% in Q4 2014. Monthly US economic readings released so far for the period beyond Q1 point to a rebound in growth in Q2, but not as powerful a rebound as occurred a year earlier in Q2 2014 when again GDP growth was negative in Q1. The most encouraging readings relate to housing activity. Pending home sales rose strongly in April, by 3.4% after rising by 1.2% in March. April retail sales, in contrast, were flat and industrial production fell by 0.3%. Commentary by senior Fed officials, including Fed Chair Janet Yellen, gloss over the inconsistent strength of the US economy and paint a picture of recovery strong enough to warrant a first hike in the near-zero funds rate later this year. The market’s view of when the Fed will hike is shifting on the relative strength of the latest batch of economic data and leading to greater volatility in the US bond and equity markets.
In China, April economic readings were all softer than expected and imply that GDP growth is running below 7% y-o-y (the Government’s target growth rate for 2015) in Q2. The Peoples’ Bank of China followed up the big 100bps cut in April to the banks’ reserve ratio requirement with 25bps cuts to its official deposit and lending rates in May. Borrowing restrictions on local government authorities have also been eased to help prime local infrastructure spending. Weaker economic readings in China may persist for a few more months, but the substantial policy easing moves by the authorities point to growth basing and firming a little late in 2015.
In Europe, GDP growth firmed slightly to 1.0% y-o-y in Q1 2015 from 0.9% in Q4 2014. Among the big four euro economies growth was better than expected in France, Italy and Spain, but disturbingly was worse than expected in Germany. Continuing relative economic strength in Germany is probably a necessary requirement for any solution to the Greek sovereign debt crisis involving further accommodation from creditors. With German growth looking a touch softer creditors are more likely to take a firm stance requiring Greece to agree to budget cuts and economic reforms if credit terms are to be extended. Key dates for interest payments on Greek debt loom in early June and default is looking likely. The European Central Bank will try and offset any disturbances emanating from Greece by reaffirming strongly and at every opportunity that the ECB will continue to purchase 60 billion euro of bonds each month through to at least September 2016 as announced back at its February policy meeting.
In Australia, the RBA’s May cash rate cut and the Government’s Budget with its focus on assistance for small business lifted consumer sentiment and bolstered the already strong housing market. Home building approvals rose by 2.8% in March and were up 23.6% y-o-y. Residential construction work done lifted in real terms in Q1 by 4.8% q-o-q and was up by 11.8% y-o-y. Set against the housing activity strong point, business investment spending is even weaker than expected. Q1 private new capital expenditure fell by 4.4% q-o-q in real terms and more worryingly the survey of 2015-16 capex took a weak turn too and is travelling 24.6% lower than the survey taken at the same time last year for 2014-15 capex. Australian annual GDP growth in Q1 2015 (due this week) may have slipped to 2.0% y-o-y, or lower, from 2.5% y-o-y in Q4 2014. Moreover, annual GDP growth still seems to be sliding further beyond Q1.
In its latest assessment of the state of the Australian economy and the outlook produced early in May just after its decision to cut the cash rate further, the RBA reduced slightly its forecasts of growth and inflation for 2015 and 2016. The forecasts also showed a more prolonged growth soft patch. The RBA wants to provide further support for growth but also recognises that low interest rates have the unwanted side effect of priming house price inflation and potentially driving an unstable leveraged lift in household consumption. Cutting interest rates further has become a matter of carefully assessing the benefit over the cost. Our view is that the marginal benefit of cutting rates further will probably show again in August after evidence of low Q2 inflation is published in late July and after a run of economic readings still pointing to very soft growth in Q2. After a 25bps cash rate cut to 1.75% in August we see the cash rate remaining at 1.75% until mid-2016 at least.