Risk assets again charted a bumpy course in June, but falling towards month end as the threat of Greek default on a payment due to the IMF loomed. The softening Chinese economy also influenced markets, notably the Australian equity market as the iron price started to fall again. Most central banks held their policy rates unchanged in June although the Peoples’ Bank of China was a notable exception reducing its one year loan and deposit rates, cutting banks’ reserve ratio requirement and providing support for the sharply falling equity market. All major equity markets traded lower in June ranging from down by 1.6% for Japan’s Nikkei to down by 5.5% for Australia’s ASX 200. The Australian equity market performed even worse than the European Eurostoxx 50, down by 4.1% in the month.
Australian credit gave up ground in June partly reflecting the weakness in the local equity market. In government bond markets, yields rose again, although by month end were showing signs of stabilizing. The US 10 and 30-year bond yields rose in June respectively by 23bps to 2.35% and 22bps to 3.10%. Australian bond yields rose by more than their US counterparts and the 10-year bond yield rose by 34bps to 3.06% although has rallied below 3.00% in early July. The RBA left its cash rate unchanged at 2.00% at its June policy meeting but indicated that if demand in the economy needed further support it was not averse to cutting the cash rate further.
On the US economic data front the final revision of Q1 GDP showed US growth declining by 0.2% on an annualized basis. Monthly economic indicators released for April and May have been mixed-strength but consistent with GDP growth rebounding to around 2.5% annualized pace in Q2 2015. At its June policy meeting the Federal Reserve continued to point towards a first hike in its Funds rate later in 2015 but at the same time revised lower its GDP forecast for 2015. The market has been working on the assumption that the Fed may start lifting rates at its September policy meeting but the events in Europe surrounding Greece would seem to imply a later start.
In China, May economic readings remained comparatively soft and imply GDP growth running nearer to 6.5% annual pace rather than the Government’s aim of 7.0% for 2015. The authorities are responding to the weakness in growth. The Government announced an urban housing renewal program. The Peoples’ Bank of China cut its one year lending and deposit rates by 25bps to respectively 4.85% and 2.00%. The rate cuts were the fourth since November 2011. The PBoC also cut the reserve ratio requirement for financing companies by 300bps and early in July announced financial assistance to support the China’s equity market. The authorities remain well placed to provide further support if needed.
In Europe slow economic improvement continued through June although the main focus was how the EU would deal with Greece. Negotiations over whether Greece would or would not accept the terms of its creditors for further financial support ebbed and flowed ahead of a contractual payment due to the IMF at the end of June. The Greek Prime Minister stunned his fellow European leaders by declaring a referendum on the terms of the bailout a week after the IMF payment was due. Greece defaulted, the economic crisis in Greece worsened as Greek banks took measures to preserve diminishing euro liquidity. In early July it remains uncertain how the Greek crisis will unfold although the probability has increased that Greece will be forced to exit the euro. Much feared contagion via financial markets reacting badly has been comparatively modest so far. Equity markets have fallen, but not particularly far and the bond yields of other peripheral European countries have not pushed up far either.
In Australia, economic readings have been mixed strength. Housing indicators have remained very strong although escalation of house prices has become more narrowly confined to Sydney and to a lesser degree Melbourne and Brisbane. Employment has been surprisingly strong, up by 42,000 in May and causing the unemployment rate to edge down to 6.0%. Retail spending ,however, remains lack luster and consumer sentiment has fallen sharply after the spike in May on an initially favourable reaction to the Government’s Budget as well as the May cash rate cut by the RBA. Australia’s international trade position has taken a marked turn for the worse in April and May and iron ore prices have weakened sharply over recent weeks. The RBA is starting to talk aloud about the effectiveness of monetary policy in the current low interest rate environment, but still makes it plain that it can cut the cash rate further if needed. One consolation is that with heightened international uncertainty and the softness in China’s economy the Australian dollar is starting to decline more in line with Australia’s weak terms of trade.
Looking ahead, it is quite likely that the RBA will need to reduce its growth and inflation forecasts further in August when it publishes its next quarterly Monetary Policy Statement. We see the RBA wanting to provide further support for growth even though it is wary of the impact of lower interest rates driving house prices up even higher. We feel that it will become clearer that there is growing marginal benefit from cutting interest rates further by early August and we expect another 25bps cut to 1.75%. Beyond August it still seems likely that growth will be soft for some time. It is possible the cash rate may need to be cut further but our base case is that the cash rate is stable at 1.75% until late 2016.