Risk assets were very volatile in June buffeted by influences including the changing guidance on interest rates of the US Federal Reserve (Fed), the Bank of Japan seemingly backing away from additional monetary stimulus, the surprise Brexit vote outcome in the United Kingdom and the expected policy reaction of the Bank of England. The early July election in Australia and its initially indeterminate outcome is also likely to add to uncertainty in local markets. With these various influences in play, major equity markets showed very mixed results in June. The best performing share market, surprisingly, was the British FTSE 100, up 4.4% and recovering steep losses post-Brexit vote as the Bank of England indicated it would not only provide near-term liquidity support but was in a position to ease monetary policy if needed. The worst performing share market was Japan’s Nikkei, down by 9.6% in June and reflecting the reluctance of the Bank of Japan to provide further policy stimulus. In Europe, the Eurostoxx 50 index was down by 6.5%, the US S&P 500 index was up by 0.1% while locally the ASX 200 fell by 2.7%.
Australian credit was quite volatile through the period of the Brexit vote and its immediate aftermath but finished June more or less where it started the month. Australian risk assets were finding favour compared with their international peers for a period in June, but the indeterminate election result if it results in a hung parliament could cast Australian economic and investment fundamentals in a less favourable light. On the interest rate front, the uncertainty globally and at home has promoted strong safe-haven buying of government bonds. Bond buying was reinforced in mid-June when the US Fed at its policy meeting left rates on hold and indicated diminished likelihood of any rate hike throughout the northern summer. The RBA left its cash rate unchanged at 1.75% in early June and seemed neutral on the rate outlook in its accompanying statement. Various less growth friendly events since including Britain’s Brexit vote and the too-close-to-call Australian election, plus the likelihood of a very low Australian Q2 CPI result later in July make it likely that the RBA will resume cutting rates soon. The US 10-year bond yield fell in June by 38bps to 1.47%, while the 30-year treasury yield fell by 37bps to 2.28%. The Australian 10-year bond yield fell by 33bps to 1.97%.
Returning to the US economy GDP growth moderated noticeably in late 2015 and early 2016 with GDP growing at 1.4% annualised pace in Q4 2015 followed by a 1.1% lift in Q1 2016. Housing activity and household consumption spending appear reasonably strong in Q2 although indicators of business investment spending remain weak and there are some signs that labour market conditions are not as strong as they were. May nonfarm payrolls were up only 38,000 after a downwardly revised 123,000 lift in April. The June nonfarm payrolls report is due later this week and will be watched with considerable interest to see if there is further confirmation or otherwise of the softer trend. For the time being, the Fed is sufficiently concerned about the softer turn in the labour market to postpone hiking interest rates. Given rising uncertainty in the global economy the postponement may last through the remainder of this year.
In China, a run of softer-than-expected April and May economic readings point to GDP growth in Q2 being about the same as the 6.7% y-o-y reported in Q1. Lack of a discernible improvement in growth will be disappointing outcome after the monetary and fiscal policy stimulus applied over the past 12 to 18 months. China’s economy is rebalancing as the authorities intend towards consumer spending and production of services, but the fall away in exports and manufacturing activity is very pronounced and is adding to problems of insufficient corporate earnings to service interest on corporate debt. The potential remains for a banking crisis to develop in China. The authorities have the capacity to recapitalise poorly performing banks, but considerable reform of bank lending practices is needed too. The return of rapidly rising residential property prices in China’s major cities in part reflects on poor bank lending practices.
In Europe, GDP growth was surprisingly strong in Q1 2016, up by 0.6% q-o-q, 1.6% y-o-y. Europe’s unemployment rate fell again in May to 10.1% from 10.2% in April and deflation in April and May turned to slight inflation. 0.1% y-o-y in June. While the economic numbers in Europe looked a little better, the big event was Britain’s surprise referendum decision to exit the European Union. The vote decision opened up many avenues of uncertainty surrounding the lengthy formal divorce process, chaos in both of Britain’s major political parties, whether the EU would play hard ball negotiating Britain’s exit, whether other EU members might follow Britain’s lead and many months of difficulty assessing economic and financial market impacts. In the immediate term central banks – the Bank of England and ECB – are promising more liquidity support producing knee-jerk buying in share markets that could easily turn tail again. Europe’s economic prospects have become more uncertain.
The Australian economy has been standing up as a beacon of relative economic strength in an uncertain world. There have been signs, notwithstanding an apparently strong Q1 GDP reading (+1.1% q-o-q, +3.1% y-o-y) that strong economic activity may be both starting to fade and becoming more isolated to New South Wales and Victoria. Housing activity has taken a noticeably softer turn everywhere other than Melbourne and Sydney. Employment growth has moderated noticeably in the early months of 2016 and what there is has become limited to New South Wales and Victoria and is overwhelmingly part-time rather than full-time. Retail sales growth has moderated noticeably in the early months of 2016 too. The Federal election result when it is eventually known – either a government with tiny majority or a minority government relying on cross-bench support to pass legislation, plus an even more difficult Senate than the one that preceded – is likely to dampen business and consumer sentiment, limit business investment and employment growth, dampen general growth prospects and further limit growth in government revenues. Even more pressure will be placed on the RBA to try and promote reasonable growth. We see the RBA cutting the cash rate in August and again in November and by 25bps to 1.25%. The risk is that they may need to cut rates even more aggressively than we are indicating.