Risk assets rallied strongly in July assisted by a conviction that central banks around the world are close to providing more monetary policy support, even though policy meetings held in July mostly left settings unchanged. Post-Brexit vote concerns quickly faded in July assisted by a smooth Government leadership change in Britain. The initial negative impact of the close Australian Federal election result was also very limited and short-lived. The best performing major share market in July was the German DAX, up 6.8%, although not far behind was Japan’s Nikkei, up 6.4% and Australia’s ASX 200, up 6.3%. Even the softest gains in the month were impressively big with Britain’s FTSE 100, up 3.4%, and the US S&P 500, up 3.6%.
Australian credit rallied strongly through July taking its lead from the buoyant share market. Bond markets were also stronger through July somewhat surprisingly as strong buying in risk assets usually goes hand-in-hand with selling in bond markets. The US Federal Reserve left its funds rate unchanged in a range of 0.25% to 0.50% at its late-July policy meeting, but the commentary accompanying the decision pointed to US economic activity improving on a broad front, implying that next meeting for late-September could be live for a rate hike. That less dovish rate guidance was neutralised shortly after the Fed meeting when the Q2 GDP report came in much softer than expected. The US 10-year bond yield fell in July by 2bps to 1.45%, while the 30-year treasury yield fell by 10bps to 2.18%. The Australian 10-year bond yield fell by 10bps to 1.87%, rallying in the face of post-election comments by international ratings agencies that Australia’s AAA sovereign credit rating was at risk of downgrade and despite the RBA leaving the cash rate unchanged at 1.75% at its early-July policy meeting.
Returning to the US economy GDP growth was surprisingly soft in Q2, 1.2% annualised, and with Q1 growth revised lower to 0.8% from 1.1%. The Q2 GDP report had one strong point, consumption spending rose at 4.2% annualised pace. Set against the strength in consumer spending, residential investment spending fell 6.1% annualised while investment spending generally was down by 2.2%. Recent monthly US economic data point to strength in US new and existing home sales which may help residential investment spending rebound in Q3. Employment indicators in the US have mostly been firm too. Weekly initial jobless claims in the first half of July were down to their lowest or strongest readings since the series started in 1971, while nonfarm payrolls in June jumped by 287,000, albeit after a very weak 11,000 lift in May. All told, US economic indicators remain mixed-strength while GDP growth has been softer than expected over the past year. The soft GDP growth profile in particular makes it unlikely in our view that the Federal Reserve will be able to hike rates at its next meeting in September or the one after in early November.
In China, GDP growth in Q2 was 6.7% y-o-y, the same as in Q1. However, the quality of economic growth in China is coming in to question with much support coming from government investment spending. The June monthly reading of urban investment spending illustrates the point quite clearly. Annual growth in urban fixed asset spending was softer-than-expected down to 9.0% y-o-y from 9.6% in May. Private sector urban fixed asset investment spending, however, rose only 2.8% y-o-y in June with public sector spending up close to 20% y-o-y with much of that spending channeled through state-owned enterprises which the Government should allow to fail to promote genuine reform in China’s economy. In other words that need to spend government money to prop growth in the near-term is preventing economic changes that could reduce inefficiencies while causing an even greater debt build up in companies that are shaping up as potential problems for China’s banks. The least-conflicted policy tool that the authorities have to hand to support growth is depreciating the renminbi and not surprisingly currency depreciation has become more pronounced over recent months and seems likely to go further over the months ahead.
In Europe, GDP growth faded in Q2 coming in on the preliminary reading up 0.3% q-o-q, or 1.6% y-o-y from +0.6% q-o-q, +1.7% y-o-y in Q1 2016. Concern about Britain’s Brexit vote has faded in July although the negotiations of Britain’s exit still lie ahead over the next year or two. Both the European Central Bank and the Bank of England while doing nothing at their respective July policy meetings have both made it plain that they stand ready to act with easier policies in need. That promise of easier policy settings has helped European share markets to lift strongly, but there is still a sense that Europe has become politically more fragile and that the European Union remains at risk.
The Australian economy is showing signs of fading economic strength as well as evidence that very low inflation is entrenched. Retail sales growth was soft in April (+0.1% m-o-m) and May (+0.2%). Home building approvals fell 5.2% m-o-m in May and more residential property developers are reporting difficult trading conditions. Notwithstanding a rare burst of full-time employment growth in June, total employment growth remained soft, up only 7,900. The unemployment rate is starting to show signs of edging up rising to 5.8% in June from 5.7% in May. The clearest signs in Australia’s economy, however, relate to persistently low inflation. The Q2 CPI inflation rate was up 0.4% q-o-q, but only 1.0% y-o-y, the lowest annual reading in 17 years. The average of the two main underlying inflation rates – the trimmed mean and weighted median – was 0.45% q-o-q or 1.5% y-o-y, the lowest annual reading in the entire 20-year series. Other signs that low inflation is here to stay came with the Q2 import price index, down 1.0% q-o-q, and -2.8% y-o-y, and the Q2 producer price index, up only 0.1% q-o-q and +1.0% y-o-y. Moderating economic growth with evidence that annual inflation is travelling well below the RBA’s 2-3% target band and signs that inflation will stay well below target for some time make it likely that the RBA will cut the cash rate 25bps to 1.50% at its policy meeting tomorrow and will probably repeat the exercise in early November taking the cash rate then down to 1.25%.