Risk assets were mixed-strength in August after the strong rallies experienced in July. Share markets rallied further in countries and regions where central bank and government economic policies either lent more towards supporting growth in August, such as in Japan and the United Kingdom, or where signs were building of possible policy easing soon, such as in the European Union. In the United States, share market progress was halted as the prospect firmed through the month that the Federal Reserve might increase its funds rate sooner rather than later on the back of mostly firmer economic data and hawkish comments from several senior Fed officials. In Australia, weaker commodity prices and attacks by both the Government and Opposition on the banks saw the local share market fall. The best performing major share market in August was again the German DAX, up another 2.9% after rising 6.8% in July. Japan’s Nikkei and Britain’s FTSE 100 were up respectively 1.9% and 1.5%. The US S&P 500 was down by 0.1% while Australia’s ASX 200 was a big under-performer in August, down by 2.3%.

Despite the poor performance of the Australian share market, Australian credit was stronger in August responding to favourable sentiment towards credit markets internationally. Government bond markets, however, were mixed in the month responding to varying views about central bank moves. In the US, mostly firm economic readings in August plus several senior Federal Reserve officials starting to talk about the possibility of a September rate hike pushed up US bond yields. The US 10-year bond yield rose in August by 14bps to 1.59%, while the 30-year treasury yield rose by 7bps to 2.25%. The Australian 10-year bond yield, in contrast, fell by 5bps to 1.82%, finding buying strength as the local share market weakened and amid a view that even though the RBA left its cash rate unchanged at 1.50% at its early August policy meeting it would likely need to cut rates again later in 2016 because of persistently low inflation and a relatively strong Australian dollar threatening to complicate the task of priming non-resource export drivers of economic growth.

Returning to the US economy GDP growth was surprisingly soft in Q2, 1.1% annualised, compared with Q1 growth of 0.8%. Even though Q2 GDP growth was low, beneath the surface of the headline growth rate were signs that Q3 GDP growth was likely to be much stronger. Falling inventories detracted 1.3 percentage points from Q2 GDP while household demand rose with consumption spending rising very strongly at 4.4% annualised pace. Attempts by businesses to rebuild inventories in Q3 amid still very strong household spending could lift annualised GDP growth well above 3% in Q3. July and August monthly readings, especially of housing activity, point to greater strength too. Non-farm payrolls, however, have been on a rollercoaster run, very strong in June and July, but comparatively soft in August. Views about Federal Reserve interest rate intentions seem to be driven primarily by payrolls and while the talk was skewing towards a late September rate hike during August that talk seems to have been stymied early in September with the release of August non-farm payrolls.
In China, the run of July and August economic readings so far seem consistent with GDP growth in Q3 slipping to around 6.4% y-o-y from 6.7% reported in both Q1 and Q2. China’s July economic readings were almost all surprisingly soft and slipping from June. Softer July urban fixed asset investment spending in particular, down to 8.1% y-o-y from 8.8% in June indicates that the single biggest contributor to growth in China is decelerating sharply, but with nothing else to take up the slack. Export growth was still very weak in July, down 4.4% y-o-y and retail sales growth moderated to 10.2% y-o-y from 10.6% in June. There is some hope that a new phase of residential construction may lift growth at some point, but that looks more a story for 2017 and could easily be delayed as pressing economic reform issues relating to bank lending practices in particular take priority. China’s growth prospects still hang in the balance between stabilization and continuing softness.

In Europe, GDP growth faded in Q2 coming in 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. There are also signs that progress lifting Europe’s inflation rate and reducing unemployment may have stalled in July and August. Annual inflation in the EU went sideways at 0.2% y-o-y in both July and the preliminary August reading. The EU unemployment rate at 10.1% in July was the same as in June. The ECB has moderated its growth forecasts, but while talking of the possibility of easing further has yet to act. In contrast, the Bank of England surprised at its July policy meeting by adding to its asset purchase program (QE) while delivering as expected a 25bps rate cut to only 0.25%. Brexit concerns have faded but will most likely resurrect once Britain formally triggers the start of exit negotiations with the EU.

The Australian economy is showing signs of reasonable past economic growth but fading economic strength in Q3 and Q4 2016. The signs are that inflation still remains very low, reinforced by another very low wages growth reading for Q2, up only 0.5% q-o-q, 2.1% y-o-y still at the record low level reading for the twenty-year survey. Signs of softness in economic growth in Q3 are showing in fading growth in retail trade. In July, retail trade was flat, after rising only 0.1% in June and 0.2% in May. Housing activity is still buoyant in parts but with increasing evidence of over-supply in parts of the new home unit market threatening a sharp downward correction in housing not too far ahead. Business investment spending continues to fall, down by 5.4% q-o-q in real terms in Q2 after falling 5.2% in Q1. Employment, while growing modestly, is confined to growth in part-time jobs. Growth in paid hours worked in 2016 so far has stalled and that combined with record low wages growth is placing a vice-like grip on growth in household disposable income and spending. 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 at least one more time. We expect the next 25bps rate cut to 1.25% to occur in early November, shortly after the Q3 CPI release in late October which we expect to confirm that inflation is still very low.