Risk assets were mostly stronger in March although with greater volatility later in the month amid growing doubts about the ability of President Trump to deliver his promised fiscal expansion as well as amid shifting views about the US Federal Reserve’s rate hiking intentions. One positive driving force for risk assets was further indications that global economic growth was gathering pace and on a broader front. The threat of Brexit-like populist politics spreading to continental Europe seemed to reduce after the Dutch election resulted in a swing towards the government and away from populists. European share markets rose very strongly in March with the Eurostoxx 50 index up by 5.5%. Australia’s ASX 200 also fared well amid signs of firm growth in China and rose by 2.7%. Swinging investor sentiment left the US S&P 500 index virtually unchanged over the month while worst performer was Japan’s Nikkei softened by flaring tensions relating to North Korea and down by 1.1%.

Australian credit spreads continued to tighten over the month assisted by mostly strong profit reports from Australian companies as well as the quite strong rally in the Australian share market. Government bond yields rose early in the month, but then rallied mostly, especially after the US Federal Reserve delivered a very widely expected 25bps hike in its funds rate to 1.00%. The seemingly perverse bond market reaction to the Fed’s rate hike was driven by the accompanying statement and economic forecasts which made it plain that the Fed would not be seeking to do more than another two rate hikes this year. Subsequent comments by senior Fed officials hinted that two rate hikes may even turn to one given a heightened degree of uncertainty about the outlook for financial markets and the economy. The US 10-year bond yield fell in March by 2bps to 2.39%, while the 30-year Treasury yield rose by 1bp to 3.01%. The Australian 10-year bond yield fell by 3bps in March to 2.69%.

Returning to factors influencing US financial markets, the strong reflation-based rally in shares post Trump-election victory continues to show signs of becoming more erratic in line with signs that President Trump is struggling to guide his legislative program through Congress. One key change to replace Obamacare had to be abandoned when it became clear that President Trump faced not only total opposition from the minority Democrats in both legislative houses, but also opposition from a proportion of the Republicans too. While doubts are increasing about President Trump’s ability to push through his tax cutting and increased government spending plans, what is in less doubt is that the US economy is continuing to strengthen. Final Q4 GDP was revised up to 2.1% annualised growth from 1.9% previously and most indicators point to at least that growth in Q1 too notwithstanding the growth-crimping effect from unusually severe winter weather at times.

Recent indicators at the leading edge of US economic activity have strengthened across a broad front. The February readings of the National Association of Homebuilders index – up to 71 from 65 in January – and pending home sales, up 5.5% m-o-m both point to strong growth momentum in housing activity. The jump in consumer confidence in March to 125.6 from an already strong 116.1 in February points to a strong likelihood that consumer spending will accelerate. Durable goods orders rose in February by 1.7% m-o-m, after lifting by 2.3% in January, a sign of rising business investment spending. At the same time elevated purchasing manager index readings in both manufacturing and non-manufacturing point to strongly improving business conditions and that reflected in strong labour demand evident in non-farm payrolls rising by more than 230,000 in both January and February. The US economy growing well is using up spare capacity fast pointing to risk of higher inflation later in the year. We see the Fed becoming more hawkish in its comments before long and we see two rate in the remainder of the year increasingly being viewed by the market as a minimum rather than a maximum placing upside pressure from time-to-time on US bond and Treasury yields.

In China, while the Peoples’ Bank of China has edged towards tightening policy with two rounds in February and March of mostly 10bps increases to some of its official interest rates, it is unlikely that the policy tightening cycle will be more than modest in scale. China is trying to achieve a difficult economic policy balancing act. It wants to sustain stable GDP growth around 6.5%, a target reaffirmed at the start of the latest Peoples’ Congress meeting, while at the same time progressing a number of economic reforms – tempering excessive residential property construction and speculation; improving the quality of bank lending; winding out the worst, most inefficient State-Owned Enterprises; closing the heaviest polluting industries and becoming greener – that would seem to mean weaker growth for a period. In the near-term, however, the numbers are pointing to firm economic growth and it seems likely that the mid-April release of Q1 GDP will show growth around 6.8% y-o-y and touch firmer than the average 6.7% y-o-y through 2016.

In Europe, some near-term political uncertainty diminished when the Dutch election delivered a set-back to populist candidates and after the UK Government invoked Article 50 starting divorce proceedings with the EU. Both the Dutch election result and the spectacle of what lies ahead for Britain – two-years of exhausting negotiations on terms of dis-engagement and re-engagement with the EU – both make it less likely that other member countries will seek to break from the EU. Meantime, the Europe’s economic readings mostly continue to improve and leading economic indicators, especially business purchasing manager indices, point to accelerating growth. Europe still faces problems – managing Greek sovereign debt restructuring is back on the radar – but the problems are potentially easier to manage as the region experiences stronger economic growth.

The Australian economy, rebounded sharply in Q4 2016 with real GDP growth up by 1.1% q-o-q, 2.4% y-o-y after -0.5% q-o-q, +1.9% y-o-y in Q3. Just about everything that weakened in Q3 strengthened in Q4 including housing activity, government spending, business investment and net exports. The stronger quarter was funded in large part by the household sector running down its savings (borrowing even more). Wages growth was a notable weak part of the Q4 GDP report falling 0.5% q-o-q in real terms. Whether the household sector can continue grow its spending on housing and consumer goods and services given weak income growth is becoming an issue. Also there is the associated question of whether extremely high levels of household debt could become a major future constraint on economic growth?

Increasingly, the RBA and APRA are viewing the continuing housing boom in Sydney and Melbourne as the equivalent of a two-edged sword. The continuing boom serves to boost household wealth encouraging much- needed consumer spending and at a time when it might otherwise be compromised by very weak growth in wages. The boom in house prices is also encouraging an already very heavily indebted household sector to borrow even more and especially to fund investment in housing on the assumption that further increases in house prices will compensate for very poor yield on housing investment. Left unchecked the borrowing activity of households could cause an even more inflated house price boom which when it busts would cause near panic selling by the most over-leveraged investors leading to stains on banks and plummeting the economy in to a deep recession.

A priority for the RBA and APRA is to try and promote an orderly topping out of the home boom. Initially APRA has taken steps over recent months to place speed limits on growth in investment loans extended by banks and most recently a tighter speed limit on growth in interest-only loans. The APRA moves add to incentives for banks to lift interest rates on housing investment loans. Meantime, the RBA remains reluctant to fire a big gun at the housing boom – a cash rate hike – because firstly, the general inflation rate is still low and does not warrant a rate hike and secondly, too big and general a lift in interest rates could generate too sharp a turn in home buying possibly generating the recession that the RBA wants to avoid.

Over this past month as the RBA has started to worry aloud the high level of household indebtedness and its continuing rapid growth, Australia’s interest rate outlook has become more complicated. Very low inflation should imply no change in the cash rate this year. If, however, APRA regulatory changes fail to contain growth in investment home loans there is a growing possibility that the RBA could hike the cash rate 25bps to 1.75% late in 2017.