Global share markets rose strongly in April recovering much ground lost in February and March. A sense among investors that global economic growth will lift again after the minor deceleration in Q1, plus mostly strong company profit reports and signs that major central banks continue to reduce monetary accommodation at a very slow pace contributed to boosting sentiment in share markets. An apparent easing of tension on the Korean peninsula played a part in lifting sentiment too. Areas of concern for share market investors such as rising US government bond yields and a possible international trade war still flared occasionally but were calmed by strong company profit reports and encouraging forecasts of more growth in profits ahead. The Australian share market enjoyed a better month too, notwithstanding Bank Royal Commission revelations of poor business practices in the banking and insurance sectors. Better global economic growth is improving the outlook for Australian resource companies, banks have been provided with the opportunity to reform and the RBA looks set to maintain its very growth friendly 1.50% cash rate setting for a few more months.

Among the major share markets the European markets made best gains in April with Britain’s FTSE 100 up by 6.4% and the Eurostoxx 50 up by 5.2%. Japan’s Nikkei rose by 4.7% benefitting from the surprise peace overtures between North and South Korea. The US S&P 500 had the smallest gain in the month, up by 0.3%, with the market challenged at times by a sense that earnings for US companies were about as good as they could get in this cycle and that rising bond yields were placing pressure on valuations too. The Australian ASX 200 rose by 3.9% with banks recovering some ground lost from the initial shock at the extent of poor practices revealed in various testimonies to the Royal Commission. There is also a growing sense that commodity prices are starting to rise again causing positive reviews of future earnings from Australian resource companies.

Australian credit spreads narrowed over the month reflecting the more positive views in global share markets. The more positive outlook for the global economy also lifted government bond yields in April with the US 10-year Treasury yield touching 3.00% for the first time in four years at one stage. It settled back subsequently to 2.95% by month-end but was still up 21bps over the month. The US 30-year Treasury yield lifted by 15bps to 3.12%. The increases in US government bond yields in April occurred despite the Fed leaving the Funds rate unchanged at 1.75% at the May 2nd policy meeting as widely expected. The issue is that with every new sign that that the US economy is operating close to full capacity the bond market becomes more accepting of the Fed’s stated plans to keep slowly lifting the Funds rate over time. US bond yields are likely to keep stepping higher over time while the Fed continues fostering the view that Funds rate will rise eventually above 3.00% by early 2020.

Australian monetary policy is marching to a different beat compared to US monetary policy. The RBA left the cash rate at a record low 1.50% for a nineteenth consecutive month in early May. Although Australian economic growth is improving there is still plenty of spare capacity to use up before there is a flicker of a higher inflation threat. Australia’s unemployment rate has been flat-lining over recent months around 5.5 (the most recent US unemployment rate for April was an 18-year low 3.9%), still a relatively high rate compared with just under 5.0% back in May 2011 and 4.0% in mid-2008 ahead of the global financial crisis. Most estimates place Australia’s current “full-employment” unemployment rate somewhere between 4.5% and 5.0%. In other words, Australia needs strong employment growth to continue to reduce the unemployment rate and place upward pressure on wages growth. Until there are signs of more growth in wages the RBA is reluctant to change the current very growth accommodating monetary policy setting.

The difference between steadily less growth-accommodating US monetary policy and continuing very growth-accommodating Australian monetary policy led Australia’s 10-year bond yield to rise again by less than the US bond yield in April. The Australian 10-year bond yield rose by 17bps to 2.77% sitting 18bps below the US 10-year bond yield and there is a strong likelihood that gap will push beyond 50bps by the end of 2018. The loss of interest differential support for the Australian seems likely to become much more pronounced potentially promoting more bouts of weakness for the Australian dollar against the US dollar.

The RBA may need to face several issues as it tries to maintain very accommodative Australian monetary policy in the face of varying moves to normalise interest rate settings overseas. The first is the risk of a destabilised and much weaker Australian dollar exchange rate potentially lifting inflation faster and higher than the RBA is forecasting currently. A second issue is that low Australian interest rates again start to feed asset price inflation in parts of the Australian residential real estate market. A third issue is that households maintain higher levels of debt than are comfortably serviceable over the medium-to-longer term.

These are just few reasons why the RBA’s stated position that it will wait for wages to lift before hiking the cash rate is a high-risk position. Our view remains that the RBA will find enough cause in the data releases over the next few months to start hiking the cash rate in August or September.

Footnote: Author on leave for the next fortnight. The next economic report will be on Monday 28th May.