Volatile trading was the main feature of trading in most major share markets in November with big daily movements down and up. Share market movements in the major markets in November ranged from a 2.0% gain for Japan’s Nikkei to a 2.8% fall for Australia’s ASX 200. The US S&P 500 after falling sharply early in the month ended the month up by 1.8%. The late month recovery was driven by signs that the US Federal Reserve (Fed) might hike the Funds rate by less and more slowly than previously announced. At the beginning of December, the announcement of a pause in the trade war between the US and China after talks between President Trump and President Xi at the G20 meeting in Argentina provided another boost to share market sentiment. Two of the major concerns besetting global share markets – rising US interest rates and rising international trade tensions – have been tempered for the time being allowing investors to start to focus again on what are still mostly relatively strong economic growth readings, especially in the United States and increasingly in Australia.

The better news on US rates and international trade came too late to prevent deterioration in credit markets in November. Negativity in Australian credit markets was reinforced as spreads on bank credit widened, not reflecting any fundamental weakness but rather recognition of the sharply higher future capital raisings the banks will need to meet much more conservative capital ratios in a post-Hayne-Royal- Commission environment.

Government bond markets, in contrast to credit, rallied in November, led by falling US bond yields. Through much of November the weakness in risk asset markets drove safe-haven buying and asset allocation shifts in favour of government bonds. The news late in November that the earlier Fed policy meeting had discussed the possibility that the Federal funds rate at its current 2% to 2.25% being “close to the neutral rate” implying less need to lift rates beyond December also helped the US bond market to rally. The US 10-year bond yield fell by 15bps in November to 2.99% while the 30-year Treasury yield fell by 10bps to 3.29%.

The Fed last hiked the cash rate 25bps to 2.00 to 2.25% range back at its September policy meeting. It meets again this week but will wait probably until its meeting in December before hiking again. The Fed has also indicated another three hikes are likely in 2019.

Falling US bond yields in November also helped to generate a small rally in Australian bonds with the 10-year bond yield falling by 4bps to 2.59%. Interestingly, the gap between US and Australian 10-year bond yields that widened out to more than -50bps at one point came in to -40bps at the end of November. This narrowing in the negative yield spread between the Australian 10-year bond and its US counterpart is likely to be reinforced if the US Fed announces a slowing or a pause in its rate hiking program at the mid-December Fed policy meeting as it will reinforce what has been a subtle change in the relative monetary policy positions of the US Fed and the RBA in November.

In November, the RBA left the cash rate unchanged at 1.50% and is still indicating no intention to hike in the near term. However, the RBA also upgraded key Australian growth and inflation forecasts in the quarterly Monetary Policy Statement released just after the November policy meeting and reaffirmed that the next monetary move is likely to be a rate hike. The RBA effectively firmed its commitment to hike the cash rate at some point in all the various statements and speeches in November and at the same time Australian economic data readings in the month were mostly strong, confirming why the RBA is slowly developing a bias to tighten monetary policy.

In contrast the US Fed has been hiking rates for three years and is approaching a point where it is about to pause, or develop, a relatively easier policy stance than it has pursued through 2017 and 2018 so far. The factors driving these changes in Fed and RBA monetary policy intentions look set to continue over the next few months implying that if the US bond market rally extends in the near -term whatever rally follows in Australian bond yields will be relatively less pronounced.

Looking more specifically at the factors influencing Australian monetary policy while already strong growth in the Australian economy is gaining momentum, there are still some soft patches. The most notable soft patch is the down-turn in housing activity and house prices that is being reinforced by tightening bank credit; reduced growth in immigration; and a marked reduction in demand by foreign investors for Australian residential real estate. The weakness in housing if it escalates has the potential to reduce growth in demand in a key part of the economy, household consumer spending. Yet at present, the weakness in housing is only serving to ensure that the Australian economy does not grow too fast. The strength of the labour market (more than 300,000 jobs added over the past year and the unemployment rate down to a six-year low 5.0%) provides strong evidence that non-housing parts of the Australian economy are growing fast enough to swamp the impact of weakness in housing activity.

If the strength of the non-housing parts of the economy continues, as seems likely in our view, at some point that strength will spill over in to renewed demand for housing. Our view is that the softness in housing may not persist much beyond mid-2019 and the RBA cannot leave the emergency low 1.50% cash rate in place once Australian growth is firing on all cylinders. Our view is that the first RBA cash rate hike will occur in the first half of 2019.