Most risk asset markets including major share markets rose strongly in January casting off the gloom besetting markets in the closing months of 2018. The fear factors prominent before Christmas 2018 – the risk of the US Federal Reserve pushing interest rates too high and an escalating trade war between the US and China – both receded in January. The Fed’s January policy meeting left rates unchanged but importantly with an accompanying message that the Fed would be “patient” lifting rates, a strong signal that the Fed is on an extended rate pause. On the trade war the news was promising too with indications that negotiations between the US and China were progressing providing hope that a bi-lateral trade agreement may be reached before long. Another important contributor to improving market sentiment in January was evidence that growth in the US was proving resilient and that growth in China, although moderating was showing no signs of a sharp pull-back feared by some analysts.
Major share markets all showed strong gains in January ranging from 3.6% for Britain’s FTSE 100 to 7.9% for the US S&P 500. Australia’s ASX 200 gained 3.9% in January despite continuing selling pressure in financial stocks ahead of the release of the final report of the Hayne Banking Royal Commission. Mining stocks, in contrast were much stronger reflecting strong increases in mineral resource prices and another sign that the outlook for global economic growth is brighter than indicated in some analysts’ gloomy forecasts.
The strength in global share markets also carried across in to credit markets in January. Spreads on Australian bank credit narrowed and retraced a little of the blow-out in the closing months of 2018. The final report of the Hayne Banking Royal Commission is due for public release today and may still contain findings and recommendations capable of pushing bank credit spreads wider, but the reaction is likely to prove temporary given a world where investors seem to be adopting a more positive view of risk markets in general.
Often when risk assets rally strongly Government bond markets are a casualty as a brighter view of growth prospects causes bond yields to rise. In January, it was more a case that an overly gloomy view of global growth prospects had lifted to a less gloomy view. Part of the reason why the view had become less gloomy surrounded expectations of Fed rate policy changing from the Fed pushing rates up too much causing US growth to weaken to the Fed leaving rates on hold permitting reasonable US economic growth to be sustained for longer. Stable Fed policy and no imminent risk of runaway US economic growth allowed the US bond market to consolidate the big rally in December.
In January, the US 10-year bond yield fell by 5 basis points (bps) to 2.63% extending the 30bps rally in December. The 30-year Treasury yield fell 1 bps to 3.00% consolidating the 28bps rally in December. Whether lower US bond yields can be sustained will depend in part upon how long US economic conditions permit the Fed to stay on policy hold.
While current US economic readings point on balance to resilient US economic growth (Q4 GDP growth due this week is expected to come in around 2.6% annualised from 3.4% in Q3), there is likely to be a patch of softer readings through Q1 relating to the impact of the US Government shutdown as well as unusually severe winter weather conditions. The US Q1 GDP reading due in late April will almost certainly be quite weak, but with a relatively strong probability that Q2 GDP due in late July will be quite strong resetting the dial to conditions capable of lifting US inflation.
On this outlook for US GDP growth the Fed will almost certainly remain on hold throughout the first half of 2019 and will not start to consider a resumption of rate hikes until late Q3 at earliest. Six months at least of steady. “patient” Fed policy leaves room for US bond yields to move even lower.
In Australia, the data through January has remained consistent with mixed-strength economic activity. Housing remains weak and seems unlikely to base in the near-term given tight housing credit conditions, weak foreign investor demand and a federal election probably in May and where the most likely outcome is a change to a Government committed to reducing the tax concessions applying to investors in housing.
Australian exports, in contrast, are strong aided by prices that lifted 3.7% q-o-q in Q3 2018 and a further 4.4% q-o-q in Q4. Mining investment is lifting. Engineering construction spending generally is lifting strongly. Household consumption spending firmed in Q4 and employment growth is very strong promoting 40-year low unemployment rates in New South Wales and Victoria.
So far, Australian growth has not primed inflation, although the latest CPI report for Q4 2018 held the first hints that inflation may no longer be falling. The 0.5% q-o-q, 1.8% y-o-y headline CPI result was the first to beat market consensus expectations in two years.
Mixed Australian economic readings in January reinforced the reasons why the RBA has been on lengthy policy hold and why it is likely to stay on hold for probably all 2019 as well. Australian government bond yields followed US bond yields lower in January. The 10-year bond yield rallied 7bps to 2.24% after rallying 28bps in December. Australian bond yields may move even lower over the next few months.
At this stage, the next policy move by the RBA looks likely to occur in early 2020 and is still more likely to be a rate hike rather than a rate cut. A slow pick-up in wages growth plus a relatively soft Australian dollar exchange rate are factors that are likely to generate a lift in annual inflation towards the middle of the RBA’s 2-3% range by late 2019, a key reason why the RBA is likely to start hiking rates in 2020.