Risk assets fell in August in volatile trading day-to-day but by month-end were trading above their lowest levels. Longer term government bond yields fell further during the month and in the US the inverse yield curve regarded as a harbinger of recession with long term yields sitting below short-term yields became more entrenched. Yet the US economy continues growing and readings related to US household spending, the bedrock of US GDP growth, remained very strong in August. Much of the volatility in risk asset trading reflects heightened economic uncertainty caused by the erratic escalation of the US/ China tariff war and President Trump intensifying pressure on the Federal Reserve to act as he wants rather than according to their view of US economic prospects. Neither the tariff war or presidential pressure on the Fed look like diminishing in the near- term keeping risk asset markets uncertain and volatile.
Returning to the month of August, major share markets fell between 1.2% for the Eurostoxx 50 and 5.0% for Britain’s FTSE 100, where the likelihood escalated of Britain falling out of the EU without a deal at the end of October. Australia’s ASX 200 was down by 3.1% in August as major China export companies came under consistent selling pressure amid evidence of damage to China’s economy from the tariff war. The monthly fall in the ASX 200 in August, however, was the first this year coming after seven consecutive monthly increases. The US S&P 500, after a few very big daily losses in August finished the month down 1.8% after a strong rally in the last week of the month generated by more conciliatory comments by President Trump on the tariff war at and after the late-August G7 meeting in France.
Australian credit markets weakened in August and while at times taking their lead from share markets are proving less volatile. The RBA, after cutting the cash rate by 25bps each time in both June and July to 1.00% paused at its August meeting just ahead of issuing its latest economic forecasts in the August Monetary Policy Statement. The tenor of the RBA’s latest economic forecasts are slow gradually improving economic growth through the rest of this year 2020 and 2021 but with unemployment slow to fall, wages growth taking more time to lift and annual inflation barely rising above the bottom of the RBA’s 2-3% target range by the end of the forecast period in 2021. The latest RBA forecasts and subsequent comments by senior RBA officials make it plain that the RBA is prepared to cut the cash rate further in need.
The RBA is also making it plain, however, that there are limits to what cutting the cash rate can achieve in isolation and that other policy measures, notably more government infrastructure spending targeted at improving productivity would be more effective promoting growth, lifting wages and reducing unemployment. So far, the Government is resisting calls for more spending, instead highlighting its plan to balance the budget and start reducing government debt.
The reluctance for the government to spend more if it means incurring more debt coincides with slow growth in household and business borrowing. The net result is that in Q2 2019 it is likely that Australia generated more new saving than new investment spending for the first time in more than 40 years resulting in a current account surplus on balance of payments. The Q2 current account surplus (data release tomorrow) is a marker of soft growth in Australian domestic spending to the point where Australia has become a net lender of surplus savings to the rest of the world.
The weakness in growth in Australian domestic spending is keeping the RBA primed to cut the cash rate further even though it believes that more policy easing will achieve relatively little. The local bond market continues to rally even though there is no certainty that the RBA will cut rates again quickly. The 10-year bond yield fell 30 basis points (bps) to 0.88% in August, 12bps below the official cash rates. Interestingly, bond yields in the US fell more than in Australia in August even though domestic spending growth is stronger in the US than in Australia. The US 10-year bond yield fell 51bps to 1.50%, while the 30-year treasury yield fell 56bps to 1.96%. Both yields sit well below the 2.25% Fed funds rate.
In broad terms, bond markets are betting that weaker economic growth prospects will force central banks to lower official cash rates substantially. More specifically bond market at current very low long-term yields are betting against strong US household spending persisting; against any resolution of the US/ China trade war; against any significant lift in government spending and borrowing in any major economy and in Australia against the promising signs of rising home sales and prices gaining traction and any improvement in domestic spending. The bond market bet is looking stretched, but it has looked stretched for some time.
Our view remains that there is no immediately pressing need for the RBA to cut the cash rate further. We expect the cash rate to stay at 1.00% until there are far more signals of need to change rates from GDP growth, unemployment, wages growth and inflation.