Risk assets have been on a roller-coaster ride through September and the first week of October with the ups coinciding with signs that the global economy is not weakening as much as feared and the downs driven by signs pointing to the opposite. Through much of September US economic data surprises were mostly on the upside of expectations. The surprises in the first few days of October, however, were mostly to the downside until the release of the US September non-farm payrolls highlighting that it is hard for the US to fall into recession when the unemployment rate is down to a 50-year low 3.5%. International events and heightened political uncertainty also influenced markets briefly in September – erratically hot and cold trade talks between the US and China; impeachment proceedings starting against President Trump; the bombing of Saudi Arabian oil refining facilities; increasing Brexit uncertainty – to name just a few. At the same time, central banks made it very clear that they will ease monetary conditions with rate cuts and policy easing by the US Federal Reserve, the Peoples’ Bank of China; and the European Central Bank in September and by the RBA at the beginning of October.
On balance, the conflicting influences on risk assets we believe still point to improvement mostly because of the determination of central banks to sustain very low interest rates. It is also reasonable to expect progress to be volatile given the conflict in particularly the US economy between strong domestic spending and weakness in the internationally facing and supplied parts of the economy.
Returning to the month of September, major share markets mostly recovered the losses incurred in August. Gains in the month ranged between 0.2% for Japan’s Nikkei to 4.2% for the Eurostoxx 50. The US S&P 500 rose by 1.7% and Australia’s ASX 200 was up by 1.3%. However, the September share market gains were almost wiped out in the first three trading days of October mostly on weaker than expected US and European manufacturing sector purchasing manager reports signalling damage to global growth prospects from the US/ China trade war and potential escalation to a US/ EU trade war. A partial recovery of the early-October share market losses occurred with the release of the US September non-farm payroll report showing moderate employment growth and very low unemployment calling into question whether US economic growth prospects and by extension global growth prospects are as weak as sometimes feared in the market.
Australian credit markets softened a little during September taking little heart from the improvement in the share market. Essentially still soft growth in bank lending and credit is one of several factors causing the RBA to lower the official cash rate. After back-to-back 25bps cash rate cuts in June and July and then a pause in August and September the RBA cut another 25bps at the early October policy meeting to a record low 0.75%. The RBA is also indicating the possibility of further easing ahead.
Apart from still soft growth bank lending the RBA is cutting the cash rate primarily to try and boost economic growth to a point where employment growth exceeds the rapid growth in labour supply and starts to reduce the unemployment rate and eventually increase the pace of wages growth to a point that helps to underpin better growth in household spending. Stronger wages growth will also help to lift inflation inside the RBA’s 2-3% target band, still a very useful indicator of an economy growing sustainably well.
From the RBA’s point of view promoting very low Australian interest also helps to ensure that Australian interest rates are not out of step with interest rate developments overseas that might threaten an unwanted over-valuation of the Australian dollar exchange rate.
Another reason for unusually low interest rates is that several factors over the past few years are serving to drive up saving in Australia (across government, businesses and households) relative to investment. Among those factors are the ageing population as well as Governments at all levels in Australia aiming for budget balance and surplus trying to save more at a time when a reduction in saving could prove better for longer-term growth prospects. The RBA wants to see more investment relative to saving and very low interest rates help to shift that balance.
The lower-for-longer theme for interest rates although well-entrenched seemed to wobble in September when bond yields rose a little in the US and in Australia. The US 10-year bond yield rose 16bps to 1.66% in September while the 30-year Treasury yield rose by 15bps to 2.11%. The Australian 10-year bond yield rose by 13bps to 1.01% in September notwithstanding market expectations of an early-October RBA cash rate cut. Bond yields have retraced most of the September rise in the first week of October.
One near certainty for bond markets is that central banks look set to continue cutting official interest rates where they can. Our RBA rate view changed during September from expecting the cash rate to be stable at 1.00% to a 25bps cut in October (delivered) and another 25bps cut to 0.50% early in 2020. We changed view because the RBA made it plain in commentaries the reasons that they were likely to cut further. The rise in the unemployment rate in August to 5.3% and a clear turn down in August official job vacancies made it clear that at least one of the RBA’s reasons to cut rates was a pressing reason. At this stage, our latest RBA rate call is more of a minimum policy easing expectation by the RBA rather than the maximum that might occur. With this cash rate outlook, there is little reason for Australian longer-term bond yields to push up other than temporarily. There are increasingly good reasons for the Government to borrow more at low rates to invest at relatively higher rates of return, but until this happens it is unlikely that the long- term decline in interest rates will end.