Risk assets strengthened in November with the US share market pushing up to a new record high in the month on signs that US growth may strengthen plus confidence that interest rates will stay low and that the US and China are closing in on a trade deal. Risk assets were also helped by firmer leading indicators of manufacturing activity in Europe and Asia, confidence that no major central bank will be tightening monetary policy in the foreseeable future and some lessening of political tension around Brexit with the announcement of a British General Election to be held on December 12th. While political tension remained high through November in several other regions, notably in Hong Kong, signs of a brightening global economic growth outlook won the day in terms of underpinning risk appetite in financial markets during November and may hold sway too in December.
Among major share markets gains in November ranged from 1.4% for Britain’s FTSE 100 to 2.9% for Germany’s DAX. The US S&P 500 rose 2.2% in the month repeatedly making new record highs during the month. Australia’s ASX 200, notwithstanding a difficult month for major bank stocks, lifted by 2.7% and is trading near a record high.
The key factors powering the rally in global share markets – prospects of improving economic growth increasingly supported by easy monetary conditions and more government spending support – are also serving to subdue credit risks for the time being, even in sectors where the level of borrowings on some measures appear unsustainably high. Australian credit rallied strongly in November.
Government bond markets mostly continued to reflect a world where growth is likely to improve but also a world where inflation pressure is still subdued and central banks are likely to keep official rates low. Longer-term bond yields mostly rose slightly in November while shorter-term bond yields continued to edge lower. In November, the US 10-year bond yield rose by 9 basis points (bps) to 1.78% while the 30-year Treasury yield rose by 3bps to 2.21%.
The Federal Reserve (Fed) has reduced its funds rate three times in the current easing cycle with each instalment 25bps and the most recent delivered in late October. Senior Fed officials, including Chairman Jerome Powell, are now indicating a pause before the Fed’s next move reflecting that notwithstanding some risks to the US economy from the trade dispute with China and elevated international political risks the domestic economy in the US is in good shape supported by strong household spending underpinned by factors such as the tight labour market and rising asset prices supporting growth in household income and wealth.
Although the US growth outlook is brightening it is not likely in the near or medium-term to place undue upward pressure on inflation. As a result, while better growth is likely to place some further upward pressure on longer-term US bond yields it is unlikely that US bond yields will push up far. One key factor limiting how far the upward correction in US bond yields will go is the outlook for Fed policy action. It will take a lot more growth in the US economy and a clear threat of higher US inflation before the Fed is likely to consider lifting the Fed funds rate. At this stage, there is no likelihood of the Fed hiking the funds rate in 2020, but there is some possibility that it could cut the funds rate again.
Australian government bond yields are showing signs of marching to a different beat from their US counterparts. The 10-year bond yield fell by 11bps to 1.03%. Notwithstanding the evidence from quarterly GDP reports that the weakest point for growth was in the second half of 2018 (annualised growth only 0.8%) and there has been some improvement in the first half of 2019 (annualised growth 2.0%), there remains concern that household spending representing more than 60% of spending in the economy is growing too weakly to sustain improvement in GDP growth. Australia is different from the US in this regard where in the US household spending is growing strongly and has plenty underpinning further growth.
In Australia, wages growth remains comparatively soft (down to 2.2% y-o-y in Q3 from 2.3% in Q2) and looks set to stay soft with supply of labour rising at least as fast as demand. Australian households are also much more heavily indebted on every measure compared with their US counterparts placing them more at risk of trying to save more rather than spend more freely. In essence, the RBA’s three cash rate cuts this year to 0.75%, the Government’s tax cuts plus its recent promise to bring forward more than $A 4 billion of “shovel-ready” infrastructure spending are designed to help reduce household debt-servicing burden and lift employment and household income. There is a good chance that growth in Australian household spending will gather pace but it much less certain than US household spending continuing to grow at pace.
This key difference between Australia’s economic outlook and that of the United States means that it is more likely that RBA will lower the cash rate further in 2020 than it is that the Fed will cut further. As a result, Australian bond yields are more likely to stay low compared with their US counterparts. The base case for Australian growth is still that it continues to slowly pick up pace (housing indicators continue to look more promising) but the RBA will want to see the proof before committing to changing the cash rate again. Most likely the RBA will cut the cash rate once more to 0.50% at some point in 2020.