Risk assets mostly fell in October as covid-19 infection rates rose sharply in the US and Europe and amid rising uncertainty running towards the US presidential election. While Q3 GDP reports from the US and Europe showed record increases, there was a perception in markets that setbacks to strong growth will follow in Q4 amid doubts about post-election US economic prospects in the event of close or contested election results and concern about new shutdown measures aimed at containing the resurgence of covid-19 in Europe.
In October, most major share markets fell between 0.9% for Japan’s Nikkei and 9.4% for Germany’s DAX. The US S&P 500 fell by 2.8%. Australia’s ASX 200 was a rare exception to the falls, rising by 1.9%. Australia’s outstanding performance keeping covid-19 infections low and in the case of Victoria providing a rare example of containment of a second wave of infections stood out by international comparison. The slow easing of covid-19 restrictions and hopes of a sustainable economic recovery in Australia also marked it out from rising uncertainty surrounding the US economic outlook and sharply increasing downside risks to European growth prospects as it re-enters shutdowns.
Credit markets held up in October supported mainly by central banks maintaining very easy monetary conditions with no end in sight. In Australia, the feared negative credit consequences of banks starting to cut back home loan repayment holidays diminished with evidence that customers returning to regular repayments was occurring relatively fast and without undue adverse consequences so far. Australian housing activity generally continued to show greater resilience through October than earlier forecast by banks with several upgrading their housing forecasts.
Australian economic performance is likely to diverge from international experience through the remainder of 2020. Australian Q3 GDP when it is released in early December, will not show as big a lift as occurred in the US (+33.1% annualised, compared with –31.4% in Q2) or in Europe (+12.7% q-o-q, compared with –11.8% in Q2) partly because Australia’s GDP fall in Q2 was not as big (-7.0% q-o-q) but also because the Q3 rebound is likely to be flattened by Victoria’s shutdown. However, Q4 GDP growth in Australia with Victoria coming out of shutdown is shaping up to be much stronger than in the US or Europe.
There will be more sense of sustainable economic recovery from recession in Australia than in the US or Europe in Q4. Beyond Q4 2020, although Australia’s economic recovery will still be underpinned by very easy monetary conditions and Government stimulus spending, the shape of stimulus spending is changing with much less emphasis on direct household income support. Work Keeper and Work Seeker payments stepped lower at the end of September and step down again at the end of December.
The potentially negative impact of these two reductions in income support on household spending are likely to show in Q1 2021. How extensive the negative impact will be is difficult to predict. It could be very little if the growth momentum in Q4 fires up jobs growth and optimism encouraging households to rundown savings and spend. But It could also turn out to be a very large negative impact if households lose confidence and try to save more as income support steps down.
The RBA recognises that economic forecasts are subject to a much higher than usual degree of uncertainty in the current environment. What is certain is that Australia has been through a deep recession that has added substantially to spare capacity and pushed any meaningful lift in inflation much further into the future. Heightened economic forecasting uncertainty plus the lack of inflation pressure for possibly years to come give the RBA cause to provide as much monetary support to the economy as it can without straying into territory that may prove counter-productive in allowing banks to take deposits and lend.
Through October the RBA has provided guidance in commentaries and speeches that it intends to lower interest rate a little further. The Australian bond market has been increasingly working on the assumption that the RBA will cut the cash rate and its target for the three-year bond yield by 15bps to 0.10% at the 3rd November RBA board meeting. The three-year bond yield has rallied close to that point while over the month the dynamic for longer-term bonds has been different. The large expansion in the Government’s budget deficit and borrowing demands announced in the early October Budget plus signs of better-than-expected economic growth saw the 10-year bond yield edge up by 1bp to 0.82%.
The small rise in the Australian 10-year bond yield, however, was noticeably less than the rise in US yields where the 10-year bond yield rose by 19bps to 0.87% and the 30-year Treasury yield rose by 20bps to 1.66%. Even though the Federal Reserve continued to reassure that near-zero official interest rates and near-limitless quantitative easing will persist the strong bounce in the US economy worked against low bond yields. The current uncertainty swirling around the US election and the aftermath and downside risks to the US economic outlook may see a return of safe-haven bond buying at least for a period until it becomes clearer whether US economic recovery can return on track.