Risk assets rose strongly in November spurred on by covid-19 vaccination progress, more evidence of the strong initial rebound out of the global recession and reaffirmation by central banks that they will maintain low interest rates and liquidity support much longer into the economic recovery phase than has been the case in the past. The US election result, although messy, also boosted optimism and helped to counter the negative influence of news that the US is leading the world in new covid-19 infections and mortality.
In November, major share markets enjoyed their biggest monthly increase in over 30 years. Increases in the month ranged from 10.0% from Australia’s ASX 200 to 18.1% for Europe’s Eurostoxx50. Despite a substantial new wave of covid-19 infections in Europe and new lockdowns to combat the problem, European share markets were regarded as comparatively undervalued by investors hungry for more risk.
The US S&P 500 repeatedly hit new record highs during November and rose by 10.6% over the month. Strong US share buying was undaunted by the unusually long delay before it became apparent that Joe Biden had won the presidential race, or the roadblock his policy plans might face from what might still be a Republican Senate majority. While Senate republicans may delay and water down President-elect Biden’s stimulus spending plans, they are also likely to block any moves towards higher taxes.
Credit markets rose strongly in November still supported mainly by central banks maintaining very easy monetary conditions with no end in sight. In Australia, the biggest surprise in the economic rebound from recession has been the quick return to strong home buying activity around the nation. Potential problems for Australian banks’ housing borrowers are proving much less than feared with many borrowers returning to regular repayment schedules faster than expected and with less-than-expected negative repercussions.
More generally, Australia’s economy appears to be on the brink of starting to out-perform by international comparison. The initial rebound in GDP growth in Q3, +3.3% q-o-q, although a record quarterly rise, was much smaller than the increases recorded in the US (more than +7% q-o-q) or Europe (more than +12% q-o-q). Deeper recessions than occurred in Australia in the first-half 2020 in both the US and Europe accounted partly for the lesser Australian growth rebound in Q3. Another part of the reason for the lesser Australian growth rebound was the growth-dampening effect of the Victorian lockdown plus state border closures.
In Q4 Australia is building greater GDP growth momentum unlike the US and Europe where growth momentum is slowing even stalling under renewed restrictions aimed at containing covid-19. Australia, in contrast, has become almost free of covid-19 and has substantially reduced restrictions. Business confidence is building, and consumer sentiment is the highest in seven years. Australian households increased savings substantially during the recession and are likely to run-down savings to fund greater spending. There is already some evidence of greater spending starting to show early in Q4 with October retail sales rising 1.4% m-o-m after lifting 1.1% in September.
Australia’s deteriorating trade relationship with China means that Australian exports will be punching into a headwind, but there are other factors helping to offset. Global economic recovery is helping to underpin rural and mineral commodity prices and is helping to prime demand in markets outside China. Also, Australia is mostly enjoying better rural seasonal conditions and output lifting supply of rural exports.
Net exports detracted 1.9 percentage points from Q3 GDP growth, but on the early evidence of a large lift in the October trade surplus to $7.5 billion, it is likely that net exports will detract much less from Q4 GDP growth and may even make a positive contribution. However, it is domestic spending by Australian households and businesses that are likely to make an even stronger growth contribution in Q4 than in Q3.
The likely lift in domestic spending in Q4 is still essentially underpinned by very easy monetary conditions and Government stimulus spending. The shape of stimulus spending continues to change 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 could start to show in Q1 2021. How extensive the negative impact will be is still difficult to predict. There are, however, increasing signs it could be very little with growth momentum in Q4 firing up jobs growth and optimism encouraging households to rundown savings and spend.
The RBA has been surprised by the initially strong growth recovery from recession and upgraded its economic growth forecasts again in the latest quarterly Monetary Policy Statement published in early November. The RBA still 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. After cutting its main interest rate targets, including the cash rate, to 0.10% at its November policy meeting and introducing QE purchases of longer-dated bonds the RBA left policy settings unchanged at its early-December meeting. RBA commentaries continue to stress that low interest rates and easy monetary conditions will persist for at least three years and well into the period when the economy is growing strongly.
Persistently easy monetary conditions are helping to contain the rise that might normally be expected in economies running to stronger economic growth with investors asset-allocating in favour of risk assets. In November the US 10-year bond yield fell by 2 basis points (bps) to 0.85% while the 30-year Treasury yield fell by 8bps to 1.58%. Australia’s relatively greater economic growth factors saw its 10-year bond yield lift by 7bps to 0.89% although any further increases are likely to be met by the RBA increasing its QE purchases. Relatively high Australian longer-dated bond yields are a factor, together with high commodity prices, driving up the Australian dollar exchange rate. An appreciating currency is an unwelcome development in efforts to drive stronger Australian economic growth.