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Risk Assets started July on a strong note but weakened later in the month, notably in Europe and the United States leading to very mixed performances over the month. During July, US economic indicators were consistent with moderate economic growth but geopolitical events proved unsettling for risk markets which, after the rally over recent years, had become priced for close to perfect conditions. European markets suffered from the increasing likelihood of stronger economic sanctions against Russia after the downing of flight MH17 in Eastern Ukraine. China, in contrast, sidestepped geopolitical issues and showed signs of strengthening economic growth assisting its sharemarket. Australian risk assets were more influenced by positive developments in China. Major equity markets responded to the different influence. The US S&P 500 fell by 1.5%, while in Europe, the British FTSE 100 was down by 0.2% and the German DAX fell by 4.3%. In the Asia-Pacific region the late month sell-off was less pronounced and Japan’s Nikkei finished the month up by 3.0% and the Australian equity market was a star performer with the ASX 200 up by 4.4%.

Credit markets mostly rallied through the first half of July but retreated sharply late in the month taking a lead from the late month selling in sharemarkets. In interest rate markets more generally the main influence remains that major central banks are showing no signs of starting to lift their official rates. In the US, the Federal Reserve continued to wind back its asset purchase programme or quantitative easing at its July policy meeting by another $US10 billion to $US25billion marking the sixth consecutive reduction in purchases. However, the Fed continues to indicate that its funds rate will stay at zero until at least 2015. The Reserve Bank of Australia again left the cash rate on hold at 2.50% at its early July policy meeting and continues to advise an extended period of rate stability ahead. US 10 year and 30 year treasury yields finished July at respectively 2.56% and 3.32%, 4 basis points (bp) higher and 3bp lower respectively than at the end of June. The Australian 10 year bond yield, in contrast to the US bond market, continued to rally, falling by 4bp and finishing July at 3.50% with foreign investors, in particular, still attracted by Australia’s comparatively high government bond yields and AAA credit rating.

On the economic data front, US indicators showed a strong growth rebound in Q2 GDP with 4.0% annualized growth from -2.1% in Q1. Beyond Q2 manufacturing and services sector activity both look strong with purchasing manager index readings above 56. Non-farm payrolls continue to lift at more than 200,000 a month, but indicators of housing activity have taken a softer turn. The not too strong/not too soft US economic recovery implies accommodating Fed monetary policy well in to 2015. China’s leading economic indicators, in contrast moved firmly into expansionary territory in July implying that better-than-expected 7.5% y-o-y Q2 GDP growth could lift further in Q3. In Europe, economic readings were mixed. Encouragingly, unemployment is falling more than generally expected, but industrial production has faltered and annual inflation has softened to only 0.4% y-o-y in July which may lead the ECB to ease monetary policy further over coming months. In Australia, economic readings are pointing to weaker GDP growth in Q2 than in Q1. The unemployment rate edged up to 6.0% in June and although annual inflation touched 3.0% y-o-y in Q2, the RBA is likely to continue to forecast rather lower inflation over the next two years.

Looking ahead, economic growth still looks set to improve through the second half of 2014 in the US, China and Europe and assisted possibly by further easing of monetary policy in Europe. In Australia, the headwind to growth from the Federal Budget announced in May together with signs that annual inflation should edge lower from its relatively elevated reading in Q2, imply that the RBA is very firmly on monetary policy hold. Low interest rates should help to foster greater household spending, but the precise timing of the improvement is tricky. The RBA is unlikely to move its cash rate before Q1 2015, when we expect a modest hiking cycle to begin.