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Risk Assets were very mixed in September, although Australian risk assets weakened sharply amid concerns about weak industrial commodity prices, possible restrictions on the booming residential investment property market, and a weaker Australian dollar as foreign investors became relatively pessimistic on Australian investment opportunities. Through September, US economic readings were mixed, but still consistent with moderate economic growth and the Federal Reserve (Fed) at its policy meeting provided mixed messages on the outlook for US interest rates. China’s economic readings mostly exhibited a softer edge, but elsewhere in Asia, Japan took a stronger turn. European economic readings remained comparatively weak and the European Central Bank (ECB) cut its interest rates further into negative territory at its September meeting. The ASX 200 was down by 5.9% over the month, far exceeding the 1.6% fall in the US S&P 500. The European Eurostoxx 50 index actually rose in the month, by 1.7%, and Japan’s Nikkei lifted by 4.9%.

Credit markets tracked the gyrations in equity markets through the month. The Australian credit market gave up ground in September reflecting the under-performance of the Australian share market. In interest rate markets more generally, yields lifted in September starting to reflect the likelihood that the US Fed may start the process of lifting its funds rate from near-zero earlier rather than later in 2015. The move by the ECB cutting its official interest rates early in the month served to highlight divergent monetary policy trends around the world. The Reserve Bank of Australia again left the cash rate on hold at 2.50% at its early September policy meeting with indication of stable rates for some months ahead and notwithstanding quite blunt warnings about excessive investment in residential housing in the likes of Sydney and Melbourne. However, the key influence on longer term interest rates was the greater likelihood of a higher Fed funds rate in 2015. US 10 year and 30 year treasury yields finished September at respectively 2.50% and 3.21%, 16 basis points (bps) and 13bps higher respectively than at the end of August. The Australian 10 year bond yield rose even more than its US counterpart rising by 20bps and finishing September at 3.49%.

On the economic data front, US indicators showed a particularly strong growth rebound in Q2 GDP with the final reading revised up to 4.6% annualized growth from -2.1% in Q1. August and September monthly readings were mostly stronger too, including welcome strength in indicators of new housing activity. The National Association of Homebuilders’ index lifted to 59 from 55 in August, while August new home sales rose 4.4% in the month. August non-farm payrolls were softer than expected, lifting initially by only 142,000, but have since been revised up to 180,000 and the latest September reading was a very strong 248,000, bringing the US unemployment rate down to 5.9%. If the US labour market continues to strengthen as it has been, the unemployment rate could decline below 5.5% early in 2015; setting the scene for the Fed to start increasing its funds rate. The timing of this move is a key focus for financial markets in the US and elsewhere. China’s economic readings in September, in contrast, were mostly disappointed, notably August industrial production slipping to 6.9% y-o-y from 9.0% in July. China’s 7.5% growth target for 2014 is in doubt. In Europe, economic readings were also disappointingly soft for the most part. The ECB responded by cutting official interest rates in September, with one rate down to -0.5%. In Australia, Q2 GDP growth was not quite as soft as expected, coming in at 0.5% q-o-q, 3.1% y-o-y. National income growth, however, remains very soft and is likely to be made worse by weak commodity prices. The monthly economic data points have become very mixed including a quirky and record 121,000 increase in employment in August; cutting the unemployment rate to 6.1% from 6.4% in July. Some parts of housing activity are exceptionally strong too, notably investment demand driving high house price inflation. The RBA continues to read through the conflicting economic reports and expects that most of the economy still needs low and stable interest rates. The RBA is examining non-interest measures that may be used to target parts of the over-inflated investment housing market.

Looking ahead, economic growth still looks set to improve through the second half of 2014 in the US, but growth in China and Europe look like needing assistance from easier policy settings which will probably be forthcoming. In Australia, the headwind to growth from weak growth in national income 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. It may be some time before the RBA feels confident enough to start reversing very easy monetary policy, although the declining Australian dollar means that the first rate hike may not be quite as far away as we earlier thought likely. We still expect the next rate move, when it comes, to be a hike, but it looks at this stage that the move could be some time in the second half of 2015.