Risk assets rallied mostly in September aided by the US Federal Reserve starting to cut interest rates and a policy pivot in China with the authorities announcing stimulus measures aimed mostly at China’s beleaguered share and residential property market. The US Federal Reserve’s 50bps rate cut at its September policy meeting was delivered despite economic reports showing the US economy growing close to trend. Government bond markets rallied mostly and are still factoring in a recession in the US, even though that seems increasingly less likely based on recent US economic reports. Australia’s RBA remained on hold in September running against the tide of rate cuts elsewhere and still concerned that getting inflation down remains the local primary policy concern.
In the US, the Federal Reserve cut the Funds rate by 50bps at its September policy meeting taking the Funds rate down to 5.00%. The dot point forecasts of the various Fed presidents also indicated further rate cuts to 3.40% over the next year and 2.9% the year beyond. These forecasts imply a relatively quick turn from monetary restraint towards monetary stimulus and at a time when the US economy is growing at around 2.5% annually and generating still strong jobs growth and low unemployment. If these rate cuts are delivered, they will continue to provide support for the US share market even at current rich valuation.
September also saw a marked change in economic policy by China’s authorities moving towards monetary stimulus with 20bps cuts to the various interest rates set by the Peoples’ Bank of China, a cut to banks’ reserve ratio requirements by 50bps to 9.50% and the announcement of 2 trillion yuan ($US284 billion) of special stimulus bonds. Large cities in China have also announced relaxation of deposit restrictions on purchase of homes. These, plus official buying of shares and other measures providing support for Chinese households pushed China’s previously under-performing share markets sharply higher in September. The CSI index rose 21.0% while Hong Kong’s Hang Seng lifted by 17.5%.
Other major share markets showed a mixed performance in September, but with strong gains for the US S&P 500, up 2.0% and Germany’s Dax and Australia’s ASX 200, each up 2.2%. Australia’s share market was helped by renewed buying interest in resource stocks after the announcement of China’s economic stimulus package. Going against the trend of share market improvement in September, Britain’s FTSE 100 fell by 1.7% and Japan’s Nikkei fell by 1.9%. The Bank Of Japan is starting to lift interest rates, a belated normalisation from the long period of exceptionally low (negative) interest rates aimed at rekindling growth and inflation.
Credit markets were mostly a little weaker in September going against the trend of stronger share markets. Australian households are being challenged by high interest rates on their high borrowings and while default rates are starting to climb most households remain well placed to meet their high debt-servicing commitments. Australian small businesses are finding debt-servicing harder facing not just high borrowing interest rates, but also generally higher costs and flagging demand.
US and Australian government bond yields performed differently in September with US yields down, especially shorter-term yields, but Australian yields virtually unchanged over the month. The difference in performance in September reflects that the US Federal Reserve has started to cut interest rates and will cut rates further whereas the RBA is still holding rates and probably until at least early next year.
The US 2-year bond yield fell by 28 bps in September to 3.64%, while the US 10-year bond yield fell by 12bps to 3.78%. The US bond yield curve became more steeply positive in shape in September, a process that is likely to continue as the Federal Reserve cuts rates further. In early October, longer-term US bond yields have lifted towards 4.00% in the case of the 10-year bond yield. The worsening Middle East conflict with its potential threat of restricted global oil supply and higher oil prices may make keeping US inflation down a more difficult prospect.
Australian bond yields were little changed in September as the RBA continued to dampen any hopes of a cut in the 4.35% cash rate in the near term. The 2-year bond yield fell by only 2bps in September to 3.64% whereas the 10-yield edged up 1bp to 3.97%.
Essentially, the RBA is still concerned that inflation will not return consistently to the 2-3% target band until 2026 and that means little opportunity to cut the cash rate until it becomes clear that forecast is on track. Most recent economic indicators include still strong employment growth, low productivity, strong home buying activity and most recently a lift in retail sales. These reports point to the RBA maintaining its view of slow progress reducing inflation but needing several more months of economic reports to confirm.
Our view remains that the RBA will keep the cash rate on hold at 4.35% at both the November and December policy meetings. It may be in a position to deliver a rate cut in February 2025, but economic indicators will need to show softer growth and labour market conditions between now and February to permit a first rate cut. Australian bond yields are likely to remain comparatively sticky because of the cash rate outlook.