Risk assets were mixed-strength again in October responding to a wide mix of influences including firmer economic readings, on balance, in several key economies; the increasing likelihood of a rate hike by the US Federal Reserve (Fed) before year end; swirling concerns about a hard Brexit; and the shifting fortunes of the two candidates in the approaching US Presidential election. Bond yields mostly marked higher through the month while major share markets ranged from a 5.9% gain for Japan’s Nikkei to a fall of 2.2% for the US S&P 500. Australia’s ASX 200 suffered one of the bigger falls in the month, down by 1.9%, even though there were signs that the economy continued to grow reasonably well. Most share markets have fallen early in November impacted by polling in the US election indicating a resurgence in support for Donald Trump in the past week or so.
Australian credit was comparatively steady in October, notwithstanding greater volatility in the local share market. Government bond markets saw a relatively pronounced lift in yields over the month driven by perception that the US Fed is closer to hiking its cash rate and that other central banks are questioning what more they can do to ease policy in a world of very low and for some negative interest rates. The latest Fed policy meeting came and went without any policy change but with clear signs in the accompanying commentary that another rate hike is not far away. The US 10-year bond yield rose in October by 24bps to 1.83% while the US 30-year treasury yield rose by 26bps to 2.58%.
The Australian 10-year bond yield rose by more than its US counterpart, by 44bps to 2.34%. The RBA left its cash rate unchanged at 1.50% at its early November policy meeting even though inflation stayed low in the Q3 CPI report released in late October. The tenor of RBA commentaries changed through October and early November implying greater confidence that economic growth and inflation will slowly lift and also implying that the RBA will need strong cause to lower rates further, in contrast to the unchanged US 10-year bond yield, rose by 8bps to 1.90%, but down from an early month high yield of 2.13%. One reason for the under-performance of Australian bonds relative to their US counterparts in September were signals in RBA speeches and commentaries that it is in no rush to change its current 1.50% cash rate. Our view remains that the RBA will cut the cash rate again, but probably not until mid-2017 when it has evidence of a softer turn in local economic activity.
Returning to the US economy, there is evidence that economic growth took a stronger turn in Q3 with the advance reading of Q3 GDP showing 2.9% annualised growth, up from 1.4% in Q2. The contributions to US growth in Q3 were encouraging too coming from private consumption spending, business investment spending and exports. Monthly economic readings for September and October are a little more erratic but show mostly reasonably strong new housing activity, improving factory orders and still reasonably strong non-farm payrolls, up by 142,000 in October after rising by 188,000 in September. The unemployment rate edged down to 4.9% in October from 5.0% in September and average hourly earnings rose by 0.4% m-o-m following a 0.3% gain in September.
US consumer sentiment and confidence indicators have tracked lower in October reflecting uncertainty around the US Presidential election. One paradox is that the US economy is travelling quite well with strong employment growth, low unemployment and rising wages yet there are quite widespread perceptions of declining national well-being and desire to shake up Washington finding a voice in Republican candidate Donald Trump’s messages of tearing up free trade agreements and cutting immigration – policies that would make the US a smaller and less affluent economy over time. The election tomorrow has become too close to call, but its outcome will make a material difference to the US economic outlook and the global economic outlook too. If Clinton wins it is a status quo result with continuing drift firmer in US growth and a likely Fed hike in mid-December. A Trump win implies much weaker risk assets and US dollar, even ahead of his inauguration in January. The Fed would be unlikely to hike in December and through 2017 may even need to consider a renewed phase of easier monetary policy to combat a deteriorating US economic growth outlook.
In China, economic growth appears to be stabilizing. GDP growth in Q3 at 6.7% y-o-y was identical to annual growth in Q2 and Q1. The rebalancing of growth drivers in China’s economy in favour of production of services and domestic consumption spending and away from heavy manufacturing is also progressing. In September retail sales growth lifted to 10.7% y-o-y from 10.6% in August, and urban fixed asset investment spending edged up to 8.2% y-o-y from 8.1% and with a lift in private sector contribution, notably property construction. Industrial production continued to fade in September, up 6.1% y-o-y from 6.3% in August. While at face value China seems to have avoided a hard landing for its economy several key issues remain. Stronger residential construction spending running off booming house prices is a mixed blessing boosting growth over next quarter or two but ahead of declining growth as the measures already introduced in many regions to stem excessive property speculation start to bite. China’s banks also look unstable on many measures, especially their high corporate lending exposure to entities at high risk of failure.
In Europe, recent economic readings are consistent with the region stuck in a low growth groove. GDP grew by 0.3% q-o-q, 1.6% y-o-y in Q3 identical to growth in Q2. Inflation is ticking up slightly to 0.5% y-o-y for the preliminary November reading while the unemployment rate is flat-lining at 10.0% in both August and September. The European Central Bank continues to signals that it has done as much as it can on its own to support growth and needs assistance from less restrictive European budgetary policies. The chances are still very limited of European Governments pursuing more expansionary budgetary policies. The attention of governing politicians in Europe is heavily focused on issues relating to borders and free flow of labour plus making Britain’s exit from the EU a no gain to Britain process. The first step of formal divorce proceedings have now been announced by British Prime Minister Theresa May to occur by end-March 2017 although have run in to a road block from a High Court decision that indicates that the Prime Minister does not have the power to pursue Brexit. The situation may require a British General Election to resolve potentially adding to volatility in British financial markets.
The Australian economy is showing signs of reasonable past and current economic growth but with fading economic strength likely in Q4 2016 and beyond. GDP growth accelerated to 3.3% y-o-y in Q2 from 3.1% in Q1 and the signs are that GDP growth may hold around 3% y-o-y in Q3 with a very strong contribution to growth likely from net exports based on a marked narrowing of the monthly trade deficit since June. The monthly trade deficit averaged $A1.7 billion a month in the three months ending September, compared with $A2.3 billion a month in the three months ending June.
While exports are strengthening other indicators of Australian economic activity are more mixed-strength. Home buying activity remains strong in Sydney and Melbourne although housing finance commitments are showing signs of softening and lending institutions announced further restrictions on housing lending during October. Retail spending activity is a little firmer in nominal terms, up 0.6% m-o-m in September after rising 0.5% in August, but weakened materially in volume terms in Q3, down 0.1% q-o-q after rising by 0.4% in Q2. Australia’s labour market although showing a low unemployment rate at 5.6% in September, has seen employment fall in both August, -8,600 and September, -9,800.
Inflation also held comparatively low in Q3 with the CPI up 1.3% y-o-y and the two main underlying inflation measures, the trimmed mean and weighted median, at respectively 1.7% y-o-y and 1.3% y-o-y. All are tracking below the RBA’s 2-3% inflation target and on the RBA’s forecasts contained in its quarterly Monetary Policy Statement are expected to stay below through to the end of 2018. The RBA, however, feels that the headwinds impacting the Australian economy – falling export prices and declining mining investment spending – are fading. Also while inflation and wages growth are low, there are few signs that they will go even lower. The RBA is inclined to leave its cash rate unchanged, but we see some risk that other interest rates will drift upwards and the Australian dollar could move higher too. This unwanted effective tightening of monetary conditions may be the trigger over time that leads the RBA to cut its cash rate again in May or June 2017. Forces driving another cash rate cut could materialize even more quickly if Donald Trump wins the US presidency with all that implies for lower economic growth prospects around the world.