Risk assets staged a strong improvement in October after the sharp falls in August and September. Helping to drive the rally was primarily a sense that the selloff through Q3 was overdone, moderation of concern about China’s growth outlook and signs that key central banks might ease monetary policy settings further. The Peoples’ Bank of China cut official interest rates and the banks’ reserve ratio requirement again, while the European Central Bank provided a strong indication at its October meeting that it would ease policy further in December. The Australian ASX 200 registered one of the smaller gains in October, but it still rose by 4.3%. Several major sharemarket indices registered gains in October of 9% and more including Japan’s Nikkei, up 9.7% and the Eurostoxx 50, up 10.2%. In Europe, Germany’s DAX starred, rising by 12.3%.
Australian credit gained ground in October as the cloud over risk assets in general lifted through the month. Investors in turn found less need to seek the relative safe-haven of Government bonds. Given the strength of the rally in risk assets the lift in Government bond yields was small, reflecting a view that world is still essentially caught in a very low interest rate environment. The US 10 and 30 year bond yields rose respectively by 10bps to 2.14% and by 7bps to 2.92%. The Australian 10-year bond yield barely rose at all, up only 1bp to 2.61% in October. At the beginning of October the RBA again left its cash rate unchanged, essentially awaiting more information about the economy before deciding whether there is any need to cut rates further.
On the US economic data front August and September economic readings were mixed strength with softness in manufacturing and export readings; still past strength in housing indicators although with weakness in forward looking indicators; flattish retail spending; and very mixed labour market readings ranging from exceptionally strong weekly initial jobless claims to slowing in gains in monthly non-farm payrolls. The first reading of Q3 GDP showed pronounced slowing to 1.5% annualized growth from 3.9% in Q2. The Federal Reserve’s October policy meeting, just ahead of the Q3 GDP release, left the Federal funds rate unchanged, but the accompanying statement was an ambivalent affair hinting in some parts that a rate hike may come in December, but in other parts that key parts of the economy were softening.
In China, GDP growth slowed in Q3, but to 6.9% y-o-y from 7.0% in Q2, not as much as the market feared. Tertiary sector activity lifted in Q3 to over 8% y-o-y, the type of growth that the authorities have been actively encouraging, but secondary activity, of which manufacturing is a large part, softened below 6% y-o-y. The authorities showed that they are keen to support economic activity in general with the Peoples’ Bank of China easing monetary policy for a sixth time since November 2014. The official one year lending rate was cut by 25bps to 4.35%; the official one year deposit by 25bps to 1.50%; and the commercial banks’ reserve ratio requirement by 50bps to 17.5%. The Plennum meeting of senior officials covering China’s 5-year economic outlook has also outlined some changes including relaxation of China’s one child policy to help address China’s challenging demographic outlook including stalling in growth in the labour force.
In Europe, The European Central Bank’s policy meeting early in October emphasized downside risks to European economic growth and pointed out that the policy stance would be reconsidered at its next meeting in December where all aspects including interest rates, the size of monthly asset purchases (QE), and the end date of QE (September 2016) could all be considered. European economic readings took a softer turn in August, but most September readings have lifted slightly with the unemployment rate falling to 10.8% from a downwardly revised 10.9% in August and the flash inflation reading in October edging up to 0.0% y-o-y from -0.1% in September. The small improvement in the economic data is unlikely to deflect the ECB from easing monetary conditions further in December given the considerable excess capacity that still bedevils Europe’s economy.
In Australia, monthly economic readings continue to be mixed strength. Housing activity remains strong but is topping out and recent moves by all of the big four banks lifting variable home loan interest rates between 15bps and 20bps are threatening a pull-back in housing. Growth in retail sales is modest and the unemployment is stable around 6.2%. Inflation, however, is weak. Headline annual CPI inflation remained at 1.5% y-o-y in both Q2 and Q3, below the bottom of the RBA’s 2-3% target band. Q3 underlying annual inflation readings in the form of the trimmed mean, 2.1% y-o-y, and weighted median, 2.2%, also were unexpectedly weak and near the bottom of the RBA’s target range, signaling that the Australian economy is running too slowly and may need further policy assistance.
We see the RBA at the very least needing to reduce its inflation forecasts in its quarterly Monetary Policy Statement due on Friday. The policy meeting tomorrow, Melbourne Cup Day, presents the best opportunity for the RBA to provide a little more support for growth ahead of the Christmas spending season. Inflation is no impediment and the interest rate moves by the banks were probably unexpected by the RBA. We see the RBA cutting the cash rate by 25bps tomorrow to 1.75%. We also expect a follow-up 25bps cut to 1.50% will be needed either in December or February 2016, the first policy meeting next year. The new low cash level should persist throughout 2016 given known headwinds facing the Australian growth next year including increasing drought, mining sector job losses, the winding down of automobile manufacturing, and the topping out of home building activity.