After falling sharply in August risk assets fell further in September amid continuing concerns about China’s economic and uncertainty about the near-term monetary policy outlook in the United States. Australia’s economic readings remained mixed strength, but with signs that the strongest part of the economy, housing activity, may be starting to flag. The Federal Reserve’s September policy meeting sent mixed messages about the US interest rate outlook causing shares to lose more ground after the dismal showing in August. Falls in major sharemarkets ranged from 0.4% in September for the US S&P 500 to 8.0% for Japan’s Nikkei. The Australian ASX 200 fell by 3.6%. However, the losses registered in September have mostly reversed early in October amid signs that US interest rates may stay lower for longer.
Australian credit lost ground over the month partly reflecting the weakness in the sharemarket. Investors seeking a safe haven turned to Government bond markets. The US 10 and 30-year bonds rallied and their yields fell in September respectively by 18bps to 2.04% and 11bps to 2.85%. In contrast, Australian bonds rallied modestly by comparison with their US counterparts and the 10-year bond yield fell by 6bps to 2.60%. The RBA left its cash rate unchanged at 2.00% at its September policy meeting and continues to be comparatively upbeat about Australia’s economic prospects, while still pointing out that it will wait for more economic data to inform its policy decisions looking ahead.
On the US economic data front indicators of consumer spending and housing activity remained firm in July and August. In contrast, manufacturing activity appears to have weakened and indicators of strength in the labour market have become mixed-strength. In particular, non-farm payrolls were noticeably softer in August, up 142,000 on revision, and in September, up 136,000, although the unemployment rate remained low and steady at 5.1% in both months. There still appears to be excess capacity in the US labour market and while that remains the case the Fed may stay reluctant to start lifting interest rates as it was at its September policy meeting.
In China, August economic readings were again mostly softer than expected. Relative to market expectations, the weakest pair were exports -8.9% y-o-y against forecast -5.2% and industrial production 6.1% y-o-y against expectations of 6.5%. Another worryingly soft feature of China’s economy is escalating falls in producer prices, -5.9% y-o-y in August, pointing to deflation risk and a growing margin squeeze on businesses in China. On a more positive note services activity appears to be strengthening and growth in retail sales is accelerating, to 10.8% y-o-y in August. While overall annual GDP growth may not have based yet, the change in drivers of economic growth that the authorities are trying to promote may be occurring, although this is cold comfort for Australian mineral resource companies focused on the areas of China’s economy that look set to grow well below annual GDP change over coming years.
In Europe, the moderate improvement in economic activity in Q2 may be struggling early in Q3. Slight price deflation made an unwelcome return on the preliminary September inflation reading of -0.1% y-o-y. Progress reducing Europe’s very high unemployment rate also seems to have stalled with the unemployment rate flat-lining at 11.0% in both July and August. Retail sales growth also seemed to stall in August after a run of quite firm monthly readings. ECB President, Mario Draghi, has made it plain that there is more that the ECB can do with its asset purchase, or QE, program to support growth in need. It seems increasingly likely that the ECB will announce an expanded QE program before long
In Australia, the monthly economic readings continue to present a mixed-strength view of the economy. Employment growth remains firm for the time being, up another 17,400 in August after lifting by 39,200 in July, and the unemployment rate edged down to 6.2% from 6.3% in July. However, the strongest part of the economy, new home building activity seems to be topping out with home building approvals falling by 6.9% in August. Retail sales also seem less robust in July (-0.1% m-o-m) and August (+0.4%) than they were in the April through June period. The lack of improving growth momentum in the economy calls in to question how well employment can continue to grow.
Looking ahead, it is quite likely that the RBA will need to reduce its growth and inflation forecasts further when it publishes its next quarterly Monetary Policy Statement in early November. We see the RBA wanting to provide further support for growth even though it is wary of the impact of lower interest rates driving house prices up even higher. We feel that there is a clear marginal benefit from cutting interest rates further. We place a high probability on the RBA cutting the cash rate another 25bps to 1.75% at its November policy meeting. Given the softening global growth outlook there we now expect a further 25bps cash rate cut to 1.50% early in 2016, probably at the February policy meeting. We expect the cash rate to stay at the new low rate through the remainder of 2016.