Risk assets fell sharply in August amid concerns about China’s economic outlook and policy changes overlaid by uncertainty about the near-term monetary policy outlook in the United States. Continuing economic growth softness in most emerging economies added to fears that the global economic growth outlook may be deteriorating. Australia’s economic growth rate took a noticeably softer turn in Q2 as well. Several major sharemarkets showed their biggest monthly falls in August since the early stages of the global financial crisis. was bumpy early in July, the resolution – possibly only temporary resolution – of a number of worrying issues paved the way for strong relief rallies later in the month. Falls in major sharemarkets ranged from 6.3% in August for the US S&P 500 to 9.3% for the German DAX. The Australian ASX 200 fell by 7.5%.
Australian credit lost ground over the month although recovered a little ground from its weakest levels at month end. Government bond markets were comparatively stable in August but failed to gain strong safe-haven buying demand that might normally be expected in a very poor month for risk assets. The US 10 and 30-year bond yields actually rose slightly in August respectively by 4bps to 2.22% and 6bps to 2.88%. In contrast, Australian bonds rallied and the 10-year bond yield fell by 9bps to 2.66%. The RBA left its cash rate unchanged at 2.00% at its August and September policy meetings 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 the second reading of Q2 GDP showed US growth improving more than expected by 3.7% on an annualized basis, up from 0.6% growth for Q1. Other US economic indicators point to moderate if unspectacular growth continuing early in Q3. The best of the readings relate to housing activity and the labour market. Retail sales and manufacturing activity, in contrast, have been patchy. Various senior Federal Reserve officials continue to point to the need to start lifting US interest rates relatively soon. Despite the turbulence in the global economy there are still signs from Fed officials that the mid-September policy meeting could still be a live one for the first rate hike in eleven years.
In China, July economic readings were almost all softer than expected, especially exports down by 8.9% y-o-y and industrial production, up only 6.0% y-o-y. More recent manufacturing purchasing manager surveys point to growth fading in Q3. Apart from signs that economic growth has not yet based the authorities also acted in August depreciating the yuan exchange rate and adopting measures aimed at supporting the falling sharemarket. At times the policy moves by the authorities implied discomfort with market signals and desire to move back to stricter controls heightening concerns among international investors. More conventionally monetary policy was eased for a fifth time in the current cycle in August and a saving grace is that China’s authorities still have ample room to ease monetary and budgetary policies further in need.
In Europe a support package for Greece was agreed in August although one casualty was the Greek Prime Minister who resigned. A Greek General Election may cause uncertainty to resurface. Otherwise, European economic growth in Q2 was modest at 0.3% q-o-q, 1.2% y-o-y compared with 0.4% q-o-q, 1.0% y-o-y in Q1. One positive development is that high unemployment in Europe is slowly declining falling from 11.1% in June to 10.9% in July, the lowest reading since February 2012. At its early September policy meeting, the European Central Bank left policy settings unchanged, but because of the deteriorating global economic outlook downgraded slightly its forecasts of European economic growth in 2015 and 2016. ECB President, Mario Draghi, at the press conference after the meeting effectively introduced a stronger bias to easy monetary policy further by noting that the ECB had flexibility to change the amount of QE (currently 60 billion euro a month), its timing and duration (currently set to run until September 2016) if needed.
In Australia, although employment has been surprisingly firm and the unemployment rate appears to have stabilized around 6.0%, GDP growth is still slipping. Q2 GDP growth was weaker than expected, up only 0.2% q-o-q, 2.0% y-o-y and compared with 0.9% q-o-q, 2.5% y-o-y in Q1. Spending growth in Q2 was boosted by a blip in government spending. Other expenditure components were soft or declining. National income also fell in real terms in Q2 and is a sign of the downward pressure on spending that lies ahead. July retail sales were weaker than expected falling by 0.1% m-o-m. The downturn in mining investment continues unabated and will continue for some time. The RBA left the cash rate unchanged at 2.00% in August and September, but the softness showing in the economy, other than in housing activity, still points to the need for easier monetary conditions.
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 is also an increasing chance that the cash rate may be cut further beyond November to 1.50%.