Risk assets showed mixed fortunes in November with US and Asian share markets continuing to rise but European markets falling. The richly valued US share market was supported further by more indications of US economic strength plus a first legislative win for President Trump with tax cut proposals gaining Senate approval. In Europe, share market sentiment was undermined as uncertainty about the future of Angel Merkel’s government in Germany came to the fore when post-election coalition negotiations floundered. Among major share markets, the best gain in November came from Japan’s Nikkei, up 3.2%. The US S&P 500 also showed a strong gain, up 2.8%. On the weaker side, Europe’s Eurostoxx50 fell by 2.8% and Britain’s FTSE 100 was down by 2.2%. Australia’s ASX 200 had a reasonable month and finished November up by 1.0% after gaining 4.0% in October.
Australian credit after rallying strongly in October made further ground in November assisted by investors continuing to seek out any value in risk assets. The biggest potential threat to the long rally in risk assets is when strong global growth eventually spills over to higher inflation causing central banks to tighten monetary policy settings more aggressively. There were still no signs of consistently higher inflation through November and central banks continued to indicate only slow withdrawal of monetary accommodation. The US Federal Reserve (Fed) left its funds rate unchanged at the beginning of November but is likely to deliver another 25bps rate hike in its slow tightening program at its policy meeting next week. The RBA continues to hold its cash rate at a record low 1.50% and with mixed-strength Australian economic readings is in no hurry to start lifting rates. The US 10-year bond yield rose by a modest 3bps in November to 2.41% while the 30-year Treasury yield fell by 5bps to 2.83% causing the already very flat US bond yield curve to become even flatter. Reflecting differences in monetary policy outlook in the US and Australia, the Australian 10-year bond yield fell by 20bps in November to 2.49%, only 8bps above its US counterpart.
The main positive influence on US financial markets through the month was more evidence of strong US and global economic growth boosting the earnings of US companies. Despite growth-crimping severe US weather events in September, Q3 GDP grew at an above trend 3.3% annualised pace above the 3.1% pace recorded in Q2. Various US indicators point to strong US growth continuing with consumer and business sentiment readings running near record highs and the US unemployment rate down to 4.1% in October the lowest reading since the beginning of the century. The sense of political crisis swirling around the Trump Administration seemed to intensify through November but was ignored by financial markets buoyed by continuing strong economic growth and one important success for President Trump, the passage of highly big-business-friendly tax cuts through the Senate.
In China, October economic readings were mostly a touch softer than expected but still consistent with annual GDP growth above 6.5% y-o-y in Q4. The resilience of economic growth in China averaging just under 6.9% y-o-y in the first three quarters of 2017 has been an important positive surprise this year coming at a time when the authorities have made progress cutting back the activities of polluting industries, taming growth in shadow-banking activities, reducing speculation and price pressure in residential property and tackling inefficiency, over-indebtedness and corruption in the business sector. There is still much further to go in these areas of economic reform but so far China has made progress without the order of set-back to top-line GDP growth that might have been expected. China’s economic management has contributed more towards firm global economic growth than was widely considered likely early in 2017.
Europe continues to grow well with annual GDP growth accelerating to 2.5% y-o-y in Q3 from 2.1% in Q2. One key marker of the improvement in Europe’s economy is the falling unemployment rate, down to 8.8% in October, the lowest reading since January 2009. The unemployment rate picture still varies however from very high in Greece – above 20% unemployment rate – to very low (effectively full-employment) in Germany, 3.6% and new front-runner in the low unemployment rate stakes in October, Malta, 3.5%. The variance in economic performance is leading to greater dissention in the ranks of the European Central Bank’s Monetary Policy Committee members. Evident in the minutes of recent meetings is greater disagreement with the prevailing view of ECB President Draghi that Europe’s economic outlook remains uncertain and that withdrawal of monetary accommodation should be a very gradual affair. The political uncertainty in Germany after the election and the difficulty forming a Merkel-led coalition government provides support from Draghi’s monetary policy view, but stronger economic readings are also emboldening the hawks who see a need for the ECB to withdraw monetary accommodation more quickly. The ECB monetary policy outlook is becoming less clear
In Australia, economic growth prospects are improving on balance although one big area of uncertainty remains how well very heavily indebted households will spend especially as more signs emerge that the boom in house prices is over. Several parts of the economy are growing well. Employment growth in 2017 so far is the best it has been in more than 15 years and the unemployment rate is down to a 4-year low of 5.4%. Exports of goods and services are rising strongly. There are pockets of big infrastructure building under way, especially in the eastern states. Engineering construction spending rose by 33% in Q3. The long slump in business investment spending appears to be over. Private new capital expenditure rose by 1.0% in Q3 after a 1.1% rise in Q2. Set against these positive influences, housing activity, a strong contributor to growth in 2015 and 2017 is starting to present a headwind to growth in 2017 and one that may intensify next year. Household consumption spending is anemic beset by persistently low wages growth, high household debt, and increasing concern about the future because of a perception that Government is caught in a prolonged phase of weakness and policy-making inertia. On balance, GDP growth should improve, but not as much as overseas.
Comparatively modest improvement in Australian economic growth and still with only modest inflation leaves the RBA to continue doing what it has done for more than year – leave the cash rate unchanged at a record 1.50%. Leaving the cash rate at 1.50% is also unlikely to unsettle the heavily indebted household sector. The problem is that leaving the cash rate so low may also prompt households to become even more heavily indebted risking a much more pronounced retrenchment of household spending at some point in the future and a retrenchment that may plummet the economy in to recession. Increasingly, the RBA is entering a phase of what will cause it least regret – leave the cash rate low with a high probability of helping to foster a deep recession at some point, or lifting rates and prompting softer near-term growth but with household balance sheets in a better position in the future ameliorating the risk of a deep recession down the track. We suspect that wages and inflation will move higher around mid-2018 and could be the deciding factor helping to shift the RBA towards hiking rates with a first 25bps cash rate hike to 1.75% probably in August or September 2018.