Risk assets were mixed-strength through June amid signs that the forces supporting global economic growth were shifting with US contribution fading, but Europe and Asia a touch stronger. Another complicating factor was a growing group of key central banks making it clear that the era of super-supportive monetary policy is over. The US Federal Reserve is leading the move away from easy monetary conditions and at its mid-June policy meeting hiked its funds rate 25bps to 1.25%, the fourth hike in the current tightening cycle. The Fed reaffirmed the likelihood of another hike later this year and three more next year. The Bank of Canada and the Bank of England both signaled they would start lifting interest rates soon. The European Central Bank indicated an end to policy easing while the RBA remains upbeat in its economic forecasts an unheeded warning signal to the Australian market that its next move is likely to be a rate hike. The official warnings of higher interest rates tempered share market buying, although the US S&P 500 was still up by 0.5% in June. The best performing major share market in June was Japan’s Nikkei, up by 2.0%, but most other markets were down ranging from a minor 0.1% fall for the Australian ASX 200 to a 3.2% fall for the Eurostoxx 50.
The Australian credit market was stronger in June, still largely ignoring the ebbs and flows in the local share market as well as a push higher in Australian bond yields. The US Fed’s mid-June policy tightening and the hint of tighter policy before long in Canada and Britain caused bond yields to rise and bond yield curves to flatten. The US 10-year bond yield rose in June by 9bps to 2.30%, while the 30-year Treasury yield fell a little, by 4bps to 2.83%. The Australian 10-year bond yield rose by more than its US counterpart, by 21bps in June to 2.59%. Australian interest rates also pushed up under the influence of a flurry of mostly stronger-than-expected economic readings in released in June, notably stronger labour market readings.
Returning to factors influencing US financial markets, the economic readings remained mixed-strength through June although with a noticeable stronger turn in the so-called softer indicators such as consumer sentiment and regional manufacturing purchasing manager indexes. Existing and new home sales took a stronger turn in May a signal that home building activity may hold up through the northern summer months. A case is building that US annualised GDP growth lifted above 2% in Q2 from a final reading of 1.4% in Q1, which in turn implies that the US unemployment rate at a 15-year low 4.3% may push even lower over coming. Even tough US inflation eased a touch in April and May, the tight US labour market and the likelihood that annual wages growth will accelerate to 3% and higher implies a strong probability that inflation will accelerate above 2% later this year. The Fed has made it plain that it will continue to carefully adjust monetary policy tighter so that interest rates eventually become appropriate for an economy growing above potential placing upward pressure on inflation. The US bond market is still some way from accepting the Fed’s guidance implying a risk that bond yields could push higher, especially if data releases show signs of confirming the Fed’s economic forecasts.
In China, economic readings took a firmer turn in May and imply that annual GDP growth remained comfortably above 6.5% y-o-y in Q2. The authorities are trying to balance the seemingly incompatible policy objectives of maintaining GDP growth at 6.5% y-o-y or higher while conducting reforms of banking and finance and state-owned enterprises that would normally be expected to slow economic growth for a period. Some run-down in residential property construction in the second half of 2017 is also on the cards responding to policy tightening moves late in 2016 and early 2017. While the economic balancing act is tricky China has greater capacity than any other major economy to ease fiscal and monetary policy settings in need and to direct those changes with greater immediate impact than in other countries too. raising the issue of whether China’s growth rate will slide later in the year and below the Government’s aim of maintaining GDP growth of at least 6.5% y-o-y. China is still well placed to meet its economic growth objectives and at this stage is helping to support global economic growth better than analysts expected at the beginning of this year.
In Europe, signs of economic improvement continue to blossom and concerns about adverse political developments have faded considerably, especially after the stunning electoral victories of centrist Emmanuel Macron and his party in France and the with the prospect much improved that European-ideal stalwart Angela Merkel will retain power comfortably in the approaching German elections. It has been the improving economic numbers in Europe, however, that have served to lift all boats. Revised Q1 GDP growth of 0.6% q-o-q and 1.9% y-o-y was strong and looks like being at least repeated in Q2. The number of unemployed Europeans is falling by around 200,000 a month and the unemployment rate is down to a decade-low 9.3%. Core inflation has lifted above 1% y-o-y. While there is no urgency for the European Central Bank to start lifting interest rates it is no longer looking to ease policy further. The United Kingdom faces a challenging Brexit phase in the wake of the General Election that failed to shore up the Government’s majority as planned. Inconveniently, the UK is looking more inflation-prone than most implying a need for the Bank of England to start lifting interest rates soon. The UK economy is at greater risk of underperforming relative to much of the rest of Europe.
The Australian economy is precariously balanced. The biggest headwind to Australian economic over the past few years, falling business investment spending, is fading fast. Private new capital expenditure rose by 0.3% q-o-q in Q1. At the same time the strongest supports for Australian growth over recent years, housing activity and household consumption are starting to fade. Tied to the fading strength of housing and household consumption spending, the household sector has borrowed to the limits of what can be considered prudent at a time of record low annual growth in wages. The financial regulatory authorities have tried to limit growth in lending for investment housing but in the process have added to banks’ costs causing a drift upwards in lending interest rates. The Government in its May Budget also decided to add to banks’ costs with a new tax which may show in higher lending interest rates too.
Predicting the local housing cycle has become very difficult, but the best outcome would seem to be a topping out which itself would mean that housing activity will contribute less to Australian growth than it has the past year or two. There are still some strong elements in Australia’s growth story, exports of goods and services notably. The RBA’s view is that the lumps and bumps in Australia’s growth rate will iron out over time with growth slowly accelerating above trend by late 2018. This scenario is possible and has gained support from recent economic readings that have mostly come in stronger-than -expected. Retail sales jumped by 1.0% in April, employment has risen by more than 40,000 monthly for the past three months in a row in the process lowering the unemployment rate to a 2-year low 5.5%. Job vacancies are up more than 10% y-o-y implying more strong employment growth readings in the pipeline. If the stronger data continue it will not be long before higher wages growth and inflation follow. In these circumstances, the RBA would need to start hiking the cash rate, although it is still unlikely that this need will arise before early 2018.
It is also still possible that the financial pressures in the household sector lead to a retrenchment of spending and economic growth slipping, the type of circumstances that would lead the RBA to lower its growth forecasts and cut the cash rate. Over this past month we have been influenced by the mostly stronger economic readings and are less convinced that the weaker growth scenario is entrenched. On balance, our view of Australian economic growth over the next year or so has firmed a touch. We see the cash rate unchanged through the remainder of this year with a 25bps hike to 1.75% early in 2018. We continue to keep this forecast under review waiting for more information to help determine whether Australian growth is likely to strengthen or falter later in 2017.