Global share markets fell very sharply early in February amid mostly concern about rising US interest rates. Share markets recovered lost ground quickly mid-month on signs of still strong global economic activity only to fall again towards month-end on a potential threat to global economic growth from President Trump’s sudden announcement to impose big tariffs on steel and aluminium imports in to the US threatening to spark a global trade war. By the end of the month global growth prospects were subject to a range of mixed influences – still strong growth momentum in most big economies, but a threat to strong growth developing from rising US interest rates and the risk of an escalating trade war. The more mixed global growth signals imply that the greater volatility that developed through February in share markets and risk assets more generally could continue over coming months.

Through the rounds of sharp falls and rises in share markets during February all share markets ended the month weaker. Some of the bigger falls occurred in the European share markets with the German DAX down by 5.7% during the month. The US S&P 500 fell by 3.9%, although after gaining 5.6% in January. The Australian ASX 200 showed the smallest fall in February, down by only 0.4%, partly because it was one of the few markets that did not enjoy a strong gain in January, but also because the threat of higher interest rates is much smaller in Australia than in the United States with the RBA continuing to provide a number of signals during the month that there is no pressing need for it to start hiking its cash rate in the near-term.

Australian credit spreads widened slightly over the month, but the movements in credit were far less volatile than in the share-market. Credit has also performed comparatively well even as government bond yields continued to rise. The US 10-year Treasury yield rose by 15bps in February to 2.86% bringing the rise in yield since the beginning of 2018 to 45bps. The US 30-year Treasury yield moved up by 19bps in February to 3.12% bringing its cumulative yield increase since the start of the year to 38bps. These large increases in US government bond yields have occurred without any Fed rate hike this year so far, although that may soon change with a 25bps Fed rate hike to 1.75% expected in mid-March.

The difference between the US Fed’s rate hiking program – five 25bps hikes since the first in this cycle in December 2015 and at least another three expected this year – and the RBA’s – has not started hiking yet and the first still seems to be at least six months away – is allowing Australian government bond yields to be less influenced by movements in US bond yields. The Australian 10-year bond yield fell in February by 4bps to 2.77%, 9bps below its US counterpart. Over the next few months the yield gap between the two may widen further, perhaps to as much as 50bps if as seems likely the Fed hikes its funds rate at least twice more before the RBA starts hiking.

The various comments from new Fed Chairman Jerome Powell and locally from senior officials of the RBA, including Governor, Phillip Lowe, paint pictures of two economies at quite different stages of their growth and inflation cycles. The US economy has been growing above trend for some time and the tight labour market is generating upward pressure on wages. Jerome Powell speaks with some certainty that annual inflation will lift above 2% later this year. The Fed has little option but to keep hiking the cash rate along the lines of the forecasts of senior Fed officials implying another three 25bpps hikes this year and another set of three in 2019. The risk is that if growth stays very strong, the Fed may need to hike faster and by more than expected.

In Australia, annual GDP growth is still short of long term trend and on the RBA’s forecasts will only lift above 3% later this year. There is also greater uncertainty surrounding the RBA’s forecasts, not least around prospects for household sector spending as the sector struggles with a heavy debt burden, weak wages growth, and patchy house price growth compromising growth in household wealth too.

Australia’s inflation outlook is noticeably softer than the US inflation outlook too. One pleasingly strong part of the Australian economy has been very robust growth in employment. Despite very strong employment growth, the unemployment rate has drifted sideways around 5.5%. Strong employment growth has encouraged more people to enter the labour force, especially women. This increased labour force participation rate means that it now takes exceptionally big increases in employment to reduce the unemployment rate. The RBA has calculated that it will probably need the unemployment rate to fall another 0.5 percentage points or so to generate the order of tightness in the labour market that will push up wages significantly. At this stage a 5% or lower unemployment rate still seems some way off placing any material lift in annual wages growth running at 2.1% y-o-y in Q4 some way off too.

Australia’s modest GDP growth prospects and still quite low wages growth outlook and inflation outlook place the RBA on monetary policy hold for several more months at least. We still expect that there will be enough signs of accelerating GDP growth and potential for wages and inflation to accelerate around August. We continue to pencil in an RBA 25bps cash rate hike to 1.75% at its August policy meeting and a second 25bps hike to 2.00% in November. It is possible that the RBA may delay hiking the cash rate for longer than we expect but it is worth keeping in mind what this may mean for the differential between Australian and US interest rates. If the RBA does not hike this year the cash rate is likely to be at least 75bps less than the US Federal Funds rate by the end of 2018 with Australian bond yields sitting more than 50bps below their US counterparts.