Risk assets rallied strongly in June, mostly on strengthening market perception that a softer global economic growth would spur central banks to ease monetary conditions. While the US Federal Reserve (Fed) left interest rate settings unchanged at its June policy meeting, accompanying statements made it clear that if downside risks to US growth prospects intensify the Fed could cut rates. At home, the RBA did deliver its first rate cut in three years and indicated at least one more cut is likely. At the close of the month, a truce was declared in the tariff trade war between the US and China, raising hope that one significant downside risk to global economic growth prospects might fade.
All major share markets experienced big gains in June, ranging from 3.3% for Japan’s Nikkei to 6.9% for the S&P 500. Australia’s ASX 200 rose during June to an eleven-year high and finished the month up 3.5%, marking six consecutive monthly gains.
At this point, the rally in share markets looks set to extend. This follows the unexpected promise that the US and China would return to trade negotiations gained from the meeting between President Trump and President Xi at the G20 meeting in Tokyo. It is worth keeping in mind, however, that if trade tensions between the US and China are dialed down, the resulting improvement in global economic growth prospects may also limit the prospect of Fed easing. This may cause interest rates to rise, dampening share buying enthusiasm in turn.
Australian credit markets rallied strongly in June, taking their lead more from rising share markets as well as easier Australian monetary conditions. The RBA started to move position on interest rates in May, indicating that while the labour market was strong it could do better still and without untoward upward pressure on inflation. The RBA cut the cash rate 25bps to 1.25% at its early June policy meeting and has indicated that it will follow up with at least one more cut to ensure that a worthwhile reduction in borrowing interest rates is delivered to Australian households and businesses.
The RBA has been insistent that the current rate cutting cycle is not about dealing with a weak economy or fending off potential recession risk, but rather about encouraging the economy to grow at a faster pace capable of reducing the current 5.2% unemployment rate to 4.5% or lower. The RBA is feeling its way with what unemployment rate is consistent with inflation lifting inside its 2-3% target band.
Through May and much of June, the RBA has indicated the need for more monetary policy easing and help from Government, with economic reforms and a more active approach to productive infrastructure projects that can be ramped up quickly in times of weak demand in the economy. Interestingly, the need for more policy stimulus may be changing from a lot of change required to not quite so much.
In Australia, there are signs that housing demand is picking up momentum fast. Auction clearance rates in Melbourne and Sydney have jumped towards 70% over the past two weeks and there are signs that the rate of decline in house prices is much less than a month ago and may be on the verge of turning to mild price gain. The Government’s tax cut package looks like being legislated this week, providing immediate tax cuts in 2018-19 tax returns and confirmed tax cuts in the years ahead. It looks more certain that household spending will lift over the next few months than it did at the time of the RBA’s June policy meeting.
The global economic growth outlook looks more promising too in the wake of developments at the Tokyo G20 meeting, more promising certainly than at the time of the RBA’s June policy meeting.
Going back to June results in investment markets, global government bond markets were still factoring in a gloomy global economic growth outlook that would require central banks to ease policy, even the US Fed presiding over an economy operating close to full capacity. In the US, the 10-year bond yield fell by 11 basis points (bps) to 2.01% while the 30-year yield fell 4bps to 2.53%. The US bond market is factoring in at least 50bps of Fed rate cuts from the current 2.25-2.50% funds rate over the next year or so. After the G20 meeting there is no pressing need for the Fed to cut rates and there is a risk that US bond yields could start to rise and relatively soon.
In Australia, the 10-year bond yield fell by 13bps to 1.32% at the end of June. The local bond market is factoring in an RBA cash rate below 1% over the next year. At this stage, even though global and Australian economic growth prospects could soon look better, the RBA is still likely to press ahead with one more 25bps cash rate to 1.00% in July or August. The need for any further rate cuts beyond that is diminishing fast as global and Australian economic growth prospects brighten. The risk in the Australian bond market is that yields have fallen too far given the latest economic developments internationally and at home.
All financial assets rallied in June making it an extraordinary month but also a month that raises the need for caution looking ahead. Either share markets are right and growth prospects are sufficiently favourable to support earnings margins and profits or the bond markets are right and lower interest rates are needed to counter faltering economies some at risk of falling into recession. The pendulum seemed to nudge at the end of June in favour share markets, at least in the near term. Bond buyers at current very low yields may need to exercise caution.