• Stephen Roberts
    • Sep 6

Market Drivers - September 2021

Risk assets charted a bumpy course higher in August. Doubt continued about the strength of the economic recovery globally. Those countries relying on high vaccination rates to open up and live with the Delta strain of Coronavirus are experiencing high new infection rates, but comparatively low death rates and hospital admission rates. The concern is that the current infection wave may worsen in the Northern Hemisphere winter. In Australia, lockdowns were extended in August to limit rising infection rates in New South Wales, Victoria and the ACT, but the focus turned towards fast increasing vaccination rates and the National Plan to start opening up and live with Coronavirus potentially from mid-October.


Central banks at key meetings in August confirmed their view that the recent and current lift in inflation is temporary. Any movement away from emergency low official interest rates will depend upon achieving full employment and consistently higher wage growth and inflation. The near certainty that deflation fighting low official interest rates will persist for an extended period of time in a world experiencing some inflation is providing reason for investors to continue buying risk assets even at high prices on historical fundamental valuation.


Major share markets rose across the board in August with increases ranging from 1.2% for Britain’s FTSE 100 to 3.0% for Japan’s Nikkei. US share market indices continued to forge higher into record territory undeterred by mixed-strength economic readings. The continuing rally in US shares was assisted by higher-than-expected quarterly company profits in Q2 plus confirmation of continuing easy US monetary conditions by Fed Chairman Powell at the annual Jackson Hole symposium of central bankers. The US S&P 500 rose by 2.9% in the month. Australia’s ASX 200 rose by 1.9% buoyed by mostly strong company profit reports and unfazed by an inevitable reduction in GDP growth likely in Q3 because of lockdowns.


Credit markets strengthened further in August with investors chasing any yield pick-up available as central banks battened down on an extended period of low official interest rates. Extended lockdowns in parts of Australia through August and unlikely to be eased materially before October present little threat to the quality of Australian credit. The government income safety net reintroduced for businesses and households will tide most borrowers through lockdown while boosting the likelihood of return to robust economic growth once restrictions are lifted. Australian housing credit metrics, in particular, remain strong with rising house prices, still low borrowing interest rates and concessions from banks keeping default rates on Australian home loans low.


Government bond markets suffered only minor deterioration in August despite evidence that inflation is higher and less temporary than touted by central banks. Headline CPI inflation showed upside surprises in the US (July 5.4% y-o-y) and Europe (preliminary August 3.0%), but the more disturbing upside surprises are in factory gate or producer price inflation up in July by 7.8% y-o-y in the US, 9.0% y-o-y in China and 12.1% y-o-y in Europe. High factory gate prices globally imply more increases ahead in consumer price inflation.


Bond yields barely rose on the various inflation reports during August. The US 10-year bond yield rose 9 basis points (bps) to 1.31% while the 30-year Treasury yield lifted 4bps to 1.93% making only small dents on the July rally when the 10-year bond and 30-year Treasury yields respectively fell by 25bps and 20bps. The stickiness of low US government bond yields in the face of high and rising inflation comes down to belief that the Federal Reserve will stay slow to raise official interest rates. Even the first step reducing monetary accommodation, tapering Fed bond purchases, is in doubt for its heralded late-2021 start amid signs of less robust US economic activity.


Nevertheless, high monthly US inflation reports look set to continue over the next month or two at least and may chip away the credibility of the Fed’s guidance of when it may taper bond purchases and eventually hike official interest rates. US government bond yields look set at the very least to drift higher over coming months.


In Australia, low government bond yields were better protected than in the US by Australia’s prospective GDP fall in Q3. Australia’s 10-year bond yield fell by 2bps to 1.15% in August. At the beginning of August, the RBA was talking optimistically about Australia’s growth prospects and cutting its regular bond purchases from $A5 billion a week to $4 billion a week in September. That optimism may have been tempered by the damage to near-term growth prospects from extended Coronavirus lockdowns in New South Wales and Victoria.


Past economic readings have still been surprisingly strong. Q2 GDP showed a better-than-expected 0.7% q-o-q rise lifting annual growth to 9.6% y-o-y. Employment growth surprised in July rising by 2,200 and with the unemployment rate falling to a twelve-year low 4.6%. The good economic news will not last as the lockdowns take their toll in August and September monthly readings and ultimately Q3 GDP likely to be down 2.0% q-o-q at least.


Doubt has also started to be expressed by analysts about whether growth will rebound in Q4. There is a National Plan for easing restrictions at 70% and 80% vaccination rates (achievable by mid-Q4) but how much restrictions ease will depend upon Coronavirus infection, hospitalisation and death rates as well as Federal/State politics at the time. At the very least, it seems the downside risks to near-term growth prospects may cause the RBA to go more slowly tapering bond purchases while reinforcing its guidance on official interest rates that there will be no rate hikes before 2024.


If US bond yields rise further because of increasing global inflation concern Australian bond yields will not be immune. The difference in Australian near-term growth prospects compared with the US, however, lending greater credibility to the RBA’s message than that of the Fed of holding down official interest rates longer implies relatively less upward pressure on Australian government bond yields than may be evident on US bond yields over the next few months.

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