Risk assets charted a bumpy course through June as the rising COVID-19 infection rate around the world created doubt about the sustainability of moves reducing restrictions and economic recovery. There was no doubt, however, about the strong bounce in economic activity in May and June evident in economic readings and surveys in the US and Europe in particular. The evidence of mostly stronger than expected economic readings helped risk assets move higher over the month. Central banks, including the US Fed; ECB; and RBA also reaffirmed during June in various commentaries that exceptionally low official interest rate reinforced by unconventional monetary support will be in place for years to come.
Major share markets rose strongly again in June with gains for the month ranging from 1.6% for the British FTSE 100 to 6.2% for the German DAX. The US S&P 500 rose by 1.8% and is one of the few markets showing an annual gain, up 5.4% compared with end-June 2019. The US market gain in June occurred in the face of rapidly growing COVID-19 infections causing some states to reimpose restrictions.
Australia’s ASX 200 lifted by 2.5% in June helped by mostly stronger May economic readings and further easing of COVID-19 restrictions and notwithstanding growing clusters of infections in Victoria. Even with the gain in June, the ASX 200 was down 10.9% compared with June 2019, an annual fall second only in depth to the British FTSE 100, down 16.9%. A bad year for Australia’s major banks only tempered by the rise of recent months accounts for much of the Australian market underperformance over the past year.
The rise in share markets during June extended to credit markets. Australian credit spreads continued to narrow in June assisted in part by the US Fed’s increasing purchases of corporate debt and locally signs that banks are well placed to cope with potential problem loans down the track related to the challenging conditions facing the commercial and residential property markets once support programs reduce later in year.
Government bond markets had another comparatively quiet month giving up a small amount of ground amid evidence of strengthening economic activity. The US 10-year bond yield rose by 1 basis point (bp) to 0.66% while the 30-year Treasury yield was unchanged at 1.41%. Fed Chairman Jerome Powell’s comment that the Fed is unlikely to be even thinking about the process of lifting rates for years to come provides near certainty that the Fed funds rate will be no higher than its current 0-0.25% this year, next year and through 2022 anchoring very low short-term US government bond yields for the forseeable future.
The policy shift of recent months in the US towards massive monetary and fiscal stimulus and multi-trillion-dollar lift in government borrowing will eventually return the US economy to full-employment and place upward pressure on inflation. That higher US inflation scenario is unlikely to play out until the mid-2020s at earliest. Meantime, underutilised economic capacity in the US and around the world means low inflation bordering deflation helping to keep bond yields low.
In Australia, the RBA also expounded clearly its view about Australia’s economic outlook and the likely policy requirement to provide best chance of restoring economic output to its pre-COVID-19 trajectory over the next few years. Essentially, the Australian economy is likely to take several years to reduce high unemployment and place upward pressure on inflation. While in the near-term the economy is performing better than expected a few months ago (Australia was the only major country economic forecast upgraded for 2020 in the IMF’s latest global economic forecasts released in June) the unemployment rate will likely hover around 7% or higher and inflation will stay sub 2% this year and next.
The RBA, like the US Fed, reaffirmed in June that the cash rate will be no higher than 0.25% for years to come. Unlike the US Fed, the RBA is also working to keep the three-year bond yield at or below 0.25% as well. Short-term Australian bond yields effectively have nowhere to move – other than perhaps lower – over the next few years. Longer-term bond yields can rise but are caught between pressure from higher government borrowings and signs of improving economic activity and a long extension of low inflation and no pressure on the RBA to lift rates.
In June, the 10-year bond yield rose by 4bps to 0.91% but with little pressure to rise much further. Indeed, the recent rise in the COVID-19 infection rate in Victoria threatening Australia’s impressive record flattening and reducing the infection curve raised concern that progress re-opening the economy may slow and reverse in parts. Greater doubt about Australia’s economic recovery may favour bond buying and reduce longer term bond yields over the next month or two.
The near-term economic outlook in Australia is turning a touch less promising. The May and June economic data to be released in July will probably be firmer on balance but tinged by concern that COVID-19 outbreaks, such as the clusters in Victoria, could threaten a return to economic restrictions. There is also the issue of how key income support programs, many due to end in September, will be tweaked in the Government’s July Economic Statement. Strong income support has allowed the economy to perform as well as it has and will be needed beyond the end of September to prevent reduction in economic activity later in the year. At the very least, July is starting with higher uncertainty about the economic outlook than was the case at the beginning of June presenting challenges to the risk asset rally of recent months.