Risk assets mostly fell in September, reflecting a return to rising COVID-19 infection rates and restrictions in the US and Europe, as well as rising international trade tensions with China and a stand-off between President Trump and Congress, halting US supplementary unemployment benefit payments. On the positive side, signs of economic recovery in major economies proliferated in month with most economic reports beating market expectations.
In September, most major share markets fell between 1.4% for Germany’s DAX and 4.0% for Australia’s ASX 200. Japan’s Nikkei bucked the falling trend with a 0.2% gain for the month. The US S&P 500 showed one of the bigger falls, down 3.9% with major tech companies, that led recovering stocks since the major downward correction earlier in the year, leading the fall in September. In Australia, rising concerns about the deteriorating trade relationship with China, Victoria’s continuing shutdowns to suppress COVID-19 infections and looming end-September step-downs in income support programs all took a toll periodically on heavy-weight market sectors such as banks and resource stocks.
Credit markets fell in September, although comparatively modestly compared with share markets. Central banks around the world continue to declare they are prepared to support bond and credit markets for as long as it takes to foster economic recovery.
Deep recessions, and the one this year was the deepest since the 1930s, usually lead to sharply rising business and household bankruptcies and credit defaults. The link between recession and rising credit defaults has been severed for the time being by government income support programs, changes to bankruptcy legislation and loan repayment holidays provided by banks.
Some of this assistance is in the process of changing. In Australia JobKeeper and JobSeeker payments stepped lower at the end of September and at this stage will phase out entirely by April next year. The relative strength of credit markets is likely to become more dependent upon the strength of economic recovery as support programs diminish. At this stage, economic recovery signs are promising, especially in the key housing market where prices have fallen much less than expected in the wake of the recession and home sales, other than in Victoria, are rising faster than expected.
While credit and risk assets suffered falls in September, safe-haven Government bonds became more attractive to investors. Central banks, including the US Federal Reserve (Fed) and the RBA, again reaffirmed their commitment to a protracted period of low official interest rates and bond buying support. The Fed provided forecasts that the Funds Rate would stay in 0-0.25% range out to at least 2024. RBA guidance through the speeches of senior officials pointed to the possibility of the current 0.25% cash rate being cut, although not to negative rate territory. The US 10-year bond yield fell by 2 basis points (bps) to 0.68% in September while the 30-year Treasury yield fell by 1bps to 1.46%.
In Australia, the fall in bond yields was more pronounced than in the US in September with the hint of an RBA rate cut not far ahead. The 10-year bond yield fell by 17bps during the month to 0.81% while the 3-year bond yield (RBA target to cap at 0.25%) fell below 0.20% with barely any RBA buying support.
The Australian bond market will be tested with a sharp lift in government bonds on offer over coming months to fund a record budget deficit in 2020-21 to be announced in the Budget and tipped to be around $A210 billion. Normally a big lift in government borrowing in a recovering economy would generate rising bond yields but this is less likely with the RBA’s buying program, strong demand from overseas investors for Australian government bonds as well as persistently low inflation.
The RBA is also prepared to easy monetary conditions further in need. At its 1 September policy meeting the RBA extended the amount of its 25bps term funding facility to ADIs to help support lending. It has indicated since the possibility of cutting the cash rate again. We are penciling in a 15bps cash rate cut to 0.10% either at the policy meeting tomorrow or at the early November policy meeting. The RBA will also probably cut the cap rate for the 3-year government bond to 0.10%. These new low rates will probably stay in place through to 2024. While economic recovery is surprising on the upside presently there will inevitably be lumps and bumps ahead and even in the best of circumstances the economy will take at least three years to recover to where it would have been on the growth trajectory immediately before the devastating COVID-19 recession.