Risk assets mostly strengthened in October although there were some exceptions. Britain’s FTSE 100 fell by 2.2% in the month, driven by alternating negative and positive news about Brexit. Australia’s ASX 200 also fell by 0.3% on occasional weakness in resource and banking stocks. On balance, both economic and political developments in October were mostly positive for risk assets – economic growth softening, but not as much as feared; more central bank policy easing; and the US/China tariff war plus Brexit edging towards rather than away from resolution. Japan’s Nikkei was the best performing major share market, up 5.4% in October and the US S&P 500 rose to a record high in October and was up 2.0% over the month assisted by mostly better-than-expected Q3 company earnings reports.
The fear of an approaching global economic recession that weighed on market sentiment mid-year is receding as we approach year end. Q3 GDP readings from the US (1.9% annualised and better-than-expected); China (6.0% y-o-y not as soft as feared); and Europe (1.1% y-o-y with a better-than-expected 0.2% q-o-q reading) all point to a global economy is losing a little growth pace but not close to recession. The policy easing actions of central banks, including the latest 25bps rate cut by the Federal Reserve last week, the third in the current series taking the funds rate down to 1.75% - 2.00% range, stand to support growth allowing US GDP growth to accelerate over the next 6 to 12 months.
The change in financial market sentiment moving away from fear of recession is clearest in government bond markets. A few months ago, longer-term government bond yields were trading below shorter-term bond yields. Inverse yield curves indicated market fear of an impending recession that would force central banks to push down official interest rates much more – to 1.00% or less in the US and close to zero in Australia. Over the past two months longer-term bond yields have moved higher even with 25bps cash rate cuts delivered in October by both the US Fed and the RBA. The US 10-year bond yield rose in October by 3bps (following a 16bps rise in September) to 1.69% while the 30-year Treasury yield rose by 7bps (following a 15bps rise in September) to 2.18%.
The reshaping of the bond yield curve has been more pronounced in Australia than in the US. The 10-year bond yield rose 13bps in September to 1.01% and followed up with another 13bps yield increase in October to 1.14%. Rising longer-term Australian bond yields have occurred in the wake of three 25bps cash rate cuts in June and July and again at the beginning of October to 0.75%. The Australian bond market has turned from a mid-year heralding recession to continuing economic growth that may need little more assistance from monetary stimulus.
The Australian credit market has also rallied in October, with spreads approaching decade lows and indicating comparatively low credit risk. Share markets, credit and bond markets have turned more optimistic on global and local growth prospects in October. Official forecasters such as the IMF and market analysts, however, remain more cautious and still factor the risk of slower growth and potentially recession penciled into their forecasts. A disconnect has developed between comparatively optimistic markets and pessimistic analysts.
More economic information is needed to determine whether market optimism will win out, but it is worth noting that the signs from the US and Australia are promising. In the US, GDP growth remains well-supported by consumer spending; the jobs market remains strong and the Fed is actively working to deliver a soft economic landing after one of the longest US economic expansions in history. The trade dispute between the US and China remains an inhibitor but not a total destroyer of US growth as the signs of resolution are more promising than they have been for some time.
As far as signs in Australia are concerned home sales and prices have been rising strongly since mid-year. Housing finance commitments have risen three months in a row. Home building approvals are showing signs of basing. Jobs growth remains firm. There is still a risk that heavily indebted households might not spend as freely as they should after tax cuts and three rate cuts from the RBA but enough momentum is building in government spending, exports and some areas of business investment spending to reduce the likelihood of the economy sliding towards recession. Instead, the likelihood of the economy gaining pace seems to be improving.
For the time being we expect the RBA to remain cautious about Australia’s economic prospects. The guidance from senior RBA officials has slightly shifted through October from doing what is needed with monetary policy to support growth to taking a pause to assess the need for any further policy action. We had forecast that the RBA might cut the cash rate another 25bps to 0.50% early in 2020, but developments in the housing market, in particular, mean that there is no urgency for the RBA to cut further. We now expect the cash rate to remain on hold at 0.75% throughout 2020.