Federal Reserve cuts rates by 0.25% 

Highlights

  • US central bank drops rates by 0.25% as global growth slows
  • Local housing market picks up

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During July, several central banks followed through on earlier commitments to reduce interest rates in response to signs of a global slowdown. The US Federal Reserve reduced its benchmark interest rate by 0.25% at its meeting on 31 July. This was the first rate cut in more than a decade and broadly speaking, share markets responded favourably. 

The US economy grew at an annual rate of 2.1% over the quarter to 30 June, aided by rising household spending. Corporate investment declined due to the ongoing uncertainty in US-China trade relations which, in turn, delayed capital expenditures. 

Trump seeks rate-cutting cycle

Stronger economic data is likely to deter the Fed from cutting interest rates too quickly. This could attract criticism from President Trump, who would prefer an ‘aggressive rate-cutting cycle which would keep pace with China, the European Union and other countries around the world.’ 

In China, second quarter economic growth came in at 6.2%. This was quite low in a historical context and policy makers are shifting to higher quality drivers of growth by encouraging domestic spending rather than increasing production. Trade and manufacturing production remain headwinds for both the US and Chinese economies as trade negotiations continue.

ECB leaves rates on hold

The European Central Bank disappointed the market by not lowering the deposit rate. However, the ECB hinted at a more expansionary monetary policy with the suggestion that the region’s bond-buying program may re-start in September. 

Meanwhile in the UK, the possibility of a no-deal Brexit rose following the election of Boris Johnston as Prime Minister. As a result, the pound declined to a two-year low against the US dollar. 

Local housing market recovers

In Australia, inflation rose modestly to an annual rate of 1.6%, still below the Reserve Bank’s target. Housing market indicators continue to recover, which could encourage the Reserve Bank to leave rates on hold while they assess the economic data. Share markets finished higher during the month. US shares reached new highs but sentiment shifted as the Fed scaled down the market’s expectations of an aggressive rate easing.

Australian shares also produced strong returns as earnings in the resources sector were upgraded. Emerging market shares underperformed due to the stronger US dollar and weak growth in global trade flows.

Fixed income performed well during July as central banks delivered rate cuts. Yields moved lower which contributed to higher bond prices. The Australian dollar was lower against both the US dollar and the Euro, which boosted returns from unhedged investments. 

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Investment commentary

All pre-mixed options delivered a positive return in July as both shares and bonds performed strongly.

Australian shares benefited from higher commodity prices. The market’s higher dividend yield has encouraged inflows as the cash rate reached an all-time low. Industrial shares have generally benefited from a lower Australian dollar and banks are also seeing some relief as housing activity picks up. Retail remains in a tough spot as household spending softens.

Global shares performed well during July as economic data was broadly supportive. Increased liquidity from easier monetary policy also helped encourage investor sentiment. The US share markets reached a new high but we are monitoring this in light of the recent soft patch in global manufacturing production. 

Australian fixed interest had a positive month as bond yields fell in response to a global shift towards monetary easing. The Australian 10-year bond yield reached a new low of 1.19% and is likely to remain at lower levels as the Reserve Bank currently has a bias towards easing rates. 

Past performance is not a reliable indicator of future performance. This information has been prepared by First State Super Investments on behalf of FSS Trustee Corporation ABN 11 118 202 672 AFSL 293340, trustee of the First State Superannuation Scheme ABN 53 226 460 365.