Financial year ends with global economy in good shape

Highlights

  • Positive outlook as upswing continues
  • Trade tensions spark risk-averse sentiment

The global economic outlook remains positive as the upswing that began in mid-2016 continues to strengthen. Across the globe, the level of investment continues to increase, supported by the low interest rate policies of most central banks and more recently, increased spending by governments.

In Australia, economic growth during the first quarter was higher than expected, supported by solid export growth. Wages continued to grow at a slow but steady pace, and ongoing government spending supported economic activity.

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US trade policies create tension

Trade tensions were a focus during the month as the US announced tariffs on imports from China, Canada, Mexico and the European Union, and the targeted economies responded with reciprocal tariffs on US imports. US President Donald Trump also discussed the possibility of tariffs on imported cars and auto parts. Such a move could be detrimental for the European and Japanese car industries and particularly Canada because its auto parts industry is more highly integrated with the US. 

During the 2008 global financial crisis, central banks acted swiftly to stabilise financial markets and support economic activity by providing liquidity and lowering interest rates. Now that the global financial system is more resilient and the global economy is recovering, central banks are gradually withdrawing this liquidity and raising interest rates to more ‘normal’ pre-GFC levels.

Monetary policy returning to ‘normal’

During June, the US Federal Reserve raised interest rates for the second time this year, and the European Central Bank announced it would reduce the stimulus provided to financial markets.

Locally, the Reserve Bank left the cash rate unchanged at 1.5%, indicating an accommodative monetary policy that continues to support the domestic economy.

Concerns over US trade policies contributed to the market’s more risk-averse sentiment, and bond markets rallied as investors moved into safer assets. The safe-haven US dollar strengthened during the month, while the currencies of three commodity-centric economies (Australia, New Zealand, and Canada) weakened.

In commodity markets, iron ore and coal prices climbed higher during the month, and geopolitical tensions surrounding developments in Iran, along with limited supply, pushed oil prices higher.

Stronger US dollar hits emerging market borrowers

Emerging markets’ reliance on exports makes them vulnerable to trade tensions. They are also exposed when the US dollar rises because it increases debt held in US dollars. These factors contributed to weaker performance by emerging share markets during the month, while developed market shares were generally flat. The US delivered small positive returns, as companies continued to benefit from the recently passed tax reforms, while European shares declined due to concerns over trade.

Australian shares performed well in June, with the ASX 200 up 3%. Resources were up 3.3% thanks to rising commodity prices, while Industrials were up 3%. Energy stocks climbed 7% on the back of the weaker $A and higher energy prices.

Extract from Reserve Bank media release

3 July 2018

The global economic expansion is continuing. A number of advanced economies are growing at an above-trend rate and unemployment is low. Globally, inflation remains low, although it has increased in some economies and further increases are expected given the tight labour markets. One uncertainty regarding the global outlook stems from the direction of international trade policy in the United States. There have also been strains in a few emerging market economies, largely for country-specific reasons. Low interest rates continue to support the Australian economy. Further progress in reducing unemployment and having inflation return to target is expected, although this is likely to be gradual.

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Investment commentary

All our pre-mixed options delivered positive returns for the month as the economic environment remained supportive despite trade policy concerns. The Australian dollar weakened against the US dollar, enhancing returns from unhedged US-dollar investments.  

The Australian share market led international peers with the ASX 200 up 3% during the month. The rally was broad based, with both Resources and Industrials gaining around 3%. Energy was the standout sector, climbing 7.7% on the back of rising oil prices and a weaker Australian dollar. The Telecom sector lagged the market as increased competition continued to challenge profit margins.

Global share market sentiment turned sharply risk averse during June due to rising trade tensions. The stronger US dollar was a challenge for emerging market shares because it increases debt held in US dollars. As a result, most emerging markets posted negative returns and lagged developed markets. European markets finished slightly negative due to the trade concerns, while US markets delivered small positive returns as the recent changes in tax policy continued to boost economic activity and corporate profits.

June was a tale of two halves in bond markets. Both US 10-year Treasury and Australian bond yields climbed steadily during the first half of the month until the concerns over US trade policy sparked risk averse sentiment and stronger demand for bonds, pushing up prices and lowering yields. The Reserve Bank left the cash rate unchanged at 1.5%, noting the role that low interest rates play in supporting the economy. While inflation remains below the bank’s 2.5% target, it is expected to gradually increase as economic activity improves and unemployment falls.

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.