Growth steady as inflation pressure starts to build

Highlights

  • Labour markets tighten as spare capacity is used
  • Signs of inflation emerge

While the global economy continues to expand, many commentators believe growth may
have peaked. Even so, growth is expected to be positive over the next few years.

The US leads the way as the influence of tax cuts and increased government spending continues to take effect. Meanwhile, economic activity has moderated in China, Europe, Japan, and the UK.

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Locally, unemployment and interest rates at low levels

The Australian economy remains on track to grow by over 3% over this year. The labour market is tightening - which means lower unemployment levels - and interest rates remain low, which should support household income and consumption. Government spending on infrastructure is expected to increase and this should also support economic activity.

The cooling housing market and high levels of household debt, however, remain watchpoints.

After a decade of very low and, in some countries, negative interest rates following the global financial crisis, monetary policy is gradually returning to normal. Central banks are slowly raising interest rates and withdrawing liquidity.

This represents a major transition from the low interest rate environment that has prevailed for much of the last ten years and the shift is expected to create more market volatility than we have seen over the past few years.

Fed could pause 'normalisation' 

While the US Federal Reserve has led the trend to normalisation, in light of the market volatility in October and November, the Fed may pause its tighter monetary policy to underpin investor confidence and orderly markets.

The Australian labour market continues to strengthen, with unemployment expected to fall further and wage growth likely to be slow and steady. Inflation is low and should rise only gradually over the next few years. Low interest rates continue to support increased employment. With inflation well-contained, the Reserve Bank left the cash rate unchanged at its early December meeting. 

Inflation pressure emerges

The global expansion continues to soak up spare capacity. This is producing record low unemployment levels in several economies but also  upward pressure on inflation, which is expected to climb higher over the medium term. There is a risk that this could dampen company profit margins. We are watching closely as this could be a headwind for markets.

Another potential headwind for share markets is the recent and abrupt decline in energy prices due to declining demand and increased supply from Russia, Saudi Arabia, and the US. Falling energy prices imply lower profits for energy companies which could be a drag on share markets.

On a more positive note, the recent – admittedly tenuous - de-escalation of trade tensions between the US and China is expected to improve prospects for economic growth, company profitability, and investor risk appetite.

The US mid-term elections saw democrats gain control of Congress, while republicans consolidated their majority in the Senate.

UK Prime Minister Theresa May and European leaders agreed to a Brexit deal, but a number of UK government ministers resigned in protest. The deal has yet to be approved by UK lawmakers. 

Extract from Reserve Bank media release

4 December 2018

The global economic expansion is continuing and unemployment rates in most advanced economies are low. There are, however, some signs of a slowdown in global trade, partly stemming from ongoing trade tensions. Growth in China has slowed a little, with the authorities easing policy while continuing to pay close attention to the risks in the financial sector. Globally, inflation remains low, although it has increased due to the earlier lift in oil prices and faster wages growth. A further pick-up in core inflation is expected given the tight labour markets and, in the United States, the sizeable fiscal stimulus.

Source: www.rba.gov.au/media-releases/2018

Our performance

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Investment commentary

Most of our pre-mixed options recorded negative returns during November as Australian shares sold off. The Australian dollar strengthened against the US dollar, which dampened returns from investments held in US dollars that were not protected or 'hedged' against currency movements.

The Australian share market lagged global peers with the ASX 200 Index down 2.8% for the month. Energy fell over 10% due to falling oil prices, while Materials fell just under 5% due to soft iron ore prices. The combination of a cooling housing market, high household debt and slow wage growth continues to challenge the forecast for household consumption, with the
Consumer Discretionary sector falling 5%.

Emerging markets rallied as the Federal Reserve indicated it may pause its monetary policy normalisation (raising interest rates) which will lighten the debt burden for companies with debt held in US dollars. Developed markets had a positive month but lagged emerging markets. Energy was the worst-performing sector because of the sharp decline in oil prices and the impact on energy companies’ profitability. Spare capacity in the global economy
continues to decline, and this - along with tighter labour markets - has raised concerns that inflation might erode profit margins.

The US Federal Reserve indicated it may moderate the pace of interest rate hikes to maintain investor confidence and orderly market behaviour. Concerns about the impact of rising inflation on corporate profit margins - and moderating economic growth - led to bond markets rallying. Australian bond yields followed the US bond market lower. Domestic inflation
remains well-contained, unemployment continues to fall and the housing market is cooling. With all this in mind, the Reserve Bank left the cash rate unchanged.

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.