Rates could rise as growth continues

Highlights

  • Global growth continues, prompting talk of rate rise
  • Central banks starting to wind back stimulus measures 

The global economic expansion remains strong and broad based. Growth in investment and trade has led to solid job creation across developed and emerging economies. The trend to lower unemployment has meant a number of economies, including Australia, are reducing excess capacity in their respective labour markets. As a result, both wage growth and inflation are expected to gradually increase.

The Unites States and China continued negotiating trade policy. China exports a lot more goods and services to the US than it imports, producing a US$200 billion annual trade surplus with the US. In a joint statement, trade officials from the two nations agreed to reduce the trade imbalance.

Economic conditions in the US remain strong, boosted by the recent tax changes, and inflation is approaching the central bank’s 2% target. In China, the authorities are targeting 6.5% annual growth for 2018, which is lower than last year’s target. The Chinese continue to focus on lower debt
levels and better environmental outcomes.

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Local economy continues to improve

The Australian economy is expected to grow just above 3% this year, and business conditions remain positive. The ongoing investment in public infrastructure continues to support economic activity, and the economy’s transition away from mining remains on track.

The Reserve Bank left the cash rate unchanged at 1.5%, continuing their longstanding low interest rate or ‘accommodative’ monetary policy. The official cash rate has been 1.5% since August 2016. While the bank does not see a compelling case for changing monetary policy in the short term, if the economy continues to perform reasonably strongly as expected, it will contemplate higher interest rates at an appropriate time in the future.

Political risk affects Euro markets

Towards the end of the month, political risk emerged in Europe as a coalition of Italian populist parties won the national elections. When Italian President Sergio Mattarella rejected the populist government’s proposed cabinet over anti-Eurozone views, European markets sold off sharply,
and the Euro depreciated.

Investors sold Italian government bonds—seeking safer assets—and bought US, German, and Australian government bonds, among others. Consequently, the yield on Italian bonds spiked (prices fell), while yields on US, German, and Australian bonds declined as demand pushed up prices.

US dollar moves higher

The US dollar moved steadily higher during the month. A rising US dollar places pressure on emerging market assets because it increases the repayment costs of any US dollar-denominated liabilities and debt. This was reflected in global share markets. Emerging markets fell over 3%, while developed markets were up slightly as positive returns in the US offset the Italy-linked sell-off in Euro markets. 

The domestic share market delivered a small positive return, with the S&P/ASX 200 Index up 0.5%. Resources rose 2.6%, outperforming Industrials, which were flat over the month. Telstra had a poor month down 12%.

Extract from Reserve Bank media release

5 June 2018

The global economy has strengthened over the past year. A number of advanced economies are growing at an above-trend rate and unemployment rates are low. The Chinese economy continues to grow, with the authorities paying increased attention to the risks in the financial sector and the sustainability of growth. Globally, inflation remains low, although it has increased in some economies and further increases are expected given the tight labour markets. As conditions have improved in the global economy, a number of central banks have withdrawn some monetary stimulus and further steps in this direction are expected.

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Investment commentary

All the pre-mixed options delivered positive returns as strong economic growth underpinned market sentiment. The Australian dollar rose slightly against the US dollar, modestly lowering returns from unhedged US dollar assets.

The Australian share market delivered positive returns, with the ASX 200 index up 0.5% during the month. Iron ore and oil prices climbed higher before peaking in mid-May, supporting the 2.6% gain in Resource stocks, while Industrials had a flat month. A 12% fall in the Telstra share price due to ‘challenging trading conditions’ contributed to the flat performance.

Global share market performance was mixed as the rising US dollar weighed on emerging markets, which posted negative returns and lagged their developed market peers. European markets were also negative given the political turmoil in Italy, although the UK market was relatively unscathed, with the UK FTSE 100 index rallying on the back of a weaker currency and rising commodity prices. Despite the ongoing US-China trade tensions and political developments in Italy, US markets performed well as the recent changes in tax policy continue to boost economic activity and corporate profits.

May was a tale of two halves in bond markets. Bond yields steadily climbed during the first three weeks, with 10-year US Treasuries once again moving above 3% and Australian bond yields following their US counterparts higher. Political turmoil in Italy led to a sharp reversal, with US and Australian 10-year bonds finishing the month at 2.86% and 2.67% respectively. The Reserve Bank left the cash rate unchanged at 1.5%, noting that a rise at some point in the future will be considered if the economy continues to recover as expected.  

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.