US rates creep up another notch

Highlights

  • Ongoing US-China trade tension
  • Fed raises rates 0.25%

While the global economy continues to expand, there is widespread concern about the longer-term impact of protectionist trade policies on economic growth.

Trade policy tensions between the US and China continued. The US announced further tariffs on Chinese imports during the month, and pledged further tariffs if China takes retaliatory action. 

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Australian conditions positive

Australian economic conditions remain positive, marked by strong export growth, steady consumption growth, and an improving economic environment in Western Australia.

The labour market continues to improve, with unemployment at its lowest level in six years and a slow but steady increase in wages.

While housing prices continue to moderate, the pipeline for residential construction remains healthy. Given this backdrop, the Reserve Bank left the cash rate unchanged, believing the current level is appropriate to support the economy and achieve its inflation target. 

US momentum strong

Economic momentum in the US remains strong, with unemployment declining to record low levels as the economy benefits from ongoing government spending and tax cuts. During its September meeting, the US Federal Reserve raised interest rates for the third time this year, citing strong economic growth, a healthy labour market, and inflation in line with its 2% target. The Fed now considers its monetary policy ‘neutral’ rather than ‘accommodative’, signalling an official end to its post-GFC, crisis-era monetary policy.

Euro monetary policy more ‘normal’

In Europe, the European Central Bank left interest rates unchanged and indicated rates would remain at their present levels until mid-2018. As the ECB gradually shifts from crisis-era monetary policy towards a more normal policy, it also aims to end its financial asset purchase program at the end of 2018, provided economic conditions remain supportive.

Global bold yields increased,led by rising yields in the US, where the government has increased borrowing to pay for government spending and tax cuts. US companies continue to benefit from government spending and tax reforms, with the US share market setting record highs.

Emerging market shares remain vulnerable to rising US interest rates as their US dollar debt burdens increase. On top of that, emerging market economies tend to be more export-oriented and sensitive to trade policy tensions. Given both these factors are playing out, emerging markets lagged their developed market peers during the month.

The Australian share market also lagged due to ongoing trade tensions between the US and China and the subsequent impact on China’s economy. The Royal Commission into the aged care industry also weighed on the market, as Health Care fell 8%. Rising commodity prices provided some relief, underpinning the rally in Resources, while the rise in bond yields affected the performance of Real Estate shares. 

Extract from Reserve Bank media release

2 October 2018

The global economic expansion is continuing. A number of advanced economies are growing at an above-trend rate and unemployment rates are low. 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 both higher oil prices and some lift in wages growth. A further pick-up in inflation is expected given the tight labour markets, and in the United States, the sizeable fiscal stimulus. One ongoing uncertainty regarding the global outlook stems from the direction of international trade policy in the United States.
Source: www.rba.gov.au/media-releases/2018

Our performance

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Investment commentary

All our pre-mixed options delivered negative returns as bonds and Australian shares sold off. Trade tensions, rising bond yields and the Royal Commission all had an impact. The Australian dollar strengthened against the US dollar, dampening returns from unhedged US-dollar investments. 

Australia lagged developed market peers, with the ASX 200 declining 1.7%. Given the domestic economy’s exposure to China, ongoing trade policy tensions between the US and China continued to weigh on investor sentiment. The government announced a Royal Commission into the aged care industry, and the Health Care sector fell 8% during the month. In contrast, Resources rallied on the back of rising commodity prices. 

Trade tensions continued during September, with the US announcing further tariffs on Chinese imports. This, along with rising US rates, led to a sell off in emerging markets. In contrast, most developed markets delivered positive returns. Energy was the best-performing sector on the back of rising oil prices, as OPEC decided against further increase in oil production. 

The US Federal Reserve continued to move rates towards more normal levels with a further 0.25% increase during September pointing to solid economic growth, ‘on track’ inflation and declining unemployment as the basis for the decision. Higher bond yields and strong economic conditions led to a selloff in global bond markets. In Australia, economic growth remains on track, housing prices continue to moderate, and the Reserve Bank left the cash rate unchanged. Low rates continue to support economic growth and lower unemployment. 

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.