The Confusion of the RBA
On Monday (June 25th), Philip Lowe, the governor of the Reserve Bank of Australia commented on a panel in Canberra that he “doesn’t really understand” why the same investors who are betting on RBA’s cutting rates are also driving a massive rally in both stocks and bonds. “To me, it’s a strange world. There are investors who think the outlook is sufficiently weak that they expect central banks right around the world to cut interest rates but they are not worried about corporate profits or credit risk,” Lowe said. In fact, both of the traditional safe havens, such as gold, and riskier assets such as stocks and bonds, have hit record highs all around the world.
The governor also highlighted the contradiction of the stock market being “very strong” and credit spreads being narrow while the central bank lowered the cash rate. Generally, a narrower credit spread indicates a vote of confidence in the economy. That is, investors are confident in corporate profits and the general company liquidity.
On the other hand, Stephen Anthony, the Industry Super chief economist mentioned that there was ‘flashing red’ in the global bond market as it possesses a negative yield curve. Mr Anthony also added that although there was a rally in the equity market, he was staying on the bearish side due to the global bond market conditions. Other analysts considered that investors are being forced into riskier asset classes, such as equities because “there is no alternative” amid the global economic downturn.
Economic Conditions in Australia
According to the NAB monthly business survey, business confidence has jumped whilst alternatively business conditions have deteriorated after the federal election in May. The retail sector showed a recession, as the retail turnover in April fell by 0.1% over the previous month. The unemployment rate in Australia remained stagnant at 5.2% in May, but the number of employed individuals increased by more than 42,300 as the participation rate hit an all-time high. Underemployment rose from 8.5% in April to 8.6% in May and the underutilisation rate was 13.7%. Gross domestic product growth in the first quarter of 2019 rose by 0.4% over the previous quarter but slowed to just 1.8% over the past 12 months. This is the weakest year-on-year economic growth in the past 10 years.
The cash rate currently sits at an all-time low of 1.25% after it was lowered in the last RBA meeting on June 5th. The Reserve Bank planned to cut interest rates “to support employment growth and provide greater confidence that inflation will be consistent with the medium-term target.” However, the Melbourne Institute and Westpac Bank Consumer Sentiment Index for Australia declined by 0.6% month-over-month to 100.7 in June 2019. This suggested that the RBA’s cash rate cut on June seemed to fail to support sentiment and perhaps even weaken it, although it may be too early to tell.
The Global Economic Downturn
According to Moody’s forecast, the global economic growth rate in 2019 will drop from 3.2% in 2018 to an expected 2.8%. Within this figure, the economic growth rate of G20 countries will peak at 3.3% in 2018 and will settle down to 2.9% in 2019. In particular, for developed economies in the G20, Moody’s believed that the growth rate will fall from 2.3% in 2018 to 1.9% in 2019. This trend has been reflected in the major G20 economies including the US and Germany. The overall growth rate in Emerging markets will be around 4.6% in 2019, down from 5% in 2018.
In order to withstand the downside risks of the slowing global economy, countries such as Russia, India and Chile have engaged in quantitative easing. At the beginning of the year, JPMorgan had expected the global average interest rate to reach 3% by the end of 2019 based on the data showing that the global average interest rate reached a high of 2.82% in February. However, the bank has reversed its view and downset the forecasted average interest rate to 2.5% in December this year, driven by the Fed’s interest rate cut. Moreover, the data from the Institute of International Finance showed that total global debt (including firms, households and governments) has approached $250 trillion so far. This is equivalent of approximately 317% of global GDP with an increase of about 70 trillion U.S. dollars experienced over the 2008 financial crisis.
The escalating trade disputes and geopolitical risk in the Middle East will also increase financial market volatility and destabilise the global economic outlook.
By Steven Gao
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