Creeping central bank divergence
May was a good month for returns as investor optimism about the global economy supported equities, while the expectation for rate cuts from central banks led to falling bond yields. The MSCI World rose 4.0%, while the emerging market benchmark gained 0.5%. Global bonds also generated positive performance and the Bloomberg Barclays Global Agg rose by 1.3%. However, there is increasing divergence between central banks on the timing of rates cuts, and core rates of inflation are looking increasingly sticky.
The Australian Government 2024/25 Budget added to inflation concerns given the front loading of spending and the cost-of-living support for households. This comes at a time when household incomes will get a boost from income tax changes in mid-year. However, the inflationary consequences are still uncertain as it is not known whether additional income will be spent, saved or used to pay down debt.
Meanwhile, inflation in the eurozone rose in May, complicating the path for policy easing by the European Central Bank. Economic data for the region came in better than expected, as business surveys pointed towards a pick-up in economic momentum and growth expectations were revised higher.
A policy put is in play in China as further actions were taken to steady the economy, and particularly the housing market, as economic data has been slow to improve. However, tariff announcements by the U.S. against a limited number of Chinese imports did take some shine off the market rally. The CSI 300 fell 0.5% over the month.
Turning to the U.S., the return of the soft-landing narrative was in full effect as Federal Reserve (Fed) Chair Jerome Powell struck a dovish tone at the May meeting. Economic data surprised to the downside as concerns around the health of the consumer rose. However, several Fed committee members become more vocal on the need to cut interest rates this year until there is more clarity that inflation has been beaten. Market expectations shifted to pricing just one rate cut in December.
Economic data released in May tempered many of the concerns around an overheating U.S. economy and showed further signs of a rebalancing in economic momentum. The next move for policy rates across major developed market central banks is likely to be lower, even as there is greater divergence in the pace of easing. These factors are supportive for risk assets, and for investors to hunt further afield for better returns and regionally diversified exposures.
Australian economy:
- The Reserve Bank of Australia (RBA) held the cash rate at 4.35% in May, but stated their tolerance for further inflation was limited. Their updated economic projections show inflation returning to the mid-point of the target range by 2026, as growth softens, and the unemployment rate rises. However, this is the optimal outcome with little room to flex should things not go exactly according to plan. The RBA may be on an extended hold, but the bias is for more policy tightening.
- Consumer price index inflation for April was higher than expected at 3.6% year-over-year, triggering the sticky inflation call from many market commentators. The first monthly inflation print of the quarter is dominated by goods pricing.
(GTM AUS page 5) - The unemployment rate rose to 4.1% in May from 3.9% in the prior month, continuing the stream of lumpy jobs data. Broader indicators of the labour market such as vacancies, hours worked or simply employment intentions, all point toward a continued softening in the labour market and easing of wage pressures.
(GTM AUS page 9) - The Australian consumer is not happy. Consumer confidence index fell again in May to 88.2 and remains at a very low level by historical standards. Business by contrast is a little more upbeat. The business confidence index held steady, even as near-term views on business conditions weakened.
- Nationally, house prices rose by 0.8% month-over-month in May and 8.8% year-over-year. Across the capital cities, housing price appreciation month-over-month remains the strongest in Perth (2.0%) and Brisbane (1.4%), while Sydney (0.6%) and Melbourne (0.1%) lag. Construction activity remains muted, meaning the supply of housing is constrained, which should continue to support prices.
(GTM AUS page 10 and 11)
Equities:
- The ASX 200 gained 0.9% in May and is up 3.2% this year. Australian small caps were flat. Reversing April’s performance, Australian equities lagged international peers. The U.S. S&P 500 gained 5.0% for the month, while Europe was up 3.2% and Emerging Asia ex-Japan rose 1.5%. Only Japan was weaker than Australia with a 1.2% return in local currency terms.
(GTM AUS page 32) - Valuations across equity markets remain rich on some metrics, but equity markets have continued to rise. The expectations for supportive economic growth and lower bond yields are helping to justify the rise. (GTM AUS page 33)
- Earnings expectations are also supportive. The consensus outlook for 2024 still expects more than 10% earnings growth in the U.S. and increasing earnings in Japan and Europe. Australian earnings growth expectations continue to slide for this year.
(GTM AUS page 16) - At the sector level. Information technology (5.4%), utilities (3.4%) and financials (2.6%) had the largest gains within the ASX 200. Meanwhile, communication services (-2.6%), consumer staples (-1.0%), energy (-0.7%) and consumer discretionary (-0.6%) were laggards.
Fixed income:
- The Australian 10-year bond yield moved by 1 basis points (bps) over the month to 4.41% and has been within the 4.25-4.50% range since mid-April. U.S. 10-year Treasury yields stepped down by 19bps to 4.49%. Meanwhile, the Japanese 10-year bond yield rose by 20bps to 1.07%, its highest yield in well over a decade.
(GTM AUS page 48) - The fall in yields helped lift U.S. Treasury returns to 1.5% for the month compared to the 0.4% gain for Australian government bonds. Spreads in the credit market remain tight, with global investment grade bonds delivering a 1.9% return and besting global high yield, which rose by a smaller 1.2%.
(GTM AUS page 47)
Other assets:
- Despite falling oil prices, the Bloomberg Commodity Index was 1.3% higher over the month. Brent crude fell 8.1% to USD 82 per barrel. The softening demand outlook and fall in prices saw the Organization of the Petroleum Exporting Countries Plus members extend production cuts that were set to expire at end of June. Natural gas prices are on the move again, and the U.S. benchmark was nearly 30% higher over the month.
- The gold bugs are in full flight as the precious metal price rose by another 1.8% in May to USD 2,348. The ability for gold to sustain these higher prices is a function of expected policy easing by central banks and as a hedge against the continued macro uncertainty and geopolitical risk.
(GTM AUS page 66). - Across other metals, the picture was similar, outside of copper. The price of copper fell 0.6% to USD 9,913 a ton, in line with general softer demand. However. aluminum (5.2%), nickel (4.5%) and zinc (2.4%) were all higher.
(GTM AUS page 63) - The U.S. dollar index was 1.5% lower over the month as the greenback lost ground against the euro (-1.5%) and Swiss franc (1.6%). The Australian dollar was 2.4% higher versus the U.S. dollar at USD 0.665. (GTM AUS page 68)
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