Investment markets and key developments: Several reasons for optimism despite high near-term risks

Stock markets fell sharply over the past week, reversing their rally from lows the previous week as US inflation surprised on the upside, again adding to Fed rate hike expectations.

The weak global lead saw Australian stocks fall back to their previous week lows with falls led by property, healthcare, consumer staples and industrials stocks.

Bond yields rose due to higher short-term interest rates for longer. Prices for oil, metals and iron ore fell, not helped by fears of recession. The AUD fell as the USD rose.

Equities remain at high risk of further declines in the near term due to inflation, interest rates, recession and geopolitical risks. And as we saw last week, if US stocks fall, Australian stocks will follow even if the RBA takes a less hawkish course.

There is a danger in exaggerating the stock market drop mid-week, as it has just brought stocks back to where they were a week ago. Nevertheless, the speed of the fall highlights the vulnerability of equity markets in the near term, as inflation remains elevated, global central banks are still hawkish, recession risks are high, geopolitical tensions remain high, and the period up to ‘in mid-October is known for its actions. market weakness.

In particular, on the inflation front, core inflation in the United States was much higher than expected at 6.3% year-on-year, with the magnitude of high inflation continuing to increase, and the situation was similar in the UK, where core inflation also rose to 6.3%.

This, combined with hawkish comments from the Fed and a still strong US jobs market, likely keeps the Fed on track for another 0.75% hike in the week ahead and keeps the BoE on course. way for another 0.5% rise in the coming week as well.

The danger is that the Fed and other central banks have locked themselves into oversized rate hikes based on historical data and a loss of confidence in their ability to forecast inflation at a time when they really should be giving more Watch out for monetary policy shifts and slow the pace of hikes. This increases the risk of a recession/deep recession, as it can be difficult to slow rate hikes when they should be.

And technically, the rebound in equities from their June lows lacks the cyclical leadership normally seen in new bull markets and earnings revisions remain negative.

However, while near-term risks remain elevated, there are several reasons for optimism:

  • Producer price inflation is slowing and appears to have peaked in the US, UK, China and Japan. This is in line with our pipeline inflation gauge, which continues to decline given lower prices and costs in business surveys, lower freight rates and lower commodity prices ( excluding gas and coal).
  • Consumer inflation expectations fell in the United States and Australia, thanks to aggressive central bank measures and falling gasoline prices. This should make it easier for central banks to bring down inflation without having to raise interest rates to exorbitant levels.
  • Finally, money supply growth has slowed from its 2020 surge, which should help lower inflation going forward.

In Australia, the RBA signaled that it would consider returning to a 0.25% hike in October, which makes sense. Reserve Bank Governor Lowe, during his appearance before the House Economics Committee, reiterated his recent messages that: high inflation is hurting the economy; the RBA will do what is necessary to bring inflation back to its target; further rate hikes are likely, but the RBA is aware that monetary policy operates with a lag; and consideration should be given to slowing the pace of tightening.

The still tight jobs market and still high price and cost pressures, evident in the latest NAB business survey, indicate that the RBA will rise again next month. Governor Lowe has indicated that the RBA will consider a 0.25% or 0.5% hike at this meeting depending on incoming data and we expect the RBA to return to a 0.25% hike with a peak at 2.85%.

However, given the strength of the lagging data and the RBA’s inflation concerns, the risk is on the upside for our interest rate outlook. And Governor Lowe’s reference to the pace of hikes slowing down “at some point” suggests it’s not necessarily imminent.

But just because the Fed is likely to hike another 0.75% next week doesn’t mean the RBA will have to continue with hikes of 0.5% or more. The RBA sets interest rates for Australia, not the US; he would only need to match the US if he’s worried about a crash in the AUD boosting Aussie inflation, but so far there’s no sign of that (the Fed rose from 2015 to 2018 while the RBA fell without the AUD crashing).

Additionally, wage growth in Australia is much lower than it is in the US, which gives the RBA a little more flexibility to allow for monetary policy shifts.

Monitoring of economic activity

Our Australian and European economic activity trackers plunged last week while in the US they were little changed. Overall, they suggest that while some momentum has been lost following the post-pandemic recovery, economic activity is holding up reasonably well so far.

Based on weekly data for eg job vacancies, restaurant reservations, trust, mobility, credit and debit card transactions, foot traffic, hotel reservations. Source: AMP