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Markets caught between rate hopes and trade storms – 27 May 2019

Australian Financial Review

Firming expectations that the official cash rate will be cut next month would be broadly welcomed by markets grappling with concerns the US-China trade dispute will get worse before it gets better and softer conditions in the labour market.

With the 10-year government bond yield hitting a record low on Friday, investors remain wary about the immediate prospects for the Australian sharemarket.

The futures markets suggest the S&P/ASX 200 Index will start marginally lower on Monday, pricing in a 6462 level for the benchmark after a subdued session on Wall Street ahead of a holiday long weekend.

The ASX performed strongly last week, advancing 1.4 per cent after a shock victory for the incumbent Coalition government triggered a reassessment of the outlook for banks and building material firms.

At the same time, conviction that interest rates will fall as soon as June firmed after the Reserve Bank of Australia gave its clearest signal yet that the cash rate would be lowered from 1.5 per cent as soon as next week.

Westpac’s Bill Evans added a third interest rate cut by the Reserve Bank to his forecasts on Friday, meaning he now expects the country’s official cash rate to fall to a record low of 0.75 per cent by November.

“Our work around the weakness in the cyclical parts of the labour market (around 60 per cent of employment), which is already apparent and recent trends in the business surveys, signal that the softening in the labour market can be expected to become more apparent in the next few months,” Mr Evans said.

The Australian 10-year government bond yield hit a record low at the end of last week, trading at 1.521 per cent, and is now approaching the current level of the cash rate.

Steve Miller, from Grant Samuel Funds Management, cautioned that after the election there is some “false optimism” around the outlook for the Australian economy.

“Notwithstanding the election, Australia faces challenges. The 10-year yield is telling you that,” he said.

The gap between the 10-year government bond yield and the cash rate is expected to widen as the cash rate falls, with bond markets pricing in a cash rate of 1 per cent by the end of the year.

“I think that everyone expects the Reserve Bank of Australia to cut in June,” Mr Miller said.

For investors looking for clues on the health of the economy, the data calendar is light this week.

Private capital expenditure for the first-quarter is due out on Thursday and economists surveyed by Bloomberg are expecting a 0.5 per cent lift for the quarter, down from 2 per cent in the previous comparable period.

Building approvals for April are also due on Thursday, with a flat result expected for the month and a 22.4 per cent year-on-year drop.

Mr Miller remains sceptical about the health of the housing market and also noted that the global trade picture still looks murky with the global outlook increasingly challenged.

Trade war jitters took a turn for the worse mid-month after the US lifted tariffs against China, which retaliated with its own tariff measures. Last week, US President Donald Trump signed an executive order that laid the groundwork for a ban on US companies selling to Chinese technology company Huawei.

Amid concerns that the ongoing trade battle between the world’s two biggest economies will hurt global economic growth, oil prices fell to their worst weekly loss so far this year.

“There will come a point where [Mr Trump] will realise just how great the threat to the economy is and backtrack yet again,” Shane Oliver, AMP Capital’s chief economist, said.

“The problem is that this will likely require further economic weakness and sharemarket falls before we get to that point. The trade conflict will likely get worse before it gets better.”

After last week’s strong performance for the Australian market – in a week when many other global markets posted a five-day loss – Dr Oliver is concerned that Australian shares are now “a bit vulnerable”.

“While we see the sharemarket being higher by year end, there is a high risk of a short-term correction in line with global shares,” he said.

 

Article appeared in The Australian Financial Review on 27 May 2019.

Article written by Sarah Turner.

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