Global equities continued to grind higher last week, helped by ongoing solid economic growth yet still benign long-term bond yields. In a further sign that U.S. inflation fears have likely peaked, Wall Street shrugged off a further surge in the ISM manufacturing price index to 92.1 in June – the highest level since 1979! And although Friday’s gain in U.S. payrolls was stronger than expected at 875k (market 700k), the market focused on signs of improved labour force participation and the potential for rising supply to ease labour shortages and potential wage pressures. The $US strengthened last week, which along with weaker iron-ore prices weighed on the $A. Oil prices rose following a (likely temporary) delay in OPEC’s anticipated decision to increase supply a little further.
As expected, local economic data revealed ongoing strength in house prices and home lending, while Sydney’s lockdown dragged on. So far at least, local markets are ‘looking through’ the lockdowns, anticipating the hit to economic growth and corporate earnings will be modest and fleeting. We’ll see!
In a data-light week, minutes from the latest Fed meeting will be the highlight – with intense market focus on the degree to which the timing of bond tapering (the slowing in the rate of monthly bond purchases) and even potential rate hikes were discussed. I suspect nothing much will emerge from the minutes, with major decisions still to be agreed.
[As regards tapering, I suspect the likely eventual decision (perhaps as early as next month’s Jackson Hole meeting of global central bankers) will be to modestly scale back purchases by around $US10 billion per month, such that the current $120 billion per month program is gradually wound down over a year – with an announcement some months before the actual tapering begins. And all this will take place before the Fed contemplates any rate increase, which on this schedule would still not be before mid/late 2023. If I’m right, such a well-telegraphed and glacial pace of Fed tightening could be like hitting the market with a wet lettuce leaf over the coming year, and unlikely to derail the uptrend in stocks. Of course, all this does crucially depend on the annualised rate of core consumer price gains slowing back to a 2% or less pace over the next three to six months (as I expect)].
In Australia, the key event this week will be the RBA meeting, which is now widely expected to confirm the Bank’s open mindedness to potentially lifting rates by late 2024 (effectively by the Bank announcing it won’t extend its current 0.1% yield target on government bonds maturing in April 2024 to those maturing in November 2024). The RBA is also anticipated to announce a shift from a multi-month bond buying commitment (i.e. $100b over 5 months) to a more flexible monthly commitment (i.e. $20b per month, or $5b per week) which would be more in line with the Fed’s current approach. Like the Fed, this will give the RBA scope to glacially slow the rate of bond purchases over time, with hope that this will also feel to the market like it’s being flogged with a wet lettuce leaf.
Although it seems increasingly likely that the Fed will announce a tapering of bond purchases in coming months, given it still views current inflation pressures as temporary, and is more focused on lingering spare labour market capacity, it will likely proceed vary carefully – and try very hard not to unduly upset the equity or bond market. Provided U.S. inflation pressures ease, therefore, the backdrop for markets remains encouraging.
The RBA is likely to lag the Fed in announcing bond tapering, much less rate increases. Indeed, Australia’s low vaccination rollout makes the economy now more vulnerable to COVID than the United States.