−US: Preliminary US GDP statistics for the June quarter werereleased and showed that the economy grew at an annual paceof 4.1% in the three months ending 30 June 2018.
−This encouraging statistic followed a slightly weaker reading inthe March quarter. Viewed together the two releases confirm theeconomy performed well in the first half of 2018, growing at apace that was broadly in line with consensus expectations.
−The improved performance in the June quarter was supported bysolid consumer spending and higher soybean exports. Businessspending slowed during the period.
−The value of exports rose 9.3% from a year earlier, comparedwith a 3.6% increase in the previous quarter. Imports moderatedover the same period, resulting in a strong influence from tradeoverall. In fact, the contribution of trade to GDP growth in the June quarter was the highest since 2013.
−Headline CPI again edged higher, to 2.9%. Ongoing pricingpressures in the economy are supporting the case for officialinterest rates moving back towards neutral.
−Housing starts data released in mid-month was particularly weak,with June starts 12.3% below the May level. The residentialconstruction market may be starting to feel the impacts of higherinterest rates.
−US interest rates were left unchanged at 2.00% in July, althoughfurther hikes are anticipated before the end of 2018.
−Australia: The Reserve Bank of Australia (RBA) again leftinterest rates on hold at 1.50%, extending the record periodwhere policy has been unchanged.
−The chances of official borrowing costs being amended in theforeseeable future remain low, particularly with inflation onlyapproaching the bottom of the RBA’s 2-3% target band. AnnualCore CPI was reported as 1.9% in the June quarter, althoughhigher petrol prices helped lift headline inflation to 2.1%.
−Employment trends remain encouraging, with more than 50,000jobs created in June. The official unemployment rate remainedsteady at 5.4%, however, and there is currently insufficient wagepressure to concern policy makers.
−New Zealand: Inflation picked up to 1.5% yoy in the June quarter, driven by higher food and transport prices. The increase wasslightly short of consensus expectations, however, and is unlikelyto be a concern for policy makers. Interest rates remain at 1.75%.
−In spite of loose monetary policy, business confidence fell to a 10-year low in July. Inflationary forces could lose momentum ifsubdued confidence levels result in investment plans beingdelayed or cancelled.
−Europe: Economic activity in the June quarter did not rebound asmany economists had anticipated.
−In fact, GDP growth in the Euro area was just 0.3% in the period.This was below consensus expectations and dragged the annualpace of growth down to 2.1%, from 2.5% previously.
−In spite of subdued economic conditions, some inflationarypressures appear to be emerging; the latest estimates suggestheadline CPI in Europe has risen above 2.0%.
−UK inflation data for June came in below expectations, whicharguably should reduce the likelihood of an increase in officialinterest rates by the Bank of England (BoE).
−However, previously hawkish comments from BoE officials haveseen the market retain a 91% chance of a hike in early August.
−No meaningful progress has been made recently in the prolonged ‘Brexit’ process and the UK’s proposed withdrawal from theEuropean Union.
−Asia: The Chinese economy grew by 1.8% in the June quarter,compared to a 1.4% expansion in the first three months of theyear. The economy advanced 6.7% in annual terms, which wasin line with market expectations.
−For 2018 as a whole, the Chinese government is targetingeconomic growth of around 6.5%.
−During the month officials announced that China is taking stepsto contain debt and leverage levels in the economy in order toreduce financial risks. Rising defaults among Chinese corporatebond issuers earlier in 2018 had become a concern for investors.This news was well received by investors – the stock marketstabilised in July, having lost more than 20% of its value betweenmid-January and the end of June.
−Elsewhere in Asia, the Bank of Japan lowered inflation forecastsout to 2020, suggesting monetary policy settings will not betightened and that bond yields will remain anchored at low levels.
−With inflation running at just 0.7% yoy, Japanese interest ratesremain at zero and a Quantitative Easing program is still in place.
−GDP data for the June quarter is due on 9 August. A contractionwould see the economy enter into a technical recession, followinga negative growth reading in the March quarter.
−The Australian dollar traded in a reasonably tight range againstthe US dollar, fluctuating between 0.735 and 0.745 for most of the month.
−At the end of July, the Australian dollar bought 0.742 US dollars;an exchange rate that was almost unchanged from the end ofJune.
−Most commodity prices finished the month lower as the USannounced a new set of tariffs on Chinese goods. China isexpected to reciprocate by imposing further tariffs of its own ongoods imported from the US.
−Concerns also mounted over the outlook for global growth, whichhas been driving demand for commodities in recent months.
−Oil (-6.5%) took a breather after posting strong gains in recentmonths and reaching multi-year highs. Thermal coal (-11.3%)also retreated as deficit concerns subsided.
−Precious metals were mostly lower, with gold (-2.3%), silver(-3.6%), palladium (-2.6%), and platinum (-2.4%) all finishing innegative territory.
−Most industrial metals lost ground on concerns around globaleconomic growth, including lead (-11.0%), zinc (-7.9%), copper(-5.2%) and aluminium (-4.3%).
−Iron ore (+0.7%) edged higher as the drawdown of Chinese steelinventory continued, given stable demand and supply disruptionsfrom China’s environmental crackdown.
−After some volatility, the S&P/ASX 200 Index finished the monthup 1.4%. Investors focused on improving domestic economicdata, as well as the upcoming ‘earnings season’.
−Telecoms stocks made a noteworthy comeback in July, rising7.9% reflecting strong recoveries in TPG Telecom and Telstra.
−Technology stocks struggled following poor results from US-listedFacebook. Utilities also underperformed after the ACCCproposed wholesale and retail electricity price reforms.
−Small caps underperformed, with the S&P/ASX Small OrdinariesAccumulation Index declining -1.0%. Toilet tissue and hygieneproducts supplier, Asaleo Care lost nearly half of its value afterreleasing disappointing preliminary half year results and loweringfull year earnings guidance.
−The S&P/ASX 200 A-REIT Index returned 1.0% in July.
−Diversified A-REITs (3.4%) was the best performing sub-sector,while Industrial A-REITs (0.1%) was the weakest.
−M&A activity remained a key driver, with Blackstone’s $3.1 billiontakeover bid for Investa Office Fund being labelled unfair butreasonable by independent expert KPMG. Elsewhere, Hometownlodged a bid for Gateway Lifestyle, with Brookfield reported tohave walked away from its proposed transaction.
−The strongest performers were Mirvac (5.1%), Stockland (4.5%),and National Storage REIT (4.0%). Mirvac benefited fromsecuring Suncorp as a major tenant at its proposed officedevelopment in Brisbane.
−Underperformers included Scentre Group (-3.2%), Charter HallLong WALE REIT (-3.2%), and Shopping Centres Australasia(-2.0%). Scentre shares fell following earnings downgrades frommultiple brokers, despite expectations that FY18 earningsguidance would be reaffirmed following the Group’s recent 50%acquisition of Eastgardens, a shopping centre in Sydney.
−Globally, major property market returns underperformed broaderequity markets. The FTSE EPRA/NAREIT Developed Indexreturned 2.5% in USD terms.
−In local currency terms, Hong Kong (2.8%) was the bestperforming market, while the UK (-0.6%) was the worst.
−Stock markets fared well in July, with positive economic news anda bright start to the US earnings season supporting sentiment. Allmajor markets registered positive returns.
−US technology earnings unsettled investors in the final days ofthe month, however, dampening returns from the MSCI WorldIndex to 2.5% in Australian dollar terms.
−The German DAX finished the month up 4.1%, as the US and EUappeared to reach a trade truce towards month-end. Having been hit hard over the potential US trade war, rebounds in carmakersVolkswagen and BMW helped the German bourse to outperformother major equity markets worldwide.
−The Japanese Nikkei rose 1.4% in local currency terms, but wasthe worst performer among major markets. A number of largelisted technology stocks were caught in the Facebook-inspiredglobal sector downturn.
−Emerging markets added 1.8% in local currency terms, supported by a sharp rebound in Brazilian stocks. The MSCI Brazil jumped9.2% in local currency terms, partly reflecting easing tradetensions.
Global and Australian Fixed Interest
−News flow affecting global bond markets moderated in July, withfew major themes influencing market sentiment.
−Volatility was reasonably low, certainly when compared to theheightened level of yield fluctuation we’ve seen in recent months.
−The rise in yields in the second half of July was mostly related toincreased attention on the Bank of Japan (BoJ) after officialsindicated they were considering a change in policy settings.
−If Japanese Government Bond yields were to rise, local investorsinvested in overseas bond markets might liquidate some of thoseinvestments and reallocate the proceeds into JGBs.
−US Treasury yields are expected to continue to test their recenthighs as the Federal Funds rate is increased.
−This is likely to support higher yields in other regions, particularlythose where monetary policy is also being tightened.
−Negative investor sentiment associated with the withdrawal ofliquidity from central banks remains a key risk to this scenarioplaying out as expected.
−Credit performed well in July, providing some long-awaited goodnews for investors. Investment Grade spreads narrowed 12 bps,closing at 1.13%. This followed five months of persistentweakness, where spreads had widened by around 40 bps.
−Another solid set of quarterly earnings announcements fromlisted US companies supported sentiment towards issuers inmost regions and industry sectors. Disappointing earnings in thetech sector did not have a significant influence on the market asa whole, as credit issuance is limited in this area of the market.
−There was particular respite for Asian issuers, which haveunderperformed recently due to trade concerns. Chineseauthorities appear to be easing back on measures that had beenimplemented to contain credit growth.
−The general optimism and healthy appetite for risk extended intothe High Yield market too, with yields closing 24 bps lower, at2.95%. Following the pull-back in July, yields in the High Yieldsector are close to their average level over the past 12 months.
Chart of the Month – Could the US Treasury yield curve invert?
In these bulletins, we aim to share interesting observations from global investment markets. This month we look at the US Treasury yield curve, which has flattened substantially in the past year. Might we be about to see the curve invert, with short-term yields rising above longer-term yields?The green line shows the US Treasury yield curve at 31 July 2018. The yellow line shows the curve at 31 July 2017. The yellow bars show the change in yields over the year for bonds with different maturities. Source: Bloomberg.
As the chart shows, 2-year US Treasury yields rose 132bps, to 2.67% in the year to 31 July 2018, primarily due to rising inflation and increases to the Federal Funds rate. 10-year yields rose over the same time period too, albeit by a smaller 68bps, to 2.97%. The curve has flattened as a result and the spread between 2-year and 10-year yields has narrowed to 30bps. This is the lowest level since 2007, before the GFC.
The narrowing between 2-year and 10-year yields has attracted a great deal of attention because an inverted Treasury yield curve has historically been a fair forward indicator of economic recession in the US. Prior to 2017 the curve inverted in 2000, 1989 and 1980 – on each occasion a recession followed shortly thereafter.
Monetary policy – both actual and anticipated – remains the primary driver of the curve shape. As a general rule:
-When the Federal Funds rate (which is an overnight rate) is below neutral, the curve tends to be steep.
-When the Federal Funds rate is well above neutral, the curve is more likely to be inverted.
-Policy makers typically hold the Federal Funds rate above neutral when they are attempting to slow the economy or controlinflation. This partly explains why inverted yield curves have often preceded economic downturns.
As the Chairman of the Federal Reserve has pointed out, “It’s really not the situation we are in now”. Inflation is currently under control and the Federal Funds rate remains below neutral. Only time will tell whether the curve will invert again this year and, more importantly, whether it will prompt a reversal in the recent economic expansion in the US. We do not currently believe this is likely, as a significant depression in the ‘term premium’ at the longer end of the curve appears to have been a major contributor to recent curve flattening.
We have seen compression in the spread – also referred to as the term premium – owing to a combination of:
-Bond purchases from central banks globally;
-The low inflation environment globally; and
-Significant forward guidance on interest rates from members of the US Federal Reserve Board.
Effectively, all of these factors lower the compensation required for investors to position bond portfolios at the longer end of the curve. As a result, the near inversion of the yield curve may not have such negative implications for the US economy as it has in the past.
*Source: FactSet, as at 31 July 2018.
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Please speak with your financial adviser Mark Giles Mark Giles of Complete Financial Solutions (WA) – Financial Planning (ABN26 050 157 938) is an authorised representative of Financial Wisdom Limited (ABN) 70 006 646 108 AFSL 231138). Alternatively visit our website at completefinsol.com.au or contact Colonial First State Investments Limited at colonialfirststate.com.au or phone 13 13 36. © Colonial First State Investments Limited ABN 98 002 348 352 AFS Licence 232468. This document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) based on its understanding of current regulatory requirements and laws as at 6 October 2016. This document is not advice and provides information only. It does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement available from the product issuer carefully and assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision.