August Review

What a difference a month makes.  As mentioned in our July report, markets sharply overreacted to fears of a US recession and subsequently recovered by month’s end. Better inflation data in the US and dovish comments from Federal Reserve Chairman Powell have all but guaranteed the US will cut rates in September which saw the US market improve by 2.4%. After being down 6% earlier in the month, Australia recovered well to scratch out a 0.4% gain led by the technology sector and gold stocks. Other global markets recorded marginal gains with Europe up 1.4% and China 0.6%, with the exception being Japan which fell 2.4% after being hardest hit due to the unwinding of yen carry trades.

The prospect of lower interest rates is positive for government debt with US 10-year treasuries falling 14bp and Australian 10-year bonds moving in lock step declining by 15bp. Commodity markets were a mixed bag with oil falling 5.6%, iron ore down 6.9% on expectations of lower steel production in China, while gold advanced 2.2% benefiting from lower US bond yields and safe haven buying.

The Australian dollar was stronger over the month advancing by 3.9% on the prospect of a wider interest rate differential with the US, as the RBA is unlikely to follow the US Federal Reserve and cut interest rates this year.

 

 

 

 

 

 

 

 

 

Rate cuts are finally here

It’s been a long time coming, but there has been sufficient improvement in inflation to justify interest rate cuts in most of the world’s western economies. Europe, Canada, the United Kingdom, and New Zealand have already lowered rates. As mentioned earlier, the US Federal Reserve is almost certain to cut rates by 25 basis points in September in response to inflation on a glide path towards their 2% target level. Australia is a little behind the curve having not hiked rates as much as other countries, however it is inevitable that by early 2025 rates will also be reduced here. This ends a two-year journey of interest rate increases designed to suppress runaway inflation stoked by governments and central banks excessively stimulating demand during the COVID period against a backdrop of constrained supply. On the positive side, the accretive nature of the rate hikes has engineered a relatively controlled slowdown in economic activity such that no major economy has experienced a severe post COVID recession.

One of the reasons Australia will not reduce rates as soon as other countries is that monetary and fiscal policy are working against each other in the fight to reduce inflation, prompting a media exchange between the Treasurer and RBA governor. The recent GDP release shows that government spending remains the major contributor to economic growth which is adding to inflationary pressures and working contrary to the purpose of high interest rates.

 

 

 

 

 

 

Source AFR, ABS.

Strategy and Outlook

Interest rates cuts are well anticipated by the market so when they actually occur it will not necessarily boost share prices. In fact, markets have historically tended to underperform at the early stage of the rate reduction cycle. We are watching very carefully to what extent company earnings both in Australia and overseas will be negatively revised in accordance with the likelihood of slower economic activity. The earnings growth outlook is substantially more robust in overseas markets especially the US compared to Australia where forecast earnings growth in 2025 is basically flat. With September and October often seasonally weak months, it would be no surprise to see some consolidation or even correction over this period. Looking further out however, we remain confident about the long-term prospects given the likelihood of a significant recession being avoided, lower bond yields helping market valuations and ultimately markets anticipating positive earnings leverage towards the end of 2025.

Gary Burke

Chief Investment Officer

Level 6 / 360 Collins Street
Melbourne Victoria 3000
Phone 03 9959 9872
enquiries@boagfinancial.com.au

Boag Asset Management Pty Ltd
ABN 67 162 211 449
AFSL 469081
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