The downgrades in both the Australian growth and inflation outlook by the Reserve Bank of Australia (RBA) last week have amplified the prospect of a potential rate cut later this year. Who would have thought that with cash rates at 1.5%.
The RBA shift to a neutral policy setting stance is telling in that the commentary and forecast downgrades communicate that the RBA can see some elevated risks rising from the housing slowdown. This outlook obviously impacts valuations across all asset classes. Afterall, markets are effectively pricing in future prices and interest rate setting expectations are critical in establishing where markets should trade going forward.
A downgrade to consumption would not surprise many as the two largest housing markets, Melbourne and Sydney, have continued to come off their lofty peaks of 2017. Weaker equity markets in 2018 have also led to perceptions of negative wealth effects. Not the best combination for sentiment at the household level.
Despite business condition (in aggregate terms) holding up, it is clear Australian households are holding back from large item purchases. Unfortunately, the current slowdown to the housing cycle for Australia is occurring with a global backdrop of slowing economic activity. The two downgrades to global growth by the IMF since October have reflected the slowing emerging markets from a year ago, and also the slowing China economy.
Europe is also slowing considerably and they have issues leading into Brexit and there will be implications for confidence. It will be in their interest to try to be a little more accommodative to the difficult wedge that Britain is currently in. A hard Brexit is bad for both. However, it will be relatively worse for the UK. The predictable hard line coming out of Brussels remains problematic.
On the positive side, the China stimulus that started last year is progressive and very targeted. The stimulatory fiscal and monetary policy will help cushion the slow down and continue to help drive volume growth in our resources. This is good for Australian export volumes. However, 2019 looks like a lower global and domestic growth pulse and this will imply caution for investors. Of note, the Australian 10-year bond has rallied strongly year to date and is now yielding a very low 2.1%. A clear sign of slowing conditions and little signs of price pressures. Rates this low will be tempting for Canberra to increase borrowing. Ultimately, debt funded projects need to be a very disciplined process. This can be challenging for some.
The US economy is set to be the big contributor to global growth for 2019. Growth in the largest economy has been strong over the past year and US earnings have reflected this. In broad terms it appears that US growth will expand again this year but at a slower pace vs 2018. Therefore, anticipate an even lower AUD. This will act as a stimulatory driver for our economy and exposure to USD assets or Australian companies with USD earnings will be positive.
The RBA have signalled some challenges ahead given the continued housing sector slowdown. Infrastructure spending programs currently underway will help. The message is clear – if the housing sector slowdown worsens and impacts employment, rate cuts will likely follow. Something we all thought unlikely a year ago.
CIO | Atlas Capital
Director | Salter Brothers Asset Management (SBAM)
As seen also in Herald Sun, Tuesday February 19, 2019.