Dr Shane Oliver, Head of Investment Strategy & Chief Economist at AMP, discusses developments in investment markets over the past week, economic activity trackers, major global economic events and Australian economic events.
Investment markets and key developments over the past week
Shares got hit over the last week as the Fed cut rates again as expected but tilted a bit hawkish in foreshadowing less rate cuts next year than previously expected. Noise around a potential US Government shutdown probably hasn’t helped either. This came at a time when shares were already vulnerable after a surge to record highs left them overvalued, a bit over loved and technically overbought. The fall in global shares also weighed on the Australian share market which fell around 2.9% over the week, with falls led by resources, financials and retail shares. From their highs earlier this month US shares have fallen 3.7%, global shares have fallen 3.5% and Australian shares have fallen around 5%. Bond yields rose sharply on expectations for less Fed rate cuts which further weighed on share market valuations. Oil, metal and iron ore prices fell on prospects for less US rate cuts and as the $US rose. This also weighed on gold and Bitcoin with the latter falling back below $US100,000. The $A fell back to around $US0.62, but this is mainly a strong $US story which rose on expectations for less Fed rate cuts rather than a weak $A story. On a trade weighted basis the $A hasn’t fallen so much as other currencies have fallen against the $US too.
Shares remain torn between the negatives of rich valuations, higher bond yields, uncertainties as to how much the Fed will cut rates, uncertainties around Trump and geopolitical risks on the one hand versus the positives of global central banks still being in an easing cycle, goldilocks economic conditions particularly in the US, optimism that Trump will reinvigorate the US economy and prospects for stronger profits ahead in Australia. Of course, over the last week the negatives got the upper hand and shares could still fall a bit further in the short term. However, our overall assessment remains that the trend is still up, including for Australian shares, but expect a far more volatile and constrained ride over the year ahead.
Out of interest the Santa rally normally kicks in around mid-December on the back of festive cheer and new year optimism, the investment of any bonuses, low volumes and no capital raisings at this time of year. Over the last 15 years the period from mid-December to year end has seen an average gain of 0.5% in US shares with shares up in this two-week period 10 years out of 15. In Australia, over the last 15 years the average gain over the last two weeks of December has been 1.1% with shares up 10 years out of 15. Of course, it’s not guaranteed and so far Santa looks to have been absent – or may have come early in November leaving markets overbought and now giving way to a focus on uncertainties around the impact of Trump’s policies and uncertainty about the Fed and RBA.
Source: Bloomberg, AMP
A hawkish cut from the Fed. While the Fed cut by another 0.25% taking the Fed Funds rate down to a range of 4.25% to 4.5%, its guidance and commentary tilted more hawkish with: one official dissenting from the cut; slight upwards revisions to its core inflation forecasts; the dot plot of Fed officials’ interest rate expectations now showing only 2 rate cuts next year compared to 4 back in September; 5 Fed officials indicating no cuts next year; and a higher long term rate expectation. Fed Chair Powell indicated that the Fed having already cut by 1% can now be more cautious in cutting but would have to see more progress on inflation before cutting again and “can’t rule anything completely in or out” including a hike (must have read the RBA!). The change in tone reflects the recent run of stronger growth and inflation data and uncertainty about Trump’s policies, but its worth noting we have had several such mood shifts from the Fed, eg it pivoted dovish a year ago then back to a bit hawkish around April before starting to ease in September. While Trump adds a lot of uncertainty, our assessment is that the Fed will swing more dovish next year as inflation resumes its downswing on the back of slower wage growth. As a result, the Fed will likely end up cutting 3 times rather than 2 taking the Fed Funds rate down to 3.5-3.75%. In the meantime, a slightly higher Fed Funds rate profile is not such a bad outcome in that it’s come with stronger economic growth – so stronger profits should help offset the drag from slightly higher than otherwise rates.
Source: Bloomberg, AMP
Weaker growth outside the US will see other central banks cut by more than the Fed next year. The Bank of England left rates on hold as expected reflecting sticky services inflation, but its commentary was dovish and will likely cut 4 times to 3.75% in 2025. Reflecting lower inflation and weaker growth the Bank of Canada is expected to cut to 2.5% next year and the ECB is expected to cut to 1.5%. And with New Zealand back in recession the RBNZ could cut by 0.75% at its next meeting and is likely to go below 3%.
Source: Bloomberg, AMP
Will the hawkish tilt by the Fed impact the RBA? Maybe, but only at the margin to the extent that the RBA may cite it as an example of sticky inflation as it did earlier this year. But the Fed cut by 1% this year and the RBA hasn’t moved, the US economy with growth running around 3% is much stronger than Australia’s where growth is less than 1% and we anticipate a step down in underlying inflation going into next year. Supporting this is the reality that Australian inflation whether headline or underlying is still not that different to that in other comparable countries.
Source: Bloomberg, AMP
So we continue to see the RBA starting to cut rates in the first half next year – hopefully in February (where the money market now sees a 69% probability of a cut) or by May, with at last three cuts through the year. Note that while Trump’s policies risk adding to US inflation and hence rates, they are ambiguous to potentially negative for Australian growth and inflation.
The new RBA rate setting board from March is unlikely to change the path for rates. The changes to the RBA board members determining interest rates have turned out to be minor with seven of the nine existing Board members going to the new rate setting board and the two new board members are not obviously hawks or doves. Yes, Professor Renee Fry-McKibbon is reported to have been a monetary policy dove back in 2022, but so were many at the time reflecting the previous few years where inflation had been below target so it’s no guide to whether she is generally dovish or hawkish. As a result, we see no change in the outlook for interest rates flowing from the RBA reforms so far.
Australian budget sliding back into deficit, but not by enough to change the RBA’s view. The Government’s Mid Year Economic and Fiscal outlook confirmed a return to deficit largely due to policy decisions to further boost spending including on childcare and $5.6bn in election goodies under “decisions taken but yet to be announced’. While this year’s deficit is slightly less than projected in the May Budget, projected deficits are $22bn higher out to 2027-28.
Source: Australian Treasury, AMP
While Australia’s budget and public debt situation is a non-event compared to other comparable countries, the picture painted in the MYEFO presents three major concerns.
First the policy easing inherent in strong growth in public spending and the swing from a surplus to deficit doesn’t make things easier for the RBA. Interest rates could be a lot lower were it not for all the public spending.
Secondly, public spending seems to be getting locked in at a permanently higher share of the economy compared to that seen prior to the pandemic. This doesn’t augur well in terms of turning around poor productivity growth and hence in terms of boosting living standards which raises questions as to its sustainability.
Source: Australian Treasury, AMP
Finally, with an increasing amount of spending on things like climate, manufacturing and housing now “off budget” in that its supposedly an investment, the underlying cash budget balance is now arguably understating the actual size of the budget deficit because this spending still adds to debt and is a cost to taxpayers. Maybe this should be reviewed in a new Charter of Budget Honesty.
Source: Macrobond, Australian Treasury, AMP
Major global economic events and implications
Business conditions PMIs for December overall suggest global growth is okay and inflation still falling – consistent with ongoing “Goldilocks” (not too hot but not too cold) conditions. The G3 composite PMI improved slightly in December with increases in the US, Europe and Japan but the divergence between a strong US and weak conditions elsewhere remains. As does strength in services versus weakness in manufacturing. Input prices remain elevated but output prices remain in their pre pandemic range, consistent with further central bank rate cuts.
Source: Bloomberg, AMP
The US composite PMI rose further in December on the back of strong services. Input prices fell and output prices remain well in their pre pandemic range. The latter suggests that disinflation will resume enabling the Fed to continuing cutting next year, albeit with stronger growth resulting in a more gradual pace of rate cuts.
Source: Bloomberg, AMP
Other US data was mixed but with the Atlanta Fed’s GDPNow tracker for December quarter GDP growth running at 3.2% annualised, ie strong. Home builder conditions and housing starts remain weak but permits to build new homes and existing home sales rose strongly in November. It’s hard to see much of a housing recovery though with mortgage rates high and rising again. Regional manufacturing conditions indexes remain messy with sharp falls in the volatile New York and Philadelphia surveys and industrial production fell again consistent with the softness in manufacturing. But retail sales growth remains solid pointing to strong growth in consumer spending this quarter and the US leading index rose for the first time since February 2022. Meanwhile jobless claims remain low.
Here we go again! The US also runs the risk of another partial Federal Government shutdown starting this weekend if agreement is not reached on a continuing resolution to fund the Government out to March and will see its debt ceiling reinstated on 1 January (although Treasury can keep going for several months before it risks defaulting). Musk – how come he drives things now? – and then Trump rejected an initial interim funding deal on the grounds it involved too much extra spending. Trump and House Republicans agreed a cleaner deal to fund the Government and suspend the debt ceiling for another two years. But it didn’t clear the House let alone the Senate (where Democrats still control things). But even if a funding deal is not reached the shutdown is likely to have little impact based on past experience and is likely to be brief. But it’s a sign of volatility to come around the US Government once Trump takes over.
Canadian inflation slowed to 1.9%yoy with core underlying measures unchanged at 2.6%-2.7% leaving the Bank of Canada on track to continue cutting rates albeit at a more gradual pace next year. This is supported by the weak economy, high unemployment and the threat posed by Trump’s tariffs.
Source: Macrobond, AMP
UK services inflation remains a problem for now. CPI inflation rose as expected to 2.6%yoy but services inflation was stuck at 5%yoy with wages growth remaining strong at 5.2%yoy, partly explaining why the Bank of England remained on hold in the last week. But with the economy looking weak a further fall in core inflation is likely enabling more rate cuts next year.
Source: Macrobond, AMP
The Bank of Japan left interest rates on hold at 0.25% as widely expected, with Governor Ueda leaning a bit dovish. The BoJ is still expected to hike again next year but it wants to see more confidence regarding wages growth and wants to gauge the impact of Trump’s policies which could threaten Japanese growth. Japanese inflation rose to 2.7%yoy in November due to higher rice prices, but core inflation just ticked up to 1.7%yoy.
Chinese data was soft highlighting the need for more stimulus. Industrial production rose an as expected 5.4%yoy but retail sales rose just 3%yoy and property investment and sales are continuing to fall. However, retail sales may have been distorted by early “Double 11” sales that pulled spending into October and house price falls have slowed. 2024 looks on track for growth around 5% in line with the Government’s target but more stimulus is still likely needed. On this front, Reuters reported that that China’s leadership have agreed to growth “around 5%” in 2025 and to raise the budget deficit to GDP ratio to 4% from 3%, adding to confidence that the Government will provide enough stimulus to keep the economy ticking over at or around the 5% target.
Source: Bloomberg, AMP
New Zealand back in recession. Expect more aggressive RBNZ rate cuts in the year ahead.
Source: Macrobond, AMP
Australian economic events and implications
Australian business conditions PMIs for December weakened slightly. In fact, the employment component going negative for the first time since the pandemic adding to the likelihood that the strong November jobs data was an aberration and jobs growth will weaken going forward. The good news though is that while input prices rose slightly the trend remains down and output prices slowed further into their pre-pandemic range. This is consistent with the NAB survey and adds to evidence that underlying inflation is easing. As a result, February remains in play for a rate cut.
Source: Bloomberg, AMP
Consumer confidence slipped in December. The latest Westpac/Melbourne Institute consumer sentiment survey showed a slight fall. This was to be expected after several months of strong gains. Confidence remains soft but it’s up from its lows with the improving trend consistent with an improvement in the misery index on the back of low unemployment and falling inflation.
Source: Westpac/MI, ABS, AMP
Home buyer sentiment remains depressed.
Source: Core Logic, Westpac/MI, AMP
Rising household wealth at 10%yoy driven mainly by rising house prices has been helping support consumer spending. Expect this to wane as house prices are now rolling over and actually falling in several cities including Melbourne and Sydney.
Source: ABS, CoreLogic, AMP
What to watch over the next three weeks?
In the US, the key to watch will be jobs data (10 January) which is likely to show a slowing in payroll growth to 180,000, unchanged unemployment at 4.2% and a slight slowing in average hourly earnings growth to 3.9%yoy. In other data, expect a slight rise in consumer confidence (23 Dec), a continuing soft trend in underlying durable goods orders (24 Dec), the ISM manufacturing conditions index (3 Jan) to remain soft around 48.7, the services ISM (7 Jan) to improve to around 53 and job openings and quits data (also 7 Jan) to show a further downtrend.
Eurozone inflation data for December (7 Jan) is likely to show a fall to 2.2%yoy with core inflation falling to 2.6%yoy.
Chinese business conditions PMIs for December (31 Dec) are likely to have remained subdued with CPI inflation (9 Jan) remaining around 0.2%yoy.
In Australia, the minutes from the last RBA Board meeting (24 Dec) are likely to confirm a pivot to more dovish guidance with the RBA gaining more confidence that inflation is falling in line with its expectations. CoreLogic data for December (2 Jan) is expected to show a 0.3% fall in home prices which would be their first fall since January 2023 and see annual home price growth for 2024 come in at around 4.9%yoy, down from 8.5%yoy in 2023.
Meanwhile, November inflation data (8 Jan) is expected to show a fall to 1.9%yoy with the key trimmed mean inflation reading falling to 3.3%yoy from 3.5%. In other data, expect building approvals (7 Jan) to fall 2%, ABS job vacancies (8 Jan) for the three months to November to show a further fall, the trade surplus to remain around $6bn (Thursday) and November retail sales (9 Jan) to show a 1.5% bounce reflecting Black Friday sales with December data a month later likely to show a similar sized fall. November household spending data (10 Jan) will likely also see a bounce followed by a fall in December.
Outlook for investment markets in 2025
2025 is expected to see okay but constrained global growth, but with an imbalance between strength in the US and weakness elsewhere. Expect global central banks to continue cutting interest rates as core inflation drifts further to target but expect bigger cuts in Europe and more constrained cuts by the Fed. Key uncertainties that will contribute to volatility are: Trump’s tax and tariff policies and the high risk of a trade war and/or concerns about the US deficit along with the risk of recession; geopolitical risks particularly in the Middle East; and Chinese growth.
In Australia underlying inflation is expected to fall further allowing the RBA to start easing hopefully from February but at least by May with three rate cuts though the year. The bad news is that unemployment is expected to head up to around 4.5% but growth should start to gradually pick up helped by lower interest rates and rising real incomes. The upcoming election risks a further rise in government spending but is unlikely to result in a big change in near term macro-economic policies.
Global and Australian shares are expected to return a far more constrained 7% in the year ahead. Stretched valuations after two strong years, the ongoing risk of recession, the likelihood of a global trade war and ongoing geopolitical issues will likely make for a volatile ride in 2025 with a 15% correction somewhere along the way highly likely. But with central banks still cutting rates, with the RBA expected to start cutting in the first half of 2025, and prospects for stronger growth later in the year supporting profits, shares should still see okay investment returns.
Expect the ASX 200 to end 2025 at around 8,800 points.
Bonds are likely to provide returns around running yield or a bit more, as inflation slows to target, and central banks cut rates.
Unlisted commercial property returns are likely to start to improve in 2025 as office prices have already had sharp falls in response to the lagged impact of high bond yields and working from home.
Australian home prices are likely to see further weakness over the next six months as high interest rates constrain demand and unemployment rises. Lower interest rates should help from mid-year though and we see average home prices rising by around 3% in 2025.
Cash and bank deposits are expected to provide returns of around 4%, but they are likely to slow in the second half of 2025 as the cash rate falls.
The $A is likely to be buffeted between changing perceptions as to how much the Fed will cut relative to the RBA, the negative impact of US tariffs and a potential global trade war and the potential positive of more decisive stimulus in China. This could leave it stuck between $US0.60 and $US0.70.
Ends
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