Investment update - July 2019

Up until the very last day of the month, July was a relatively placid month for global markets. Trade tensions quietened after the truce between President Trump and President Xi Jinping that resulted from the G20 summit in late June. Attention turned to the US Federal Reserve (Fed) as it delivered its first rate cut since the GFC.

A rate cut by the Fed was widely anticipated by markets, so the initial response to the 25 basis point cut, the first of its kind since the GFC, was relatively muted. However, in the coinciding press conference, Fed Chair Jerome Powell surprised markets by saying that the rate cut was a ‘mid-cycle adjustment’, rather than the first step in a rate-cutting cycle. Powell’s less dovish than expected rhetoric caused share markets to sell off on the last day of the month. Furthermore, the US dollar rallied as it became apparent that interest rates in the US are expected to remain at higher levels than in the rest of the developed world for some time yet.

Markets had little time to digest the Fed’s rate cut as President Donald Trump brought trade tensions straight back into the spotlight. Following unproductive trade talks between China and the US in Shanghai, President Trump took to Twitter to announce that the US would be implementing a 10% tariff on US$300 billion of Chinese imports, meaning that all Chinese goods will face tariffs as of 1 September. China was quick to retaliate by allowing the Chinese renminbi to weaken beyond seven renminbi per US dollar for the first time since the GFC. The re-amplification of trade tensions caused a flight to safety in markets with share markets tumbling and bond yields reaching new all-time lows.

In Australia, the RBA continued to be the main source of economic news. The bank delivered on its second consecutive 25 basis point rate cut at its meeting on 2 July. The RBA reiterated that its dovish tilt does not reflect a notable deterioration in domestic economic conditions, rather it reflects its desire to reduce labour market slack, and in turn, provide a boost for a below-target inflation rate.

Sustained demand for Australian commodities paired with a 60% increase in the iron ore price since the start of the year caused Australia’s trade surplus to reach a record high of $20 billion in July. A current account surplus in the second half of 2019 is now a real possibility, something that has not happened since 1975. Strong trade volumes have provided underlying support to the Australian economy and boosted the Australian dollar notwithstanding two cash rate reductions.

The impact of the trade tensions is having spill-over effects in the eurozone. The continent’s economic growth slowed to just 1.1% for the year ending in June. Manufacturing PMIs are at lows not seen since the 2012 eurozone debt crisis. According to the IMF, trade volume growth in the first quarter of 2019 declined to around 0.5% year-on-year, which corresponds to weak export orders for European manufacturers. The services sector continues to be relatively resilient to the trade conflict and has provided support in the face of many other headwinds.

In light of the gloomier outlook for the eurozone, ECB President Mario Draghi announced that new stimulus measures are likely to be announced at its September meeting. A cut to the already negative deposit rate is the most likely measure, however the ECB has said that a restart to its bond purchasing program may be announced.

In the UK, Boris Johnson was elected as the next Prime Minister of the UK on 22 July. While the outcome did not come as a surprise, Brexit-related uncertainty ratcheted up given that Johnson is a staunch supporter of a hard Brexit and has gone on record stating that a no-deal Brexit is a real possibility.

Central banks continue to ease monetary policy, through rate cuts by Fed and the RBA, and increasingly dovish rhetoric from others. Their actions appear to be increasingly pre-emptive, in response to downside risks, and a new focus on the unemployment rate in the case of the RBA. Risk assets continue to be supported by this easing bias, and the opportunity costs of holding cash and other defensive assets are increasing.

Meanwhile downside risks in the form of geopolitical conflicts such as US/China trade disputes and Brexit remain ongoing areas of concern. While central banks aim to prolong this economic expansion in spite of these risks, in the absence of clear communication they could themselves be a source of market volatility.

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