Wednesday, 13 April 2016

Market moves over March were driven by improving global economic data and dovish central banks.

On the data front, surveys of global manufacturing and services businesses showed improvement across most of the world. In the US, employment growth remained very strong and inflation appears to be accelerating, while consumer spending appears to have slowed. In the Eurozone, core inflation remained close to 1 per cent, well below the 2 per cent target, while activity data suggests growth may be slowing.

In Australia, headline economic growth was surprisingly resilient in late 2015, indicating the rebalancing underway in the economy is faring well. Leading indicators of residential construction, as well as retail spending, however, have softened recently while inflation remains very low. 

In China, the first data on China’s economy in 2016 showed industrial production growth continuing to edge down, with the blow from shrinking exports cushioned by resilient domestic consumption and investment. A return to growth for real estate construction is a hopeful sign.

Central banks around the world tended to ease policy in March. The US Federal Reserve (the Fed) lowered its path for projected interest rate increases. This was followed up by very dovish comments from Chair Janet Yellen regarding the impact of international considerations on the Fed’s decision making, suggesting that aggressive monetary policy action is unlikely.

The European Central Bank cut the deposit rate by 10bps to -0.4 per cent, expanded quantitative easing to include credit, and issued new targeted lending operations. The People’s Bank of China cut its Reserve Requirement Ratio at the beginning of the month in response to growth concerns. The reserve ratio is the portion of depositors balances that banks are required to have on hand as cash, and affects the money supply in a country. A number of smaller countries, such as Norway and New Zealand also cut rates.

The overall effect of this was weakness in the US dollar with the Broad Dollar Index off around 3.7 per cent in the month. In turn a weak US dollar translated into:

  • a rally in commodity prices, with oil up around 13 per cent for  the month
  • strong performance in emerging market (EM) equities. The strong dollar hurt EM assets since mid-2014 and a reversal of this has had predictable consequences
  • Underperformance in European and Japanese equities, whose currencies appreciated  relative to the US dollar
  • a rally in credit spreads1, with default expectations for oil producers in particular falling. 

Global economic growth is likely to be modest in the year ahead, broadly in line with the past few years. Even so, risks to the outlook, and for financial markets broadly remain elevated.  We think returns to most listed asset classes will likely be low and volatile over the period. 

1. A credit spread is the difference in yield between a US Treasury bond and corporate bonds of the same maturity. Corporate bonds yield more than Treasury bonds to reflect the risk of default. The spread between a corporate bond and a Treasury bond of the same maturity is the premium that investors require for assuming the additional credit risk associated with the corporate bond

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