For the third consecutive quarter both share and fixed income markets performed well, although not at the same pace as the first half of the calendar year.
Returns were solid during the September quarter. Global shares returned 4.7% and Australian shares returned 2.4%, while fixed income markets returned 2.0% due in part to an interest rate cut by the Federal Reserve and an announcement by the European Central Bank (ECB) that quantitative easing will recommence.
The US economy continued to grow at a moderate pace during the quarter. While there is no obvious sign of weakness in the US economy at present, there is an acknowledgement that there are risks. Additionally, the economy is showing some signs of inflation leading to the US Federal Reserve (the Fed) to increasingly refer to its dual mandate of full employment and price stability. As a result, in July the Fed announced the first interest rate cut since 2008. The federal funds rate was cut again in September and investors expect further interest rate cuts over the coming year.
In the meantime, economic growth in the US remains quite robust with inflation at a moderate level. Any signs of weakness are not widespread and are relatively moderate in size, while consumer sentiment remains relatively strong. However, given the level of interest rates, only fiscal policy (increased government spending or tax cuts) is likely to be an effective tool to counter economic weakness should the need arise.
Major share markets benefited from the ECB’s announcement that its quantitative easing effort known as the ‘Asset Purchase Programme’ will restart in November this year.
Quantitative easing is used by central banks to encourage economic growth through the purchase of government bonds and other financial assets. The ECB’s Asset Purchase Programme began in early 2015 before winding down late last year. The program’s objective was to stimulate the Eurozone economy by making it cheaper to borrow money and ease conditions in capital markets. The program was implemented at a time when short term interest rates were already below zero and were thought to be losing their potency.
Restarting quantitative easing comes at a time when growth and inflation in the Eurozone are lower than desired. Fundamentals in other economies, namely the United States and China, are not showing significant signs of deterioration but we would not be surprised to see unconventional monetary policy being used for some time yet in Europe and Japan.
Early in the quarter Theresa May resigned as UK Prime Minister and the Conservative Party elected Boris Johnson as her replacement. Mid way through the quarter the new Prime Minister suffered a setback when the UK parliament passed legislation which requires his cabinet to seek approval before proceeding with a ‘no deal’ Brexit. This came as a relief to investors who are nervous about the short and longer term effects of leaving the European Union without favourable trade deals in place.
The downside is that the Brexit-related market turbulence seems likely to persist with the willingness of the Prime Minister to proceed with a ‘no deal’ Brexit in contrast to parliament as a whole.
Meanwhile in Australia, our current account balance rose sharply into surplus in the second quarter. The current account is the difference between the income generated from the export of goods and services against those that are imported. Australia’s current account has been in deficit since the 1970s, and the turnaround underscores the higher prices and volumes generated by the mining sector, with iron ore exports in particular helping to eliminate the deficit.
A lack of inflation in the Australian economy saw the Reserve Bank of Australia cut the cash rate early in the third quarter and again in early October. The cash rate now sits at a historically low 0.75%, which is hoped to boost an only moderately growing economy.
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