All eyes on potential US rate rise

Market Watch November 2016

Bond yields and commodity prices rose sharply in October, increasing inflation risks, writes Mark Rider.

The market is now pricing in about a 70 per cent chance for a US rate hike in December. However, this may change due to market jitters related to the US presidential election, and uncertainty over what Donald Trump’s victory means.

Higher bond yields means lower returns from the fixed-income asset class, with both international and Australian fixed-income experiencing negative performance for the month.

Most major sharemarkets also fell, largely driven by a recalibration of sectors within the market. Sectors that generally perform well in a defensive environment, such as real estate investment trusts and utilities, lost favour to sectors generally linked to higher bond yields and higher economic growth, such as financials and consumer discretionaries.

Signs of stability in US, Europe and China

In the US, economic data remained stable as labour-market indicators and industrial activity continued to improve.

In Europe, growth indicators continued to pick up as business sentiment improved.

In Japan, our forward-looking indicators revealed new manufacturing orders continued to rise, but inflation remained soft.

In China, third-quarter gross domestic product remained in line with analyst expectations. Higher growth in the services sector was the main contributor, driven by increased confidence, easier credit conditions and a stronger property market.

What about local rates?

In Australia, the third-quarter inflation report continued to indicate soft underlying core inflation. The Reserve Bank of Australia has, in recent times, maintained a bias towards cutting rates. At the next RBA meeting on December 6, 2016, we await governor Philip Lowe’s announcement to see which way rates will go.

From a growth perspective, higher spot commodity prices, such as coking coal and iron ore will likely boost the terms of trade and national income. Meanwhile, we consider that the property outlook continues to be stable despite declining building approvals, with auction clearance rates (particularly in Sydney and Melbourne) remaining high.

Steeper US-government bond yields

Steeper US government bond yields

Sources: Bloomberg, ANZ Wealth

Asset class summary – October

Global developed market shares were down 0.5 per cent in hedged Australian dollar terms, despite gains in European and British shares. While US shares fell, the market still performed well on an earnings per share basis.

Emerging-market shares outperformed developed markets in US-dollar terms, largely due to stable Chinese growth, higher commodity prices and better investor sentiment.

Australian shares fell 2.2 per cent, dragged down by real estate investment trusts, telecommunications and utilities. Resources continued to perform well given higher spot commodity prices.

Global fixed-income returns were down 0.9 per cent as headline inflation expectations increased due to rising oil prices. Australian fixed income fell 1.3 per cent as the market priced in further interest rate cuts.

In currencies, the US dollar strengthened in the environment which favoured lower-risk assets. The Australian dollar was down 0.7 per cent, with higher commodity prices helping to offset losses.

Major asset class performance - October (%)

Sector 1 mth 3 mths 12 mths 5 years
Australian shares -2.2 -3.2 6.3 9.0
Global shares (hedged) -0.5 -1.4 3.0 13.9
Global shares (unhedged) -1.4 -1.4 -5.4 16.8
Global emerging markets (unhedged) 0.8 3.9 2.5 7.5
Global small companies (unhedged) -3.1 -2.1 -2.7 18.1
Global listed property -5.2 -9.0 4.5 13.0
Cash 0.2 0.5 2.1 2.9
Australian fixed income -1.3 -1.1 4.0 5.8
International fixed income -0.9 -0.8 6.7 6.8

Sources: JP Morgan, ANZ Wealth. Note: data as at October 31, 2016.

Indexes: Australian shares – S&P/ASX 300 Accumulation; global shares (hedged/unhedged) – MSCI World ex Australia; global emerging markets – MSCI Emerging Free Net in AUD (unhedged); global small companies (unhedged) – MSCI World Small Cap ex-Australia; global listed property – FTSE EPRA/NAREIT Developed Rental Index ex-Australia (hedged); cash – Bloomberg Bank Bill, Australian fixed income – Bloomberg Composite Bond All Maturities; international fixed income – Barclays Global Aggregate Bond Index (hedged).

Please note: Past performance is not indicative of future performance