June 2024 quarter economic and market commentary
The winding back of aggressive policy rate reductions from the Fed continued into the June quarter as inflation reads earlier in the quarter suggested that progress on reducing inflation had stalled.
That development saw a pronounced rise in US bond yields back to cyclical highs. The US 10-year bond breached 4.70 per cent toward the end of April as inflation fears peaked. More benign inflation news through May and June saw inflation fears abate and bond yields retrace some of their earlier upward moves.
At its meeting in June the Fed issued a new “dot plot” implying a central case forecast of two more 25 basis point policy rate reductions in 2024. That markets were largely aligned with that expectation created an environment where positive inflation news could drive yields lower.
After initially confronting headwinds associated with inflation fears and attendant rising bond yields, equity markets rallied sharply from late April. To a large extent equity markets have shown some resilience throughout 2024 reflective of a “thematic” and relatively narrowly-based rally focused on technology. However, as markets became more aligned with the Fed view of the likely trajectory of the policy rate and inflation news turned a little more positive allowing bond yields to fall, “macro” themes accentuated some of the more “thematic” themes that had driven earlier market strength.
Locally, and in contrast to developments in the US, inflation news created an expectation that the RBA may need to contemplate a further increase in the policy rate.
It had been thought that a further policy rate hike was unlikely. That was based on a view that underlying weakness in activity growth will show through in a weaker labour market and allow a more confident projection of inflation declining in a timely fashion toward target.
The first part of that premise (a weakening labour market) will likely come to pass, although the current evidence is at best piecemeal.
The second – that there can exist a confident projection of the timely return of inflation back to target – looks a challenge, certainly relative to the manner envisaged by the most recent RBA forecasts.
The notion that there may be a further increase in the policy rate, combined with some concerns related to commodity prices saw the local equity market underperform its US counterpart.
Going forward, the key issues for 2024 revolve around the “stickiness” of inflation both locally and in the US.
In the US it appears that the Fed may well cut the policy rate more than once before the year is out as inflation continues to track toward target and evidence grows of a cooling in the labour market off the back of some slowdown in activity, albeit without showing signs of a lurch into recession.
That should support the prices of key US financial assets and underpin any tailwinds of a “thematic” nature.
Locally, the potential for a further policy rate hike may see some underperformance of Australian financial assets.
Within that framework there is some potential for structural factors to affect the narrative. Structural factors are undergoing some critical shifts: higher “neutral” interest rates, emboldened regulators, growing protectionism, and emergent “mega forces” such as climate, cyber-security and AI.
Geo-political risks remain elevated: the forthcoming US Presidential elections, tensions associated with the Middle-East, the Russia / Ukraine conflict, China /Taiwan, and the Korean Peninsula remain capable of upsetting any positive market narrative.
That all suggests that there will be episodic bouts of volatility where the potential for seismic shifts in sentiment and the prices of financial assets exist.
