September quarter economic and market commentary

The most prominent development in financial markets during the quarter was the pronounced upward move in US bond yields, led by longer tenor bonds (yield curve steepening). That reflected the notion that while there had been progress in getting inflation down it was only grudging progress. Moreover, services inflation which had become a particular focus for the Fed was proving “sticky”. In that context, market pricing reflected the notion that not only were future Fed policy rate hikes still on the Fed’s agenda but that at a minimum the Fed would hold the policy rate at ‘high’ levels for an extended period. In other words, the policy rate is at best approaching a “plateau” rather than a “peak”.

Inflation developments, combined with the ongoing resilience of US economic activity and labour markets to prior policy rate increases, saw the Fed raise the policy rate to an upper bound of 5.5 per cent at its July meeting, while the September “dot plot” implied the Fed saw at least one further policy rate hike in 2023.

Rising US bond yields created significant headwinds for US and global equity markets with developed country indices giving up some noticeable ground during the quarter.

Rising US yields underpinned a firming USD with the AUD noticeably weaker over the course of the quarter.

Locally the Reserve Bank of Australia (RBA) was happy to eschew any further increase in the policy rate as inflation looked to be (temporarily at least) abating. However, the incoming Governor of the Reserve Bank of Australia (RBA), Michele Bullock, echoed her predecessor’s caution in acknowledging that “some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe.” That reflected some concern over the potential for “stickiness” in inflation in Australia.

In what proved to be a challenging environment, in local currency terms Australian bond and equity markets outperformed their US counterparts.