Financial Market Update

Report contents

Global Equities Bounce Back After Early August Correction 

Australian Banks and Resources outperform

U.S Policy Easing Results In Lower Bond Yields And Higher $A 

With the Australian Reserve Bank (RBA) being one of the few developed economy central banks to keep policy unchanged over recent months, there has been less movement in rates across the Australian yield curve. None-the-less, the 10-year Australian government bond yield did fall 0.39% to 3.96% last quarter, with some evidence of lower inflation contained in the latest monthly indicator numbers for August. However, Australian labour markets remain strong, with unemployment at 4.2% removing any urgency for the RBA to cut interest rates before securing sustained lower inflation.

After declining for much of 2024, the $A appreciated against the $US last quarter, rising from US 66.2 cents to US 69.3 cents. Support for the $A was driven by the decline in interest rates in the U.S., as well as the Chinese policy stimulus, which was viewed as being positive for Australia’s trade position. The $A was also 0.2% higher against the Euro but declined 7.9% against the Japanese Yen.

Considerations For Investors

Equity market sentiment received another boost in September, with policy stimulus from both the US central bank and Chinese authorities being a catalyst for another wave of investor optimism. Upward momentum on global share markets has been substantial, with equities moving higher in 10 out of the last 11 months. One year ago, investors appeared deeply concerned about the prospect of a global recession. Today, the global share market is 29% higher.    

 Although the growth in share market valuations can be justified by the healthy state of company earnings, periods of investor exuberance should call for a more critical risk assessment than would normally be the case. Uncertainty over the course of the US election, and the possible further deterioration of the situation in the Middle East, are two recognisable sources of risk. Market reaction to date implies the consensus view is that these risks are unlikely to have a long-lasting impact on the broader global economy or company earnings.  However, investor sentiment can be fickle, and the potential implications of these events may start to erode investor conviction, particularly as the election looms closer.

Bond markets, of late, have shared in the wave of investor optimism. This investor confidence has driven a downward adjustment to bond yields. However, this fall in yields presents another risk to financial markets. Underpinning a 0.9% reduction in the U.S. 10-year Treasury Bond yield over the past 5 months (to 3.8%) is a belief that the fight against inflation has been won. Assuming an eventual return to a normal upward sloping yield curve, current bond market pricing implies a US cash rate around the 3% level. This requires the Federal Reserve to reduce the cash rate by another 2%, which will only occur if inflation continues to track towards a long-term average of 2% to 2.25%, or lower; or if there is a significant deterioration in the economic outlook. It could be argued, therefore, that bond markets are “priced to perfection” in terms of the inflation path. Any deviation from this path would challenge current yield settings, which would have negative implications for equity market pricing. Hence, the recent spike in oil prices and uplift in key commodity prices, should serve as a note of caution for investors.

In conclusion, while the current market conditions present a promising landscape for both equities and bonds, investors must remain vigilant. The interconnected nature of global economic policies, geopolitical events, and commodity price fluctuations demands a nuanced approach to investment strategies. By maintaining a balanced perspective and preparing for potential market corrections, investors can navigate the complexities of the financial markets and capitalize on opportunities that align with a long-term, sustainable growth outlook.

This Market Update contains information that is general in nature. It does not constitute financial or investment advice. Any information, material or commentary is intended to provide general information only. Zone Financial Pty Ltd makes no representation as to the accuracy or completeness of the information. Before acting on any information contained on this website, each person should consider its appropriateness having regard to their own or their clients’ individual objectives, financial situation and needs. You should obtain independent taxation, financial and legal advice relating to this information and consider it carefully before making any decision or recommendation.

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