This month’s rate decision was once again a coin toss situation for the Reserve Bank of Australia (RBA). Namely, minutes from the September board meeting published on Tuesday revealed that the bank considered both the option of hiking rates and of keeping them on hold, with the latter eventually prevailing.

According to the RBA, the argument to raise the cash rate by a further 25 basis points was centred around the expectation that inflation will remain above target for a “prolonged period”, coupled with the risk that this period may drag out for even longer.

“This could occur if productivity growth does not pick up as anticipated or if high services price inflation is more persistent than expected,” the central bank said.

“Members observed that, were inflation to remain above target for an even longer period, this could cause inflation expectations to move higher, which would be likely to require an even larger increase in interest rates in the future. Such an outcome would be costly for the economy.”

Members of the RBA board, including Philip Lowe in his last meeting as governor, pointed out that a recent increase in petrol prices, which is a key input for households’ inflation expectations, demonstrated that the process of returning inflation to target may be “uneven”.

Inflation decreased to 4.9 per cent in the year to July, according to the latest monthly consumer price index (CPI) indicator, driven by falls in the prices of fruit and vegetables as well as fuel.

“However, fuel prices had increased sharply in August. By itself, this would boost headline inflation in the September quarter, relative to expectations in early August. Overall, however, inflation was still expected to continue to moderate over the second half of 2023,” the RBA said.

Overall, the RBA board members assessed that inflation was still too high and was expected to remain at a high level for an extended period, with the experience of other countries still suggesting that services price inflation could take some time to ease.

n reaching their latest interest rate decision, the board members acknowledged that the Australian economy is now experiencing a period of “subdued growth”.

“This was being led by household consumption, as high inflation weighed on household incomes and the effects of prior tightening in monetary policy worked their way through the economy,” the RBA said.

“The outlook for the Chinese economy had also become more uncertain over the prior month, and there were several channels through which this could affect Australia.”

The argument to remain on hold was based on interest rates having increased significantly over a short period and that the effects of tighter monetary policy have yet to fully flow through.

The RBA did consider the possibility that Australia’s economy may slow more sharply than is currently forecast given the potential for weaker consumption and the downside risks in China.

“On balance, though, members concluded that recent developments had not materially altered the outlook or their assessment that the economy still appears to be on the narrow path by which inflation comes back to target and employment continues to grow,” it said.

“In weighing up the two options, members agreed that the case to keep the cash rate target unchanged at this meeting was the stronger one.”

As repeatedly highlighted in the RBA’s recent communications, the board members warned that further tightening may be required if inflation proves to be more persistent than expected.

Members also noted that they will continue to pay close attention to developments in the global economy, household spending, and the outlook for inflation and the labour market.

The RBA’s next meeting on 3 October will be the first to be overseen by new governor Michele Bullock.

International Equities

International markets continued their tremendous 2023 with another 2.08% and 2.86% return in unhedged and hedged equities. The Nasdaq set a half-yearly record of ~39% increase to start this year, powered by an AI-mania and falling inflation. With inflation continuing to cool and economic activity remaining robust, equity markets have remained strong to say the least.

Through July, there was a broad-based rally with all sectors returning positive numbers via the MSCI World Index. Markets were led higher by a significant jump in the oil price, propelling energy companies higher. This was followed by communications services, financials, and materials, as ‘value’ stocks outperformed ‘growth’. Healthcare and utilities lagged the index as the more defensive areas of the market were unloved for the month.

Both India and China saw significant gains across the month as Emerging Markets sought relief from a stubborn United States Dollar.

Australian Equities

Australian shares increased more than international peers with a 2.99% increase on the month. This was again led by energy as oil prices increased and financials remained strong. Australia’s high weightings to both financials saw Australian markets outperform other major developed markets.

Surprisingly, technology also increased significantly with a 5% increase on the month. Australian technology has caught the tailwinds of the global tech rally as inflation concerns continue to ease.

Domestic and International Fixed Income

In June, Australian bonds again fell for a second straight month with a -1.95% decline. The market started to price in a ‘higher for longer’ narrative that was not only isolated to Australian markets. The fight against inflation remains top priority for the RBA, even as there has been signs of cooling in recent months. ‘Peak rates’ do appear to be approaching, however.

International bonds fell a muted -0.16% during the month as the markets ultimately suggested that inflation is too high, growth is still too strong, therefore there is a need for more rate hikes. Strong U.S. services data combined with a strong private payrolls number was partially to blame for this move higher in longer-term interest rates globally.

Australian Dollar

In July, the Australian Dollar (AUD) fell slightly (-0.6%) on the month. This occurred even with the US Dollar Index falling 1.6%. This suggests a weakness in the Australian dollar potentially stemming from the weakness of China’s reopening combined with a clear indication of the near top of the interest rate hiking cycle.

Commodities – Gold and Oil

Gold prices rose by 2.73% the past month, this contrasts with falls in both May and June that likely stemmed from continuing monetary policy tightening in the US, Australia, and other countries globally. The RBA held the cash rate target stable in July and are waiting to see the potential effects of their rate increases on inflation before acting further. Investors may see the end to these rate hikes over the coming quarters, which should further propel gold prices priced in Australian Dollars.

Oil saw a significant rise of 16.09% this month, the highest monthly gains since January 2022. This is partly due to OPEC countries reducing their output and tightening global supply. This combined with a rise in global oil demand to an estimated 102.8 million barrels per day in July could explain the rapid rise in prices. With Saudi Arabia cutting its output by 1 million barrels per day until at least September we may see a further rise in prices.

Disclaimer

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Whilst all care has been taken in the preparation of this material, no warranty is given in respect of the information provided and accordingly neither Centrepoint Alliance Ltd nor its related entities, guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution.

As you may have heard US bank Silicon Valley Bank (SVB) collapsed over the weekend, largely the result of a bank-run.

WHAT HAPPENED?

The timeline of events is roughly as follows:

• March 8 – SVB sold about US$21 billion of securities (largely government bonds) from its portfolio, resulting in a US$1.8 billion marked-to-market loss. Company simultaneously tries to raise equity to fill the hole caused by the trading losses. Capital raise fails.
• March 9 – SVB shares fall by more than 40% after the company announced it had sold all of the available-for-sale securities in its portfolios. SVB CEO tries to calm clients. Whispers that SVB management are attempting to sell the company.
• March 10 – prominent venture capitalists tell businesses to withdraw money from the bank. Shares in SVB halted from trading. US Treasury comments they’re monitoring developments carefully. California regulator shuts down the bank and appoints the Federal Deposit Insurance Corp (FDIC) as receiver - 2nd largest bank failure in US history.
• March 11-12 – US Treasury says they’re not considering a bail-out. FDIC begins to auction SVB for immediate sale, unsure if they will find a buyer. The Federal Reserve (Fed) and the FDIC start considering a bail out.
• March 13 – the US Treasury, the Fed, and the FDIC announce all deposit holders will be made good (even on amounts above $250k). Same will apply for New York bank Signature Bank. Liquidity facility opened by the Fed for banks who might need it to effectively remove risk of other bank-runs.

WHAT GOT SVB INTO TROUBLE?

1. Concentration in one industry – i.e. technology. Under industry stress given widespread layoffs, share price falls, and fall in crypto.
2. Didn’t hedge the interest rate risk on their book, possibly because less than 50% of its deposits (very low) were lent out. The rest were invested.
3. Fed hiking rates caused losses in their investment book (mostly government bonds).
4. Whispers of investment losses and capital raise spooked deposit holders.

HAS THIS HAPPENED BEFORE?

US banks fail all the time given the significant competition encouraged in their market (vs Australia’s Big 4). E.g., there are over 4,800 banks in the US right now, down from over 8,000 banks pre-GFC, with approximately 7 US banks going under on average each year since 2012.

WHAT HAVE AUTHORITIES DONE TO STEM THE RISK?

Yesterday morning (our time), the following has been resolved:

1. The FDIC is insuring all SVB deposits (and that of another bank – Signature Bank) – immediate payment of insured deposits (ie. up to US$250k), and payment within a week to all uninsured depositors (ie. amounts over US$250k).
2. The Fed has opened a short-term funding facility for unlimited amounts (held against eligible collateral - using the par value of the collateral, rather than the marked-to-market value) for 1 year to provide liquidity to banks for calls on deposits.
3. SVB being auctioned off to the bigger banks.
4. SVB shareholders and unsecured creditors will not be protected.

IS THERE RISK OF BROADER CONTAGION/NEGATIVE SENTIMENT?

There always is in financial markets. However, significant regulatory buffers have been inbuilt since the GFC (e.g., Australian Big 4 banks have 2-2.5 times more regulatory capital than they carried into the GFC) and central banks stand ready to provide liquidity where necessary. Markets didn’t like the uncertainty at the back end of last week and over the weekend, but the position taken by US authorities this morning currently has the US equity futures market trading up whilst the stock market is closed. A positive sign.

We obviously can’t control market sentiment, which is generally driven by short-term noise, but we can ensure we keep a close eye on what’s held in portfolios (transparency), hold investment managers to account, all whilst maintaining appropriate levels of diversification and a skew to high quality companies through the cycle.

The biggest news last week was the collapse of crypto trading platform FTX - one of the biggest and most reputable players in the market for digital assets. After Binance pulled the plug on its bailout, FTX has now declared bankruptcy. While not going into the specific details of what has happened, the reason why it is important is that it could in itself be the unexpected spark that can ignite unforeseen financial fires. Across broader markets, recessionary risks are well understood but the collapse of FTX really highlights that we need to be acutely aware of liquidity risks across markets.

Last week saw softer than expected CPI inflations in the US. Within the CPI print, more generalised core goods disinflation seems to be setting in, in line with expectations, as weaker goods demand meets improved supply conditions. While this was good news, monthly core services inflation remained stubbornly high. It is the trajectory of core services inflation that will dictate how high policy rates reach and then how far and quickly they eventually decline. But expect this category to be much stickier than goods, even if the trajectory will be down from here. However, the Federal Reserve is unlikely to be diverted from its rate-hiking path, even if it slows the pace in December and they remain consistent in the messaging and get inflation completely under control.

Local and most global equity markets rose this week as investors responded positively to the weaker than expected US inflation print.

Medibank Private said it would not pay a ransom demand to the perpetrators of last month’s cyber hack, saying there is no guarantee it would ensure the return of the customer data. Subsequently, the criminals have started to dump customer data online with two dumps reported thus far.

The Aussie dollar rose strongly against the US dollar as risk-off sentiment waned following the weaker than expected US inflation print with some suspecting the US Fed might be closer to the end of its rate hiking cycle.

Australian consumer sentiment plunged in November, falling almost 7%, and now sits at the very low level reached at the start of the pandemic in April 2020. The main driver of the fall was a large drop in expectations for family finances in the next 12 months given rising costs and concerns over the labour market.

The US mid-term election results are astonishingly still yet to be finalised, but it looks likely that the Republicans land a majority in the House whilst the Senate will come down to three states with either party ahead in two of them whilst the third enters a run-off. A disappointing result for the Republicans versus expectations, and hence a good outcome for the Democrats. 

New covid cases have risen in the manufacturing hub of Guangzhou and other Chinese cities raising concerns of further lockdowns. Other news flows seemed to indicate that President Xi is looking to move on from strict covid protocols, but no plans or timeframes were released. Chinese equities have rebounded strongly in line with improved global sentiment. China equities are up over 15% month to date recouping almost all the losses they incurred through October and sentiment continues to improve which could draw in further flows from international investors.

• Local and global equity markets largely trended sideways this week though not without volatility.
• The Aussie dollar fell to a two and half year low against the US dollar, with interest rate differentials between Australia and the US expected to widen and risk-off sentiment also not helping the Aussie.

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• Global equity markets fell whilst the local equity market held up better, benefiting from being furthest removed from global issues.
• In local stock news, OZ Minerals made a final decision to go ahead with its $1.7 billion copper-nickel mine in WA after receiving permission.

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• Local and global equity markets fell this week as rate rises and increasingly hawkish central bank rhetoric spooked investors.
• In local stock news, OZ Minerals shares rose during the week after reports that BHP was considering upping its $8.4 billion, $25 a share, offer for the copper miner.

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• Local and global equity markets fell this week after the US inflation rate fell, but at a slower pace than expectations putting additional pressure on the US central bank.
• In local stock news, Atlas Arteria shares fell after a stoush appeared to be developing between the toll road operator’s board and a superannuation fund manager (IFM) that owns a 20% stake in the The dispute came after Atlas Arteria confirmed that it was participating in the sale process for a US toll road operator, with IFM demanding that it withdraw from the bidding or face a board spill.

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• Local and global equity markets were mixed this week as investors digested hawkish Fed comments and a European central bank rate rise.

• In local stock news, James Hardie announced new leadership with Aaron Erter becoming its new CEO, effectively immediately, and will work out of the company’s Chicago office. The company fired its last CEO in January.

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• Local and global shares fell this week, spooked by comments from the US central bank chair Jerome Powell reaffirming their commitment fighting inflation which might mean higher rates for longer.
• In local stock news, Wesfarmers reported a full year net profit after tax of $2.3 billion down by 2.9% from last year but ahead of consensus expectations. The final dividend was lifted to $1 per share, also coming in ahead of expectations.

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