While US shares fell slightly over the last week, most major share market saw gains. Bond yields fell a bit in the US and Australia but rose elsewhere. Oil prices rose after OPEC left output unchanged, but metal and iron prices fell. The $US rose, particularly as the Euro fell on renewed Italian budget worries, and this saw the $A slip back to around $US0.72.

Although major global share markets performed well in September, defying seasonal weakness, Australian shares fell after reaching a 10-year high in August as defensives, consumer stocks, financials and high yield sectors came under pressure not helped by rising bond yields.

The heat is on

The trade threat from the US has not gone away. While markets saw a relief rally in response to the latest tranche of US/China tariffs being less than feared, it’s clear that the issue is far from resolved. The proposed fifth round of US/China trade talks didn’t happen. China has released a defence of its position and is going down its own path on the trade issue by announcing a cut to its average tariff to 7.5% from 9.8% and reducing non-tariff barriers and seeking to offset the impact of US tariff hikes by policy stimulus rather than engaging with the US on its gripes. And tensions between the US and China appear to be rising, with Trump accusing China of interfering in the mid-term elections and some low-level signs that military tensions may be rising too. Our view remains that while the tariffs actually implemented so far are relatively small, further escalation in the US/China trade conflict is likely, with a negotiated solution still a way off. Meanwhile, the risk is rising that Canada will not agree to a revamped NAFTA deal with the US, the US and Japan are now to enter new trade talks, with Trump clearly wanting concessions from Japan and French President Macron said he would not agree to a new EU trade deal with the US unless the US commits to the Paris climate agreement. Of course, Trump wants to get US allies on side so he can focus on China but there is still a long way to go on that front too. So trade will remain a periodic issue for markets.

US rates up, Aussie down

The US Fed provided no surprises, hiking rates by another 0.25%, describing the economy as strong and indicating that further gradual rate increases are likely. While the Fed is no longer describing monetary policy as “accommodative”, it’s far from tight either and Fed officials’ interest rate expectations (the so-called dot plot) point to rates rising above the Fed’s estimate of the long run neutral rate, which is currently at 3%. We expect another hike in December and, like the Fed, three more hikes next year. Market expectations for just over two more hikes over the year ahead remain too dovish. Continuing US rate hikes mean ongoing downwards pressure on the Australian dollar and the risk of more out of cycle rate hikes by Australian banks to the extent global borrowing costs rise. Trump’s criticism of Fed rate hikes are clearly not having any impact though with Powell indicating the Fed’s focus is keeping the economy healthy and that it doesn’t consider politics.

Republicans losing control

The issues around Brett Kavanaugh’s nomination to the US Supreme Court add to the risk that the Republicans will lose control of the Senate as well as the House. While this will not change our views around Trump and his economic policy – there is a good chance he will get impeached but there still wouldn’t be enough votes in the Senate to remove him from office and Congress won’t change or reverse his economic policies – it will be something that markets will worry about in the run up to and after the November 6 mid-terms.

Aussie property market

In Australia, the risks around house prices appear to be mounting and rising petrol prices pose a threat to consumer spending power. 

The risks around the housing market are continuing to mount, with more banks withdrawing from SMSF lending and signs of a crackdown on property investors with multiple mortgages, as the banks move to comprehensive credit reporting (i.e. sharing information on customer debts) and focusing on total debt to income ratios. The latter is significant, given estimates that nearly 1.5 million investment properties are held by investors with more than one property.

Credit growth to property investors remains very weak, as tighter lending standards and falling investor demand impact.

Source: RBA, AMP Capital 

Prices at the pump

Petrol prices over the last week have pushed higher on global oil supply concerns, with more upside likely as supply from Iran and potentially Venezuela is cut. The weekly Australian household petrol bill is now running over $10 a week higher than a year ago. So, while higher petrol prices (if sustained) will add to headline inflation, they will also cut into household spending power and dampen spending elsewhere which will keep underlying inflation down.

Source: Bloomberg, AMP Capital

For the RBA, these considerations largely offset each other for now so we see no reason to change our view that it will remain on hold for a lengthy period. I am even tempted to the RBNZ approach that the next move in rates “could be up or down”.

What to watch

The RBA will yet again leave interest rates on hold when it meets tomorrow. While recent economic growth and jobs data has been good, we are still waiting for inflation and wages growth to pick up and the slide in home prices risks accelerating as banks tighten lending standards, which in turn threatens consumer spending and wider economic growth. As a result it would be dangerous to raise rates and we don’t see the RBA hiking until 2020 at the earliest and still can’t rule out the next move being a cut. Meanwhile, on the data front expect CoreLogic data (today) to show another fall in home prices for September, August building approvals (tomorrow) to show a 2% bounce, the trade surplus (Thursday) to fall slightly to $1.4bn and retail sales (Friday) to rise 0.2%.

Outlook for share and property markets

We continue to see the trend in shares remaining up, as global growth remains solid helping drive good earnings growth and monetary policy remains easy. However, the risk of a correction over the month or so still remains significant given the threats around trade, emerging market contagion, ongoing Fed rate hikes, the Mueller inquiry in the US, the US mid-term elections and Italian budget negotiations. Property price weakness and approaching election uncertainty add to the risks around the Australian share market.

National capital city residential property prices are expected to slow further, with Sydney and Melbourne property prices likely to fall another 10% or so, but Perth and Darwin property prices bottoming out, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.