The case to cut rates in Australia has been building for some time, with broad-based weakness in housing activity, sharp falls in house prices, the ongoing issues with meeting RBA inflation targets – and more recently, a rise in the unemployment rate. As widely expected by markets, Governor Phillip Lowe cut rates again by 0.25% (to 1.00%) in July. All of these considerations provide ample support for some further monetary policy loosening. However, we think there are no more than another one or two cuts warranted in Australia.
The Australian economy has had 27 years since a recession. However, there are several obvious downside risks to the economy. The first, that the housing downturn (both clearance rates and prices) fails to stabilize, affecting confidence downward and creating negative wealth effects and consumption pull backs. The second, that trade (especially with China) collapses amid global trade and tariff tensions (based on the current US/China trade war) feeding back into commodity prices and export volumes. Clearly either a US or Chinese recession would be a disaster for Australia.
On the other hand, there are also some positives. Easier monetary policy will lower borrowing costs and improve the availability of credit. This will also increase disposable income and hence, spending in the economy. Fiscal policy is also set to be eased, with promised income tax cuts providing a boost to household disposable incomes. In addition, there is a significant pipeline of non-residential construction projects – such as infrastructure initiatives – that can help to partially offset the declines in housing growth and demand.
The US economy also has it challenges. Growth numbers are declining, trade tensions are increasing, and inflation is persistently (and irritatingly for most central banks) undershooting. However, the Fed will continue to support with lower rates. There is also some blue sky with the US/China trade negotiations starting once again. However, it is far from over and this could still cause equity market volatility (as well as another September 2018 like correction) based on the outcome or lack there of.
While 2019 has started strongly, investors would do well to remember the difficult environment of 2018. Lower rates means less income for retirees and a greater “push” towards riskier assets to compensate for higher income needs. It is imperative to remain cautious in this market with valuations that are somewhat stretched (although there are always pockets of value and opportunities) and the chase for “yield” can result in capital volatility and a potential for loss. Diversification is key to managing this risk, and buying quality assets that can withstand the ebbs and flows of sentiment-driven market volatility is more important than ever.