How Do Global Financial Shocks Affect The Australian Economy

The Sino-US trade tension has sent the shock wave to the global economy, raising recessions risk and uncertainties in the international trade. In addition, a yield curve inversion in the US Bond market is acting as a lead indicator of recession risk in the United States and the emerging global market. Given this scenario, coupled with weaker economic data and the insistence of President Donald Trump, the Federal Reserve is likely to open doors for a rate cut in its policy meeting this week.

But the bigger question is how these global financial shocks are impacting the Australian economy:

China-US Trade War

To no surprise, it has been recorded that growth in international trade had remained subdued as the Sino-US trade war is getting intense. Despite the optimism built in the start of this year at the US-China trade talks in Beijing, the world’s two largest economies have ended up as each other’s rivalries.

Finally, when Beijing could not satisfy Trump on its ways of doing business with the rest of the world, the U.S. government under Trump administration slashed 25% tariffs on $200 billion of Chinese goods. And this is expected to get worse with Trump’s savage attack of another $300 billion if no trade deal is reached with Chinese President Xi Jinping in upcoming G20 summit scheduled at the end of June 2019 in Japan.

The aftershocks of the US-China trade war were felt in Australia on 4 June 2019. This translates Australia’s interest rates cut by 25 basis points to a record low of 1.25 per cent as announced by the Reserve Bank of Australia earlier this month. The move that has broken the three years silence is stated to be in favour of the slow-moving economy in Australia that has emerged due to the slump in the housing market and the disappointing economic condition in Australia’s largest trade partner, China.

Governor Philip Lowe stated that Australia’s central bank decision to cut interest rate is to support the employment growth and accelerate subdued inflation with the medium-term target.

The Australian central bank has presented optimism for the Australian economy with a moderate level of pick-up expected in the growth of household disposable income, which in turn could push the household consumptions. In addition, RBA eyes a further moderate lift in wages growth which, when coupled with other labour market outcomes indicates that the Australian economy has the potential to sustain a lower rate of unemployment.

Mr Lowe said the Australian economy is forecasted to grow by around 2¾ per cent in 2019 and 2020. In support of the forecast, he stated that this outlook is underpinned by the growth in the resource sector and the increased investment in infrastructure, partially reflecting an upward momentum in the prices of Australia’s exports.

However, in the global arena, trade tensions remain standstill. The United States has recently taken its trade knife to Asian country India by withdrawing trade privileges for Indian products from 5 June 2019. India in retaliation has imposed tariffs on 28 U.S. products including almonds given the fact that India is the largest importer of U.S. almonds.

Federal Reserve likely to cut interest rates

Federal’s benchmark overnight lending rate- the federal funds rate is likely to be trimmed by the U.S. policymakers in response to the weaker economic conditions and the unemployment touching its 50-year low. The ongoing trade tension is another major factor contributing to the uncertainty in the global economies.

With this backdrop, markets have dressed up to watch a cut in Federal Funds Rate by the end of this year, which was earlier expected not to be witnessed until the third quarter of next year. The upcoming policy meeting of the U.S. central bank is expected to lay the foundation to the likely cut. Now it is interesting to see that whether the cut would be as deep as the investors expect or Trump wants, or it would be a nominal correction to the subdued economy.

The cut in fed’s interest rates could lead to the weakening of the U.S. dollar, thereby giving an uplift to the Australian dollar in cross exchange. Over the past few months, the Australian dollar has depreciated to some extent and is currently at the lower end of its range.

Further, in the latest monetary policy update, Reserve Bank of Australia noted the subdued inflationary pressures across many parts of the economy in Australia; however, it still expects the inflation to pick up in the June quarter underpinned by an increase in petrol prices.

Mr Lowe stated that the underlying inflation is projected to be 1¾ per cent in 2019, 2 per cent in 2020 and edging higher even thereafter. RBA has further addressed the downside risks stemming from the trade disputes, which could potentially impact the FDIs and FIIs in a number of countries going forward.

Inverted Yield Curve

Inverted Yield Curve in the parts of the U.S. government debt market has shaken the investors’ sentiments across the globe. The histories have proven that this one simple indicator can be a precursor of recessions. Inverted yield curve simply explains the decline of long-term yield below the short-term yields.

In U.S. bond market certain yield curve inversion was noted which was first since 2007. Given the sensitivity of the curve to the global economic outlook, the Federal Open Market Committee is expected to gauge the likely impact of the signals and the degree of its importance. In the financial world, it is widely accepted that whenever the yield curve has inverted, the recession has followed. However, the aftermaths of the cycle still seem to be unclear. It is just based on the economic belief which states that first, the curve flattens and then eventually inverts during the tightening of monetary policy.

The long-term bond yields in Australia have been currently recorded at a low level, with risk premiums moving in the same direction. Bank funding costs have also been on a downtrend with money-market spreads taking a back-pedal from the rise recorded last year. Moreover, the credit conditions for housing loan has been tightened over the previous past months. RBA stated that the growth in housing credit has been stabilised recently, while there is strong competition for high credit quality borrowers with mortgage rate standing at low levels.

In a media release dated 4 June 2019, Mr Lowe said that RBA’s decision to lower the cash rate would ensure the faster progress in reducing unemployment and move closer to the inflation target. He further reaffirmed the Board’s commitment to monitor the labour market and make adequate adjustments in the monetary policy to support sustainable economic growth.

The market participants have analysed that there are many ASX-listed stocks which remain defensive at the time of change in the macro-economic environment. This means that these stocks are so fundamentally strong that macro-economic events would not have much deep-rooted impact on them. Some examples to quote defensive stocks are Scentre Group (ASX:SCG) and Transurban Group (ASX:TCL). SCG last traded at $3.740 while TCL last traded at $14.560 with a market capitalisation of $38.82 billion on 17 June 2019.

Also Read: Rise in Global Dividend vs Australian Dividends

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