US rates now below pre-hike levels, AU December GDP Print beats estimates

The Saga of Fed Hikes and Cuts

US Fed’s hiking cycle saw nine rate hikes of 0.25% each between December 2015 to December 2018, thereby taking the federal funds rate to 2.25-2.5% level. Over the past eight months, it has lowered policy rate by four times a cumulative of 1.25%, taking the federal funds rate to 1-1.25%.

Last year on 1 August, when the US Fed lowered policy rate for the first time in over a decade, the equity markets were rattled - DJIA lost 872.79 points in the next five trading days to 7 August, and S&P 500 lost 96.34 points over the same period.

Nonetheless, what followed consistently with the easing cycle were the all-time highs in equity markets. As recessions risks were gradually coming down, owing to ‘coordinated policy actions’ across the globe, the yields on the US-10y treasury were just shy of 2% barrier.

In 2019, US equities had a good year, but the present environment and near-term prospects are signalling volatility, given that the world is steering through a highly uncertain pandemic like coronavirus/Covid-19.

Fed to Steer Through Evolving Risks

US Fed notes that present situation is exhibiting ‘evolving risks’ to its mandate, which is price stability and maximum employment. Although the US has had strong consumer backing in its GDP – augmented with wage gains, lower unemployment and a lower corporate tax.

More Room to Cut?

Did the last two rate hikes, in the second-half of 2018, enable the US Fed to exercise an emergency cut of 0.50% in March? Well, the US monetary policy rate is still above 1%, which means that the Fed has more room to ease in the event of an instant broad-based economic shock – unlike most of the developed economies.

Flash Back

When you look back in December 2018, the last rate hike by the US Fed (20 December 2018) was followed by huge sell-offs in equity markets – such that, S&P 500 lost 145.67 points between 20-24 December and DJIA lost 1,431.92 points over the same period.

Also, the December 2018 equity sell-offs provided a solid floor for the superior equity returns delivered by the markets in 2019. In December 2018, S&P 500 ended the month with a loss of 283.65 points while DJIA suffered a loss of 2,452.11 points, a 11% drop.

Australian GDP Print Beats Estimates

In Australia, markets opened on a lower note. By the close of trading session, the S&P/ASX 200 was sitting with a fall of 1.7% at 6325.4 points. The Australian Bureau of Statistics released GDP number for December 2019 quarter.

It was noted that the economy grew 0.5% during the quarter, while recording a growth of 2.2% over the year, which remains below the long term average of the Australian economy.

ABS said, domestic demand was subdued during the quarter, growing just 0.1%. Positives were recorded in household discretionary spending and government spending on services, but these positives were offset by falling dwelling investments and private business investment.

Dwelling investing continued its weakening trajectory for the sixth consecutive month – a decline of 2.3% was recorded in the value added by construction industry. ABS also noticed signs of housing recovering in rising ownership transfer costs.

In December quarter, the softening commodity prices translated into weakening terms of trade, thereby adding to lower mining profits as well as nominal GDP. More importantly, the household income showed twelfth consecutive rise, owing to steady wage gains and non-life insurance income.

Key takeaways. these GDP numbers reflect the resilience of the Australian economy that suffered worst bushfires in many years last season, and a meaningful improvement in private investment is likely to result in better economic output.

Although this is a picture of the past, whose implications have been reflected in the earning season reports of Corporate Australia. While the recovery seems to be on track - the additional measures by policymakers, including fiscal and monetary policymakers - are likely to improve prospects of the Australian economy.

AUD firmed against USD

At the backdrop of interest-rate cuts across AU and the US, and better than expected GDP numbers, the Australian dollar firmed against the United States Dollar. Since the beginning of the year, the currency pair (AUDUSD) has seen continued weakness, reaching decade lows.

Equities to outperform bonds over long term

Forecasting interest rates decisions is quite challenging in this environment. When the US Fed raised interest rates in December 2018, the market consensus was expecting additional rate hikes in 2019.

However, what followed in 2019 was particularly contrasting to what was thought. Who would have known that recession signals would stem again and nudge the global central banks to initiate an easing cycle?

Likewise, by the end 2019 – recession possibilities were pushed out of the thesis. Now at this juncture, central banks see ‘evolving risk’ – meaning that recession chances are back, leading to proactive measures or interest rate cuts.

But what comes with lower interest rates is that the equities become attractive, as the potential returns are much higher than the prevailing returns on fixed income securities. And, if the present environment were to persist for a long period, it is likely that equities would outperform bonds.