Monthly economic update with MLC, June 2019

Funds Management

by Clive Tompkins

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MLC Senior Economist Bob Cunneen speaks to MLC Portfolio Specialist Sinead Rafferty about share market strength in June, spurred on by record low interest rates and an easing in trade tensions.

Sinead Rafferty: Welcome to this month's economic update. I'm Sinead Rafferty, Portfolio Specialist at MLC. I'm joined by our Senior Economist, Bob Cunneen. Welcome, Bob.

Bob Cunneen: Thanks, Sinead.

Sinead Rafferty: Bob, it was a strong market for global equities in June after disappointments that we saw in May. What was the reason behind that strong performance?

Bob Cunneen: Well, there are a couple of important signals that favoured global share markets. The first was that lower interest rates were signalled by the key central banks. So if we looked at the American central bank, the Federal Reserve said they were prepared to cut interest rates over the next coming months. There were also signs from the European Central Bank that they were prepared to cut interest rates. That was seen as a key positive for global share markets. Also, we had the meeting between President Trump and President Jinping from China at the end of the month. The market was quite hopeful that we'd have some resolution of the trade issue.

Sinead Rafferty: Now in Australia we had a second rate cut, so two in a row now. Is the Australian economy at that point where it really warrants these levels of rate cuts, and where to from here?

Bob Cunneen: That's a great question. From what we can see in terms of the economic growth data, if we looked at housing construction, retail spending, car sales, we can all see they are very weak at the moment. What we saw with Australia's economic growth in the year to the end of March of this year, was economic growth at only 1.8 per cent. So we are in a slow economic growth environment. We are also in a very low inflation environment. So we've got very subdued wages growth at the moment. With that in mind, that's the key reason why the Reserve Bank has cut interest rates in June as well as July. So the cash rate is now at 1 per cent, a historic low.

Sinead Rafferty: And yet the Australian share market is doing quite well, up three and a half percent in June. Was that on the back of those rate cuts?

Bob Cunneen: Yes it was. So it was largely on the back of the lower interest rates, and that means a lower discount rate for the Australian share market. That's a key positive. But what we also saw was very strong gains for commodity prices. So you saw the iron ore price rise about 9 per cent. You also saw a very strong rise in the gold price. So that was very helpful for the resources sector. Shares like BHP (ASX:BHP), and Rio (ASX:RIO), where you saw the resources sector rise about 6 per cent, so a very positive performance.

Sinead Rafferty: You also mentioned earlier about potential rate cuts in the US and in Europe. Particularly in the US, it seems quite surprising given the fact that we've got share markets at all-time highs, we've got unemployment at historic lows. What is the rationale behind those potential rate cuts out of the US?

Bob Cunneen: That's a great question. It's really puzzling for most economists because if we looked at the US economic growth story, it's quite solid. Inflation is low, but it's close to the central bank's target. What the central bank is now seeing is that the momentum in the global economy is slowing. With the mild inflation outlook, as they see it, they think they've got scope to cut American interest rates. So they're taking a very forward-looking view of the American economy at the moment, and not actually the current reality.

Sinead Rafferty: Now, on the back of all these rate cuts and potential rate cuts, we did see that bond yields have moved lower. So positive performance out of the bond market. Is there anything else that we can read into that?

Bob Cunneen: There is some concern about the global growth story. So what you're seeing in terms of the German bond market, we've got negative bond yields there. A similar story in Japan. The Australian bond market, if we looked at the 10-year government bond yield down at 1.3 per cent, that's a historic low. Extraordinarily low bond yields around the world at the moment. That largely reflects this slow growth for the global economy, low inflation. So the bond market is telling us there are some concerns about inflation and the growth story.

Sinead Rafferty: Thanks for your time, Bob.

Bob Cunneen: Thank you very much.

Sinead Rafferty: And thank you for joining us.