Fixed income yields have experienced wide ranges in the past month, trading up to their cyclical highs before consolidating into month end. The state of the Australian economy remains uncertain, which has been reflected in the bond market. During their August meeting, the Reserve Bank of Australia also shared this uncertainty and decided to maintain a cautious stance, keeping the interest rate steady at 4.10%. By the end of the month, the yield on the AU3Y government bond had decreased by 13 bps to 3.74%, while the yield on the AU10Y government bond decreased by 3 bps to 4.03%. As the Bloomberg AusBond Composite 0+ Yr Index indicated, the Australian bond market saw a positive +0.74% increase for the month.
Early in August, there was much talk about the US economy not slowing despite the best efforts from the Federal Reserve to cool things down. This caused yields to increase as the market started to price more rate hikes from the Fed. The potential for more US bond issuance because the outlook for the fiscal deficit was getting worse. Global inflation is trending lower, but not as fast as some would like, even as many supply chain pressures abate. This has caused speculation that central banks will have to keep rates higher for longer to bring down inflation.
The RBA is considering the inflation risks compared to the weakening household sector. The CPI reading for the month came in lower than anticipated, at an annualised rate of 4.9% in the July reading, which is a slight improvement from the 5.2% YoY reading seen in June. However, the core inflation remained steady, with rent and energy costs increasing significantly. Wages showed stability, rising 3.6% compared to the previous year, although larger gains are expected in Q3 after the rise in award wages. Unfortunately, the household sector is not doing well, with real retail sales declining by -0.5% in Q2 compared to the previous quarter. Nominal monthly retail sales increased, driven by the World Cup and seasonal factors, but indicators suggest further weakness in the future.
The cash rate futures markets are taking into account the uncertainties and only factoring in a slight increase in the cash rate from the RBA, reaching a peak of 4.16% in early March 2024. An interest rate decrease is not expected until late 2024. Compared to the current cash rate of 4.10%, the yield on the 90-day bank bills decreased by -13bps to 4.13%. Similarly, the rates for 180-day bills fell by -27bps to 4.37%.
US Equity Markets
US stock indices ended the month of August lower, marking the first time that both the S&P 500 and NASDAQ-100 have seen a monthly decline since February. The top seven stocks, which accounted for more than 75% of the NASDAQ gains from January to July 2023, had mixed results in August. Despite the significant slant towards growth stocks, the index, which has a strong presence in the technology and AI exposure, fell by -1.5% for the month but is still up by more than +42% year-to-date.
US Downgrade
Fitch Ratings lowered the United States' credit rating by one notch (from AAA to AA+). This was due to an increase in debt at the federal, state, and local levels and a "consistent decline in governance standards" over the last twenty years. The decrease in ratings, coupled with significant government bond issuance, actions taken by the Bank of Japan, and a shift in perspective regarding interest rates remaining elevated for an extended period, resulted in US treasury yields rising from levels below 4% to reaching as high as 4.35%, before eventually settling at 4.11% by the end of August. The instability in the bond market prompted a decline in equity market prices for the first three weeks of the month but consolidated in the last week of trade.
The market was also influenced negatively by worries about China's property sector. Other relevant indicators, such as credit, economic growth, and deflation, demonstrated poor performance. Unexpected adjustments were made to equity market trading rules, there was a decline in consumer confidence, mortgage rates were cut, access to youth unemployment data was restricted, and several major real estate developers filed for bankruptcy.
US Treasury Market
There was a major sell-off in the US bond market in August, leading to the US10Y yields trading to their highest level in 16 years. Currently, the yield on the US10Y treasury trades at 4.25%, lower than the high of 4.35% seen earlier in the month. The yield on the US30Y treasury sits at 4.36%. The shorter-term US2Y yield remained relatively stable at 4.85% throughout the month. Additionally, the yield curve has been inverted for more than a year.
US Economic Data
The US Department of Labor's Employment Situation Report for July, released on August 4th, displayed a job creation number slightly below expectations. This marks the second consecutive month with less than 200,000 new jobs (+187,000 compared to the consensus of +200,000). The report presented a lower headline unemployment rate (3.5% compared to the consensus of 3.6%) and stronger growth in hourly wages than anticipated (0.4% compared to 0.3%). These factors indicate a strong labour market and nearly full employment. As a result, the report needed to provide more strength for the Federal Reserve to raise the cash rate, and it needed to exhibit more weakness to prompt rate cuts in the near future. The rate of people participating in the workforce remained constant at 62.6%.
US Dollar
The USD lifted by over +1.7% in August, but it is still down by almost 8% compared to its highest point in September last year. The Federal Reserve's tightening measures supported the Dollar's strengthening last year, attracting foreign investors due to higher interest rates. However, a strong Dollar tends to hinder the performance of stocks and other high-risk investments, as more than a third of the revenue generated by S&P 500 companies comes from outside the United States. As the expectation grows that the Federal Reserve will soon stop raising interest rates, speculators are betting that the Dollar could lose further momentum in the future.
The Months Ahead
Historically, September has been one of the worst-performing months for equity markets. According to data from the past five decades, the S&P 500 has typically experienced an average decrease of -1.08% during September. The Federal Open Market Committee (FOMC) will announce their interest rate decision on September 20th. Additionally, on September 15th, we will witness the expiration of "triple witch" options and the simultaneous rebalancing of the S&P Index.