During May, Australian bond yields ticked higher due to apprehension about the US debt ceiling talks, which conflicted with the inconsistent data from the global economy. The market tried to focus on the more optimistic data prints, overlooking signs of policy entanglement and concerns about inflation. As a result, there was a slight reevaluation of the terminal cash rate in Australia, which pushed short and long-term AU government bond yields higher across the curve.
The RBA increased interest rates by 25 basis points to 3.85%, indicating that they would rely highly on data for future decisions. They no longer have a definite commitment to either pausing or increasing rates and would need to observe clear indications of decreases in inflationary pressure, particularly wages. The yields for AU3Y and AU10Y years rose by 37bps and 27bps, respectively, ending the month at 3.37% and 3.60%.
The focus of RBA Governor Lowe has shifted to four primary data indicators: retail sales, employment, the NAB business survey, and the Consumer Price Index (CPI). In May, the data was somewhat mixed. Although retail sales are returning to typical levels, the increase is being driven by prices rather than quantities. The May Australian employment data is starting to show signs of normalisation, with small employment growth and an increase in the headline unemployment rate. The NAB business survey is still exhibiting resilience, albeit slightly lower than before.
Although the monthly CPI was slightly above expectations, it aligns with the decreasing headline CPI. The RBA has no cause for concern with the quarterly wage price data, which rose by 0.80% quarter on quarter (QoQ). However, they remain cautious about the annual award wage setting and rely on productivity as an indicator of potential inflationary wage growth. The initial impacts of policy implementation are noticeable, and the persistence of inflation may influence future policy decisions.
The 90-day Bank Bill Swap Rate forecasts at least one more 25bps increase in the cash rate in the next 90 days. The 180-day paper currently yields 4.17%, implying a cash rate setting of 4.17% in that timeframe.
May 2023 Summary:
- Global inflation is beginning to moderate
- Artificial Intelligence technology takes the world by storm
- US Tech outperforms Dow and Russell YTD, up over 30%
- US GDP grew by +1.3% in Q1, in line with expectations
- US corporate earnings have posted consecutive quarterly declines
Over the past few months, there has been a growing interest in the latest trend in business – Artificial Intelligence (AI). In May, the news was inundated with discussions about the growth potential of AI and its impact on the financial industry.
During the month of May, Growth investments outperformed Value investments. The Russell 1000 Growth Index showed a gain of +4.6%, while the Russell 1000 Value Index displayed a loss of close to -3.9%. The Nasdaq 100 Index, which carries a significant focus on technology (leading to potential success in the AI discussion), demonstrated growth of +7.7%. Additionally, the tech index has risen over 30% YTD and reached a new high for the 52-week period this month. The Dow has remained unchanged throughout the year. Concerns have been raised regarding the market's breadth due to limited leadership and several negative technical indicators.
As anticipated, the May Federal Reserve meeting resulted in a unanimous decision to increase rates by 25 basis points, bringing the overnight rate to 5.00-5.25%. During the subsequent press briefing, Fed Chair Powell stated that while the FOMC may opt to halt future rate hikes, it has no plans to decrease rates in the near future. This statement contradicts trading analysts' predictions that there will be three rate cuts by the end of the year, as evidenced by the Fed Funds Futures market. Powell did acknowledge that if the Fed's inflation forecast is accurate, it would be inappropriate to cut rates since it is uncertain whether 5.00-5.25% is "sufficiently restrictive." In addition, the task of achieving a restrictive stance is further complicated by credit conditions tightening after the banking crisis.
US Bond Market:
Higher yields were evident across the curve in the US Treasury bond market. The US10Y increased to 3.64% from 3.43% at the end of April, while the US30Y rose to 3.86% from 3.68%. Short-term bonds also increased, with the US2Y trading at 4.40% by the end of May. However, some segments of the yield curve remain inverted, with US2Y treasuries yielding more than US10Y maturities.
US Inflation:
The headline CPI for April met expectations, rising by +0.4% on a monthly basis and by +4.9% year-over-year, compared to March's +5.0%. Meanwhile, the Core-CPI, which does not include food and energy, saw a monthly rise of +0.4%, in line with analysts' predictions, and a year-over-year increase of +5.5%, with March's YoY increase at +5.6%. The largest contributor to the overall and core CPI increase was Shelter, which rose by +0.4% and saw the smallest increase since January 2022. The market views the continued moderation in inflation, including in the Shelter index, as potentially influencing the Federal Reserve to maintain its policy rate in its June meeting.
Energy Markets:
Fears surrounding a drop in demand and a more robust dollar led to petroleum futures plummeting to their lowest point in the past few weeks. The market was left disheartened when Chinese factory output for the month underperformed market expectations, despite the end of policies related to COVID-19 in the nation.
US Dollar Index:
The US Dollar Index rose by more than +2.5%, bucking the trend after posting two months of consecutive declines. Growth in employment figures and slightly increased inflation benefited the dollar, leading market pundits to consider the possibility of an additional rate hike at the upcoming June session of the Federal Reserve.
The Months Ahead:
June is expected to bring several significant market events. On Friday morning (June 2nd), the May Jobs report will be published, with economists forecasting a rise in the unemployment rate to 3.5%. Additionally, the CPI will be released on June 13th, followed by the PPI on June 14th. The FOMC will announce their rate decision on the same day. On June 16th, the market will experience "triple witch" options expiration and S&P Index rebalancing simultaneously. The question remains whether the recent surge in tech stocks will spread to other sectors or if tighter credit conditions and slow Fed policy will negatively impact corporate earnings in the latter half of the year.