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A perceived end to the US rate hiking cycle and a boom in AI-related technology stocks led developed markets higher. The NASDAQ index rallied over 13% and the undervalued Japanese market was the strongest performer, rising 18%. The Australian dollar weakened against most major currencies apart from the yen and commodities experienced ongoing declines, especially coal. Coking coal declined 33% and energy markets continued to weaken. US 10-year bond yields rose moderately compared to Australian bonds of the same duration which rose from 3.31% to 4.03%.

 

The US administration reached agreement with Congress to raise the debt ceiling and avoid default. Similarly, JP Morgan acquired the troubled First Republic Bank further stabilising funding conditions for US regional banks. The Federal Reserve Board (FED) continued with its rate hiking program, increasing rates by 25bps in May to 5.25%. The FED’s focus shifted to services inflation and long-term inflation expectations which reached 3.2%, the highest level in 12 years. A 2.7% decline in US non-farm productivity levels reinforced the persistent outlook for inflation.

 

The US economy has slowed somewhat. Unemployment levels have risen only slightly, from the very low levels of 3.5%, to 3.7%. St Louis FED president Bullard echoed the sentiment of underlying strength saying ‘…the labour market just seems very, very strong…’. He was not expecting a recession in the second half of 2023. An inventory drawdown early in the year provides possible support, in the form of a rebuild, as the year progresses.

 

The Chinese economy’s recovery from covid continues. Growth rates are at levels below that expected by the government. There has been weakness in lending to households in April. New orders also declined, impacting exports as developing nations begin to spend more on services than goods. Amongst other measures, authorities cut the reserve requirement ratio for banks in March and reduced the 7-day repo rate from 2.0% to 1.9% in June. Fixed asset investment, driven by state-owned enterprises, rose 5.6%. Adjusting for covid, the property market is still weak. China’s strategy appears to be to prop-up the economy while also accepting that lower overall growth rates going forward are unavoidable.

 

Japanese growth has experienced a pickup coming out of covid. Consumption has risen 0.6% as pent-up demand from covid emerges. Business investment is also higher. Like China, net exports have been a drag as overseas customers transition to services-based consumption. Compared with 2022, the coming year should be brighter for Japan.

 

The Bank of Japan (BOJ) has maintained its accommodative policy settings. As the BOJ undertakes a review and inflation emerges, this might change. The base pay increase at the spring wage negotiations at 3.8% was the highest in 30 years. Low productivity growth and other inflationary pressure will also be at play for future BOJ decisions. 

 

The UK and Europe remain stagnant, barely growing over the March quarter at 0.1%. Services growth compensated for weak manufacturing. These economies are facing inflationary headwinds and higher interest rates. The European Central Bank (ECB) and the Bank of England (BOE) both raised rates to 3.50% and 5.00% respectively.

 

Inflationary risks have risen in Australia. Services inflation, specifically wage-driven inflation, is setting the ground for persistently elevated prices. This is the case even with lower prices for goods. Compounding the problem have been declining productivity, expansionary budgets, government interference with free-markets and their crowding out of needed investment. The Reserve Bank of Australia (RBA) responded, and surprised market commentators, by raising the cash rate by 0.25% in both May and June to a level of 4.10%.

 

The economy barely grew in the March quarter, rising 0.2% on December GDP levels. Consumers are feeling the pressure from inflation and higher rates. The unemployment rate has edged up to 3.6%, still at very low levels. The housing market has rebounded. Tightness in the housing market does provide a mechanism for stretched borrowers and lenders to clear the market, reducing losses and systemic risk. Consumption is likely to remain weak in the near term and GDP growth very low. Commodities continue to feed the budget. The budget position is likely to surprise going forward as assumptions are conservative.