Rob Hogg: From extreme volatility to recovered losses

Global developments  |  Australian economic data  |   Reporting season insights

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Early August was a period of extreme volatility in markets which seemed to be triggered by a sudden shock to economic growth expectations (following the publication of weaker US economic data), amplified by concerns about the potential impact on global portfolio flows of tightening Japanese monetary policy conditions.

Apart from Japan, monetary policy expectations elsewhere in the world – particularly in the US and Australia – moved more sharply toward rate cuts. These expectations were initially jolted by the early month equity market weakness but, later in the month, a sequence of weaker data and a key speech by the Chair of the US central bank reinforced the trend to heightened rate cut expectations.

Despite the sharp falls in share markets early in the month, most key markets regained their early losses to end slightly higher on the month.

Even the Japanese Nikkei index managed to end the month just -1.2% lower. Yield curves in most markets “bull-steepened” over the month (as short-term yields fell by more than long term yields) reflecting heightened expectations for rate cuts in coming months.

In this monthly update we look at:

• The early month market volatility
• The US central bank Chair’s signal of the near certainty of a US rate cut in September
• Australian economic conditions – which may soon give the RBA reason to ease policy rates
• The Australian August listed company reporting season.

Key market movements over the month of August

Global developments

Early August market volatility seems to have been due to a range of factors

Early August was a period of extreme volatility in equity, interest rate and currency markets. This volatility seemed to be driven by a combination of factors including:

• A sharp reassessment of the likelihood of near-term US rate cuts following a statement released at the conclusion of a US central bank policy meeting saying that “the economy is moving closer to the point at which it will be appropriate to reduce our policy rate”,
• Weaker than expected outcomes in key US economic data reports (the July ISM manufacturing release and the July employment report),
• Disappointing earnings updates from several of the “Magnificent 7” mega-cap US Tech stocks; and
• A sharp appreciation of the Japanese Yen in the lead up to (and following) a monetary policy tightening by the Bank of Japan.

Weaker US data helps trigger the volatility

US manufacturing index signals contraction for a fourth consecutive month

Slowing monthly growth US Non-Farm Payroll employment

Global markets volatility

As a result of this combination of factors, global equity markets moved sharply lower early in August, seemingly due to fears that the risk of recession might be higher than investors had previously expected. Market interest rates moved sharply lower at the same time.

At their lows on August 5, compared with their closing levels at end July US equity markets had fallen by:

• -5.5% Dow Jones Index
• -7.3% S&P 500 Index
• -10.7% Nasdaq Index
• -11.5% Russell 2000 Small Cap index

Larger European markets also bottomed on August 5, recording falls from their end-July levels ranging from around -5.5% to around -8%.

The Japanese market – Nikkei 225 index – was the most impacted, reaching a low of 31156.1 on August 5, down around 20% from its July close.

The Australian market (ASX 200) reached its intra-month low on August 6 at 7628.1, down around 5.7% from its July close.

However, by month end most equity markets had more than recovered, closing the month slightly higher, except the Nikkei which closed just 1.2% lower.

Market interest rates fell in sympathy with global share markets in early August with US and Australian 10-year yields both falling by around 0.20% while 2-year yields both fell around 0.3% at the time.

The Japanese Yen also moved sharply, rallying from around USD/JPY152.50 at end July to around 144.50 on August 6.

 

US central bank Chair signals near certainty of a rate cut in September

In one of the closest things to a near certainty that you ever experience in markets, the Chair of the US central bank, Jerome Powell, said at a major global central bank policy conference on August 23 that the Fed is near certain to cut rates at their September meeting.

Chair Powell’s speech communicated a clear “pivot” by the Federal Open Market Committee (FOMC) toward rate cuts and marked a major shift from previous Fed rate cutting cycles.

In previous episodes of Fed rate cuts, the FOMC has generally waited for more considerable evidence of economic slowing before moving to cut rates. However, well-anchored inflation expectations (which Powell noted) are what give the FOMC the “green light” to move on rate cuts earlier in the cycle. The more pre-emptive stance now being communicated by the Fed Chair increases the probability of a “soft-landing”

In his August 23 speech, Powell’s key phrases were:

“The time has come for policy to adjust.”

“The upside risks to inflation have diminished. And the downside risks to employment have increased…the cooling in labor conditions is unmistakable”

“We will do everything we can to support a strong labor market as we make further progress toward price stability.”

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Australian economic data

Australian economic conditions may soon give the RBA reason to ease policy rates too

Unlike the US central bank, presently the RBA is giving no signals that it is soon to cut rates, in fact the latest RBA meeting ended with a statement saying

“data have reinforced the need to remain vigilant to upside risks to inflation and the Board is not ruling anything in or out…[in regard to the next move in official interest rates]”

However, in their decision making, two variables are frequently cited by the RBA as among the more important indicators used in making their assessment of future policy changes – inflation and (un)employment.

The latest reports in August for these variables suggest that both are moving in a direction that is likely soon to give the RBA cause to cut rates.

Australian inflation measures continue to ease

The latest monthly Consumer Price Index (CPI) for July showed that the annual rate of growth of headline and underlying inflation is continuing to ease.

In the monthly CPI release the ABS highlights three different measures of the CPI, and all continued to slow (in annual growth-terms) in July:

• The monthly (headline) CPI indicator rose 3.5% in the 12 months to July, down from 3.8% in June.
• The monthly CPI indicator excluding volatile items and holiday travel rose 3.7% in July, down from 4.0% in June (this series excludes automotive fuel, fruit and vegetables and holiday travel and accommodation).
• The “trimmed mean” measure of inflation (which reduces the impact of irregular or temporary price changes in the CPI) recorded a slowing in its rate of annual growth to 3.8% in July, down from 4.1% in June.

It’s important to note that some of the downward pressure on overall prices in the July monthly CPI measure was due to the impact of the extended and expanded Commonwealth Energy Bill Relief Fund rebate, and the introduction of State government rebates.

The impact of such policy measures is usually “looked-through” by monetary policy makers as the impact of such measures on the CPI is independent of underlying trends in the economy.

While the July CPI release was not significant enough in and of itself to suggest the RBA will move any closer to cutting rates, a number of analysts expect that the next two monthly CPI releases (for August and September) could reveal that the annual rate of inflation will be back within the RBA’s 2% to 3% band. If this occurs, it is likely that market pricing will “front-run” the RBA’s actual easing in policy.

Presently, a full rate cut is priced by February 2025, but if inflation moves within the RBA’s band in the next month or two, we could see the pricing of a full rate cut moved into calendar 2024.

 

Market pricing of the expected change (in basis points) from the current policy rate

Australian labour market also cooling

Employment data is suggestive of some easing in labour market conditions – although employment growth itself is still robust (albeit underpinned by solid public sector job growth rather than private sector job growth), the unemployment rate is rising (which should cool wage pressure).

The July labour market release revealed that while employment rose by another 58,200; the unemployment rate moved up to 4.2% (and is now up 0.5% points from July 2023).

 

Unemployment rate – July 2014 to July 2024

 

Retail trade underwhelming as well

The value of retail turnover was unchanged in July from June, but both June and May had surprised on the upside, boosted by sales-driven activity.

A slightly stronger outcome had been expected in July given the tax cuts that took effect in the month. It’s too early to say that the July outcome suggests that consumer demand has plateaued and that tax cuts have been saved rather than spent (suggesting a pessimistic consumer), however it does seem that annual growth has stabilised at around 2.3%.

 

Retail turnover

 

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Read Rob’s previous macro updates  |   Watch Rob Hogg’s most recent video update  |   Back to the top of the page

 

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