Economic and market commentary
Investors remained focused on rising inflation and the possibility of policy settings being tightened worldwide.
Bond yields continued to rise – particularly in Australia – as investors brought forward their expectations for interest rate hikes. This hampered returns from fixed income markets.
Equity markets performed much more strongly, aided by the release of pleasing corporate results for the September quarter.
The latest surveys indicate conditions have improved modestly for both manufacturers and services companies, although backward-looking economic data were largely ignored given recent restrictions in NSW and Victoria.
Instead, like elsewhere, the main focus was on potential changes to central bank policy.
In early October the Reserve Bank of Australia reiterated its yield target of 0.1% on 3-year government bonds. Later in the month, market movements had pushed the yield on these securities above 1.0%, seemingly with limited effort from the Reserve Bank to defend the target.
This prompted investors to question whether officials were changing their stance on policy settings.
At an annual rate of 3.0%, headline inflation for the September quarter printed in line with consensus forecasts. The Reserve Bank’s preferred measure of inflation – the trimmed mean – rose at a more modest 2.1% over the year.
Official interest rates are unlikely to be changed for the foreseeable future.
As had been widely anticipated, official interest rates were raised by 0.25%, to 0.50% in October.
Reserve Bank of New Zealand officials appear to be concerned about quickening inflation – consumer prices rose by more than 2% in the September quarter alone, and are nearly 5% higher on a rolling 12-month measure.
As a result, some commentators are suggesting interest rates could be raised by a further 0.75% at the Bank’s next meeting in late November.
At an annual pace of 2.0%, growth in the world’s largest economy fell short of expectations for the September quarter.
Pandemic-related supply shortages and bottlenecks continued to hamper manufacturers. Car production fell around 7% in September, for example, due to a shortage of semiconductors.
Services sectors are enjoying better operating conditions, as consumers continue to increase spending following months of lockdowns and disruptions.
There were mixed signals of the jobs front – new payrolls were lower than expected, but the unemployment rate dropped 0.4%, to 4.8%.
All of these data releases were overwhelmed by comments from Federal Reserve officials on the outlook for inflation and, in turn, potential changes to interest rate policy.
The Federal Reserve is still expected to start tapering its quantitative easing program during November, likely reducing its monthly purchases of Treasuries and mortgage-backed securities.
Afterwards, attention is expected to increasingly shift to the likely timing of interest rate hikes.
Inflation remains very high and whilst officials continue to suggest this will prove temporary, pricing pressures owing to supply disruptions seem likely to persist into 2022 and longer-term inflation expectations are rising due to elevated energy prices.
Consequently, some investors are now anticipating two interest rate hikes in the US before the end of next year.
The latest GDP data in the Eurozone beat expectations. The region’s economy grew by 2.2% in the September quarter, meaning overall activity levels have rebounded to 99.5% of pre-Covid levels.
The upturn has been attributed to an encouraging recovery in services sectors.
The increase in discretionary spending is being reflected in higher inflation; consumer prices rose 0.8% in October alone.
Like elsewhere, this prompted suggestions that the European Central Bank might have to raise official interest rates.
Less encouragingly, the latest data highlighted a slowdown in industrial production in Germany; Europe’s largest economy.
Moreover, ongoing reports of supply shortages suggest weakness in the manufacturing sector could persist through the December quarter and, potentially, into next year.
In China, large property developer Evergrande Group avoided a bond default following a last-minute coupon payment.
This failed to calm investors’ nerves, however; high yield credit spreads in Asia widened sharply over the month, resulting in disappointing returns from the region’s credit markets.
In Japan, there was an unexpected upward revision to economic growth forecasts for 2022. Officials expect growth to rebound back towards pre-pandemic levels in the next 12 months or so.
The dollar reversed its recent weakness and strengthened by 4.0% against the US dollar. The ‘Aussie’ appreciated similarly against a trade-weighted basket of international currencies.
Performance relative to the Japanese yen was particularly impressive. At the end of October the Australian dollar bought nearly ¥86, an increase of 6.6% over the month.
The dollar was buoyed by rising commodity prices – coal and oil increased, which offset slightly lower iron ore prices.
The local share market started October on the back foot, as concerns about rising inflation drove the S&P/ASX 200 Index more than 2% lower on the first day of the month.
Equities quickly recovered and had moved nearly 2% higher towards the end of the month thanks to positive trading updates from the start of the AGM season.
A sudden jump in bond yields on the last day of the month saw these gains reverse, however, and caused the Index to finish the month close to where it started, with a total return of -0.1%.
The Energy sector fell 2.7%, despite higher oil prices (Brent oil rose 7.5%). Energy companies struggled late in the month as news releases indicated oil supplies could soon increase, given a surprising jump in US inventories and the possibility of a resumption in Iranian oil exports.
Weakness among iron ore miners drove Materials stocks -0.5% lower. Iron ore prices fell around 5% due to Chinese steel production restrictions and weakening demand expectations.
In contrast, Materials stocks helped drive the S&P/ASX Small Ordinaries Index 0.9% higher thanks to strong performances from several gold and rare earth mining companies.
Global property stocks fared well, with the FTSE EPRA/NAREIT Developed Index increasing by 1.9% in Australian dollar terms.
The best performing regions included Sweden (+14.0%), USA (+7.8%) and Hong Kong (+6.1%), while laggards included Germany (-0.3%), Japan (-0.3%) and Australia (+0.4%).
Several major share markets enjoyed their strongest month of performance of the year. The S&P 500 Index in the US closed October 7.0% higher, for example.
Technology stocks continued their good form, enabling the NASDAQ to perform even better; up 7.3%.
In Europe the Stoxx 50 added 5.0%, while in Asia Hong Kong’s Hang Seng and Singapore’s Straits Times rose 3.3% and 3.6%, respectively.
Japan was the only major market not to participate in the rally, with the Nikkei closing the month 1.9% lower.
Returns from all major markets were diluted for Australian investors due to the strength of the dollar. Nonetheless, global shares made a positive contribution to diversified portfolios over the month.
Global and Australian Fixed Income
Bond yields rose in most major regions, as investors continued to focus on high inflation and the possibility that interest rates could be raised earlier than previously thought.
The yield on 10-year Treasuries rose 6 bps over the month, to 1.55%. Similar moves were seen on 10-year yields in other countries (Germany +9 bps, Japan +3 bps and the UK +1 bp).
The most significant yield movements were seen in Australia, where 10-year yields skyrocketed by 60 bps and closed the month above 2% for the first time in more than two years; well before the Covid pandemic began.
Spreads on investment grade and high yield credit were little changed in October, at least in the US and Europe. Asian markets were a little weaker, partly reflecting ongoing concern about high leverage in the Chinese property sector.
Consequently, returns from global credit markets were broadly neutral over the month.
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