INSIGHTS BLOG

NOT TOO HOT, BUT NOT TOO COLD - JUST HOW INVESTORS LIKE IT

Mark Lister, 30 April 2019

Are we back in the Goldilocks zone for the world’s sharemarkets? It sure feels that way.

This analogy arises when economic growth is reasonable, but not so strong that inflation takes off allowing central bank to leave interest rate settings at benign levels, which makes for very market-friendly conditions.

This is the backdrop that has prevailed over the last several years in most parts of the world, and it’s provided a huge tailwind to investors and financial markets.

It looked like all that was about to change last year. Growth was looking good, and there were early signs of inflationary pressures amidst tightening labour markets. Interest rates in the US were going up in response and were expected to rise further in 2019.

Then came a growth scare late in the year, which saw the world’s sharemarkets sold off and confidence heavily dented. The US central bank responded with an abrupt U-turn, putting further interest rate hikes on ice and moving back to a cautionary stance.

That saw our own Reserve Bank start talking about OCR cuts, as it grappled with those same global risks, as well as low business confidence and a domestic slowdown.

All of the negatively was short-lived across financial markets, with the sharp fall in late 2018 quickly superseded by an equally abrupt rebound during the first few months of this year.

The S&P 500 has gained 25 per cent since Christmas Eve, pushing the key US index to a new record.

Not only that, but last week's advance estimate of March quarter GDP in the US came in at 3.2 per cent, well above expectations and much higher than the sub-one per cent growth rate that economists were forecasting just six weeks ago.

With the economy seemingly back on track and US shares hitting fresh highs in recent days, one might think we’re due for the central bank to spoil the party by resuming its pesky rate hikes.

Financial markets are not so sure.

Traders still see a high chance of an interest rate cut in the US this year, as the Fed stays cautious and opts for patience over action.

It’s the same story in this part of the world. Both our Reserve Bank and its Australian counterpart are expected to reduce their respective OCRs not once, but twice in the coming 12 months.

Weak inflation is playing a part in these forecasts. Just in the last fortnight we’ve seen key gauges of consumer prices in New Zealand, Australia and the US, and they’ve all been weak.

This persistent lack of inflation, despite healthy labour markets, makes it really tough for central banks to be anything but dovish (which means they’ll lean toward cutting interest rates, rather than raising them).

So there you have it, we might be right back where we’ve spent the last few years.

Lacklustre yet half-decent growth, few signs of inflationary pressures, and central banks that are very cautious about tightening monetary policy.

Not too hot, but not too cold. Just how investors like it.

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