The Federal Reserve increased interest rates to the 1.75% – 2% range last week and importantly, guided to an additional rate increase this year in the economic projections provided by the Fed Committee. Those same projections also anticipated an additional rate hike for next year to bring the closing interest rate for 2019 to 3.25% Fed Chairman Jerome Powell was notable for his confidence in the ongoing resilience of the US economy citing the low unemployment rate and strength of its economic expansion, to be bolstered further by the Trump Administration’s tax cuts. Importantly for markets, he continued to guide that monetary policy normalisation would be gradual which implies it is less likely to feature surprise hikes that weigh on both the economy and equity returns. The Australian unemployment rate fell to 5.4% while the participation rate also fell from 65.6% in April to 65.5% in May. The decline in the participation rate explains most of the fall in unemployment as lower participation in the workforce removes those dissatisfied workers from headline statistics, lowering the unemployment rate. The labour force gained 12k net jobs with part-time employment rising by 32.6k jobs offset by a decline in full-time employment of 20.6k positions. This continues the up-down nature of employment growth in recent years with part-time work rising by 1.7% or 66k jobs since the start of the year while full-time employment growth has been flat bucking last year’s trend of sizeable growth in full-time work. A broader measure of labour market slack is the underutilisation rate (the sum of the unemployment and underemployment rates) held steady at 13.9% in May, remaining elevated relative to the 10-year average of 13.3%.
In the US, jobs growth was higher than expected with the economy adding 223,000 workers in May while the unemployment rate fell further to 3.8% from 3.9%, an 18-year low. Wages growth also rose slightly to 2.7% in May. These numbers contributed to the case made by the Fed for rates to go higher on the back of a solid economic performance following rate hikes implemented both this and last year. The ECB gave guidance on its bond purchasing programme as expected with confirmation that it will stop buying sovereign and corporate bonds to the tune of €30bn per month in December this year. Since the programme began in 2015 it has purchased over €2 trillion worth of Eurozone bonds while interest rates have been held at or near zero. Accompanying this guidance was the indication that rates would be held at zero until September 2019 with ECB President Mario Draghi noted “underlying growth remained strong.
The Australian dollar depreciated against the US dollar on the back of an interest rate increase there and guidance of more to come discussed above. The cash rate differential between Australia and the US continues to widen and now sits at 0.5% and is expected to widen further to 1% by year-end. Last week featured weaker than expected Chinese data (four misses and 1 beat on industrial production and retail sales figures) with the AUD fulfilling its role as a floating proxy to Chinese economic growth given our strong trade ties to China. Risk-off sentiment dominated this week with bond yields falling however shorter-duration US yields rose as the 3-year yield for example tracks the current interest rate more closely given it is more easily substituted by simply holding cash.
US equities closed higher driven by the tech sector with the Nasdaq closing at record highs during the week. European equities benefited from a falling euro which improved the outlook for the export sector. News that President Trump was proceeding with tariffs against China as well as weaker Chinese economic data weighed on Chinese equities and the Australian mining sector which was the worst performer on the ASX last week.