01-03-2021
George Lucas, Raiz Group CEO
Last week, we saw a sell-off in equity markets driven by a significant sell-off in the bond market (a rise in developed market government bond yields).
The sharp lift in bond yields was the spark for the sell-off in equity markets, hitting growth stocks and knocking the Australian dollar off a three-year high above US80 cents.
Looking at the sell-off, it was not accompanied by the normal reaction in G10 currency markets. Usually, apart from the US dollar, safe-haven currencies like the Japanese yen and Swiss franc hold up best when risky assets falter, while commodity currencies such as the Aussie dollar struggle.
But this is not what happened, with the yen, for instance, falling against the Australian dollar. This probably reflects expectations of a continued rally in commodity markets over coming months and an improving Australian economy on the back of this.
US fiscal stimulus, vaccine rollouts buoy sentiment
The sell-off occurred in the context of rising expectations of another large US fiscal stimulus package and progress on COVID-19 vaccinations, pointing to a stronger economic recovery and prompting investors to bring forward expectations of monetary policy normalisation.
But the picture is complex, with significant changes in yield differentials between economies. The yield of 10-year US Treasuries has risen by around 50 basis point in 2021, while the equivalent yields in the commodity-exporting advanced economies, and the UK, are up by even more, as the rise in commodity prices boosts their economic prospects.
Meanwhile, yields in Japan and much of Europe have not risen as quickly.
These shifts in relative yields will probably reach a limit soon and, in the Australian context, we have already seen the RBA come in and purchase bonds to slow down the increase.
Seasonality in play on equities, bonds sell-off
Still on the sell-off in equities and government bonds, the lack of flight to safety indicates that we are probably seeing profit taking and not a full-blown market sell-off – yet.
Broadly, it’s my view that the current sell-off is just due to liquidity issues that occur seasonally in markets around March and September. Hence, the increase in market volatility that we may see in March is something we have to live with, just like many other Marchs in years gone by.
In the end, I think central banks will stay the course even if economic outlook improves above current expectations. This will mean real yields will stay low, providing a generally favourable backdrop for risky assets — like equities — so at the moment there is no need to panic.
RBA likely to keep rates at record low
In Australia, we expect the RBA to keep its policy settings unchanged on Tuesday, keeping rates on hold at the historic low of 0.1 per cent.
Also this week we get Australian GDP data, which is likely to show that the economy grew by a further 2.3 per cent in Q4, leaving it 2 per cent below pre-virus levels.
Elsewhere, in Malaysia, there’s the possibility that the nation’s central bank will reduce interest rates on Thursday by 25 basis points to 1.50 per cent.
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