George Lucas

Investors and business might have got the Prime Minister they wanted in Malcolm Turnbull, but external factors dominated the market yesterday with uncertainty about the US Federal Reserve’s decision on interest rates helping push the S&P/ASX 200 index down 1.6% to 5,096.points.

Instreet Investment Managing Director George Lucas says the market has only put a 30% chance on the Fed lifting rates, but the uncertainty around its decision has caused volatility in the markets – “possibly more than we would see if they did announce an increase.”

“Even if the Fed doesn’t raise interest rates this week, it is likely to begin tightening monetary policy soon. If this happens, here’s a summary of asset class performance during previous periods of tightening:

• US equities – The US domestic stock market tends to fare well, not particularly surprising given higher rates often reflect a stronger economic climate.
• Bonds – The 10-year treasury yield has tended to rise as investors reassess the likely path of short-term interest rates.
• Emerging markets – The response for emerging markets is not clear-cut. In 1994, it was a disaster when surprise hikes caused an outflow of capital and exacerbated the Mexican peso crisis. In 1999, emerging markets faired relatively well as they clung to the coattails of a boom in developed markets. In 2004, the emerging world was in the early stages of rapid economic growth. We think it is likely to fall somewhere in the middle, avoiding a 1994-style crisis but no 2004-style boom.
• Australia – Australia is more likely to behave like an emerging market due to the heavy weighting of our financial and resource sectors.”

China remains the wild card with Lucas not expecting August’s data to calm fears about a hard landing or provide hope that growth momentum is picking up.

“That said, not all the data has been bad and retail sales are better than expected.

“In terms of inflation, China’s CPI rose to a 12-month high of 2% in August year-on-year, up from 1.4% in July. The increase was slightly larger than most had anticipated. Looking ahead, expect inflation to rebound over the coming quarters.

“China’s credit data for August confirmed that policy easing has led to a turnaround in credit growth. The data showed that both lending to the real economy and broader credit are accelerating – exactly as expected after the recent shift to policy easing.

“Although this might raise questions about the level of debt, it should provide support for the economy in the short term and calm concerns about a hard landing.”

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