Jim Taylor: What’s driving the ASX this week?

Here are the main factors driving the ASX this week according to portfolio manager JIM TAYLOR. Reported by investment specialist Chris Adams

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THE Big Show finally hit town when the US Federal Reserve began its much-anticipated rate cutting cycle, though at a quicker pace than many judged appropriate.

With a slew of generally positive US economic data (including retail sales, employment, industrial production, housing and the Atlanta Fed GDPNow) conditions were set for new record highs across equity indices during the week.

The S&P 500 gained 1.39% while the NASDAQ rose 1.51%. The S&P/ASX 300 was up 1.38%.

Elsewhere, longer-dated bond yields saw minor gains and commodities had a pretty good week.

So, where to from here?

The immediate reaction on Wednesday was markets giving up gains on the notion that a hawkish cut of 50 basis points (bps) means the Fed knows something (about employment, most likely) that the market doesn’t, so caution is still required.

On Thursday, we saw the classic beta/cyclical rally. And by Friday, it all proved a bit hard for markets to work out, so they dipped a touch as they began a phase of recalibration.

There is a view that the cut should benefit “risk-on” assets such as small caps, cyclicals and commodities, but that a 50bp move also removes some of the Fed’s insurance against a soft landing.

In the US, the August Personal Consumption Expenditures (PCE) release on Friday will be key in setting the market’s mood. 

This week in Australia, we have the RBA Board meeting on Tuesday followed by August Consumer Price Index (CPI) on Wednesday.

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US macro and policy

The Fed

September’s Federal Open Market Committee meeting ended with a 50bp rate reduction to a 4.75-5.00% range – an outcome priced in at a 60% probability leading up to the meeting. 

In its statement, the Fed noted indications that economic activity continues to expand at a solid pace, job gains have slowed, and the unemployment rate has moved up but remains low.

It also stated that it had made further progress towards the 2% inflation objective, but that it remains somewhat elevated.

In keeping with its recent tone, the Fed noted that the risks to achieving its employment and inflation goals are roughly in balance and that the Committee is attentive to the risks to both sides of its dual mandate.

Michelle Bowman became the first Federal Reserve Governor (as opposed to Fed President) to dissent on a rate decision since 2005.

She was alone in calling for a 25bp cut rather than the cut delivered.

A 50bp cut “could be interpreted as a premature declaration of victory” over inflation, she said in a statement on Friday, while a slower pace of cuts would “avoid unnecessarily stoking demand.”

She believes that “moving at a measured pace toward a more neutral policy stance will ensure further progress in bringing inflation down to our 2% target.”

In contrast, Governor Christopher Whaller noted that “50 really was the right number.”

“We’re at a point where the economy is strong, inflation is coming down, and we want to keep it that way,” he said, adding that “inflation is running softer than I thought.”

Looking forward, the Fed’s Summary of Economic Projections (SEP) now shows the FOMC’s median expectation is for a Fed Funds Rate of 4.4% by the end of 2024 and another 100 bps of cuts in 2025.

Presumably, the Fed forecast is now for two further 25bp cuts out to Dec 24. The market is slightly ahead of this, pricing in 75bps of cuts, implying another 50bp move in November or December.

Interestingly, the Fed sees unemployment only increasing to 4.4% in the December 2024 quarter – up from 4.2% in August and 3.7% in January – and sees it also at that point in Q4 2025.

While there may be an intra-point peak above this, it still suggests a very shallow employment recession indeed.

In his press conference, Chairman Jay Powell noted that the economy is in good shape – growing at a solid pace with inflation coming down. He emphasised that the labour market is in a strong place and that the Fed wants to keep it there.

He also said that “nobody should look at today’s 50bp move and say, ‘this is the new pace.’”

This isn’t a “catch-up” rate cut because the FOMC was behind the curve, according to Powell. Instead, it was a signal of the Fed’s “commitment not to get behind.”

Housing

There were some optimistic datapoints on the housing market:

• August new housing starts were 1.356m versus consensus expectations of 1.325m, rising 5.5% from July’s 1.237m. Building permits rose 4.9% month-on-month (m/m), also ahead of expectations, while single-family housing starts in August rose 15.8% from July.  
• The NAHB Housing Market Index was in line with consensus at 41.0, up two points from August’s reading of 39.0 after four months of consecutive declines. The report noted lower interest rates mean builders have a positive view for future new home sales for the first time since May 2024. 

Existing home sales dropped to 3.86m in August (from 3.96m in July and below consensus expectations of 3.90m). They are at their second-lowest level since 2010.

Mortgage rates have fallen in previous weeks, with the 30-year rate at 6.15% versus 6.80 in the June quarter.

This may prompt increased mortgage activity, which may flow through to strengthen existing home sales in coming months

However, a mortgage rate of 6% is still well above the average rate of about 4% on the stock of existing mortgages. This means moving and taking out a new mortgage would still involve a hit to most household finances. 

Fannie Mae noted that lower mortgage rates aren’t likely to finish the current “buyer’s strike” as prices remain too high. They are not seeing an increase in loan applications or improvement in consumer homebuying sentiment.

Instead, they think buyers are sitting on their hands in anticipation of lower rates and improving affordability.

In this vein, the inventory of existing homes for sale hit the equivalent of 3.8 months of sales in August, up from 3.7 in July.

This is the highest since 2020 due, primarily, to slower sales rather than new inventory hitting the market.

The inventory of existing homes for sale remains around one-third below its 2015-to-2019 average, which helps explain – alongside population growth and rational home builder activity this cycle – why median house prices have remained elevated and steady despite higher mortgage rates and subdued sales activity.

Other economic data:

• Industrial production rose 0.8% m/m in August, 60bps higher than consensus and following a 0.9% m/m fall in July. This reflected increases in manufacturing and mining, with utilities activity unchanged.
• Retail sales rose 0.1% in August at a headline level, but a price-driven 1.2% drop in gas station sales weighed upon it. Excluding gas station, autos, food services, and hardware store sales – considered a better guide to the underlying trend – sales rose by 0.3%, following solid increases in the prior few months. The annualised rate of growth in underlying sales in the three months to August rose 5.7%, up from 4.9% in July.
• Weekly initial jobless claims dropped to 219k, from 231k, below consensus expectations of 230k. Continuing claims fell to 1,829k from 1,843k – also below the consensus of 1,850k.
• The Atlanta Fed GDPNow estimate of real GDP climbed from 2.5% to 3% for Q3 2024. 

Australia macro and policy

Employment rose by a solid 48k m/m in August, after 49k in July (after revisions) and well ahead of consensus expectations of 26k. 

The lift was driven entirely by part-time employment (up 50k). Full-time employment fell a touch, which is perhaps one sign of some softness in the data. 

Labour supply continues to grow strongly. This means that even as the participation rate climbs, the upward trend of unemployment probably remains intact.

Population growth is exceeding government expectations by roughly 100k, which is due primarily to lower numbers of residents leaving. Resident departures are running at 35% below pre-Covid levels.

So the contrast with the US, where focus has shifted from inflation to concern over employment, remains. Domestically, employment remains robust, and during reporting season there were few companies talking about job cutting to preserve margins.

The RBA remains more concerned about inflation than jobs.

China

China’s credit impulse remains muted.

Despite some hope, we have not seen the same historical surge in credit that Beijing deployed after the GFC and Covid, as well as in response to domestic slowdowns in 2012 and 2015.

This year, the credit impulse (as measured by the Bloomberg Economics China Credit Impulse) has come down since January.

In August, new home prices in 70 major cities dropped 0.7% from July, falling for the 14th month in a row.

Prices were down 5.3% from a year earlier. This is the fastest rate of decline since May 2015.

There is some dispersion by city size. Prices have fallen 9.4% year-on-year in the four tier-one cities, while second and third-tier cities were down 8.6% and 8.5%, respectively.

House prices in some smaller cities have fallen by more than 40% since peak in 2021.

At the same time, the stock of unsold properties has risen to a new high – demonstrating how far sentiment has weakened despite Beijing’s efforts to underpin the sector.

Europe and Japan macro and policy

As expected, the Bank of England kept rates unchanged, noting that there had been “limited news” in the incoming data and that “a gradual approach to removing policy restraint remains appropriate.”

Some see this as suggesting a 25bp rate cut in November, followed by quarterly steps with scope to adjust in response to material developments. 

Meanwhile, the Bank of Japan left rates unchanged.

About Jim Taylor and Pendal Focus Australian Share Fund

Drawing on more than 25 years of experience investing in top-performing Australian companies and a background in accounting, Jim manages our Long/Short Fund and co-manages our Imputation Fund. He is a Chartered Accountant with membership of the Australian Institute of Chartered Accountants.

Pendal Focus Australian Share Fund is managed by Crispin Murray. The fund has beaten its benchmark in 14 years of its 18-year history (after fees), across a range of market conditions. Find out more about Pendal Focus Australian Share Fund here.

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