US/global recession risks on the rise, although the indicators aren’t all bad and it’s still not our base case. An unexpected fall in the US ISM manufacturing conditions index to its lowest level since 2009 and weak US auto sales coming on the back of falls in Eurozone and Japanese business conditions PMIs reported a week ago indicate that the risk of global recession is still rising. In the US, the concern is that the slump in business confidence since President Trump started ramping up the trade war from mid last year will move on from depressing business investment to depressing employment and hence consumer spending.

 

Given a lack of the sort of excess that normally precede recessions and ramping up monetary easing globally we remain of the view that recession will be avoided but the risks are rising and significant. Resolving or at least de-escalating the trade war is now critical. This still looks like it will require a much deeper share market fall to make Trump more fearful, as the experience over the last year indicates that steep share market falls do make him more cooperative on trade.

 

The RBA has cut rates to a new record low of 0.75%, but even more easing looks necessary to achieve “full employment” with quantitative easing looking likely. The reasons for the latest cut are well known: downside risks to the global outlook; weak Australian growth; a likely slowing in employment; and subdued wage growth and inflation. And as Governor Lowe points out there is a global excess of saving over investment fundamentally driving low rates. The interest rate and tax cuts seen to date will provide some help but the problem of excess savings will likely be with us for some time yet and it’s hard to see growth picking up enough in Australia to attain “full employment” which the RBA is now referring to as an objective in its post meeting statement. It’s hard to get a precise handle on what exactly the full employment level is in terms of where wages growth and inflation would start to accelerate. But based on recent Australian and global experience it probably means unemployment of around 3.5-4% and underemployment around something similar which means labour market underutilisation of around 7-8%. So, at just below 14% currently we have a long way to go.

 

But with the big banks passing less and less of RBA cuts through to home borrowers – the average pass through after the June cut was 0.22%, July was 0.21% and this month’s cut was just 0.14% as they won’t cut their deposit rates below zero – rate cuts are becoming less and less effective and there will be no point in going to zero or negative (which would just scare people). As a result, it’s now likely that the RBA will have to undertake quantitative easing next year. Ideally, we need more help from fiscal stimulus and structural reforms but this looks like it will take a while to come through so the pressure will remain on the RBA.

 

Share markets remain at risk of further falls and volatility in the months ahead given unresolved issues around trade and Iran, impeachment noise and weak global economic data. But valuations are okay – particularly against low bond yields, global growth indicators are expected to improve by next year and monetary and fiscal policy are becoming more supportive all of which should support decent gains for share markets on a 6-12 month horizon.

 

Low yields are likely to see low returns from bonds once their yields bottom out, but government bonds remain excellent portfolio diversifiers.

 

The election outcome, rate cuts, tax cuts and the removal of the 7% mortgage rate test are driving a rise in national average capital city home prices led by Sydney and Melbourne. But beyond an initial bounce, home price gains are likely to be constrained through next year as lending standards remain tight, the record supply of units continues to impact and rising unemployment acts as a constraint.

Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 0.25% by early next year.