The Reserve Bank of Australia (RBA) left the overnight cash rate at 1.5% at its final meeting for 2016 in December and did the same in the February 2017 meeting. Market expectations are that the RBA continues to sit pat throughout 2017.
A sharp move in bond yields in November was moderated in December.
2016 was remarkable as yields defied expectations and continued to get even lower in the first half of the year. The Australian 10 year government bond got to a low of 1.8% in early August, before rocketing to 2.9% just before Christmas, primarily on the back of the US market.
The US 10 year hit a low of 1.4% in early August and then climbed to a year high of 2.6% in mid-December. Having said this, the spread (that is the extra yield investors demand to hold Australian bonds over US bonds) continued to tighten, reflecting the contrast between Australia’s post-mining boom economy and a US economy at full employment with the prospect of pro cyclical fiscal stimulus.
Australian equities jumped by over 4% in December, giving a healthy 11.6% return for 2016. As well as the general revival of Keynesian “animal spirits”, Australian shares were driven by developments in China, where authorities, spooked by a sharp slowdown in growth, hit the stimulus lever in late 2015. This revived infrastructure and residential property construction in 2016, which flowed on to our commodity exports.
In addition, an environmentally driven clampdown on domestic coal producers saw the two coals (coking and thermal) rally. Much of the extreme move in iron ore prices, (from USD39.51 a tonne USD 83.58), cannot be explained by fundamentals. Indeed, iron ore stockpiles in China by year end were back to 2014 levels and new supply sources are coming online in Australia, which will add to seaborne iron ore supply in the first half of 2017.
Developed market equities continued their push upwards, adding another 4.5% in December. The US dollar continued to strengthen against the Australian dollar and even moreso against other currencies due to the elevated price of hard commodities, resulting in currency hedged international shares underperforming unhedged. Emerging markets stocks recovered over the December quarter, following the initial post Trump sell off on fears of protectionism and rising US interest rates. Brazilian shares gave up -3% in December, but still remained one of the best performing markets globally for the year with 37% in local currency terms and an eye watering 67% in USD.