Aussie shares rocket in December rally, fuelled by rate cut hopes

Australian shares are charging towards their best December in over two decades, surging nearly 6 per cent and outperforming global markets.

Australian shares are charging towards their best December in over two decades, surging nearly 6 per cent and outperforming global markets, as investors ride a wave of rate cut optimism.

The S&P/ASX 200 index ended its fourth consecutive week of gains 0.8 per cent higher before the Christmas break on Friday and a key US inflation gauge showed prices are stabilising.

US data on Friday showed prices fell in November for the first time in over three years, and the Federal Reserve’s preferred gauge of core inflation — excluding energy and food prices — cooled to an annual rate of 3.2 per cent.

“It is a nice end of the year because it was yet another inflation number that came in on the low side,” AMP chief economist Shane Oliver said.

“Looking at the core number for the last six months, the annualised rate was 1.9 per cent. That’s actually running at a rate below the Fed’s target, which is a pretty positive sign that inflation is coming under control.”

The numbers gave wings to the notion central banks are nearing success in manufacturing an economic “soft landing” by bringing down inflation with aggressive interest rate hikes and avoiding tipping the economy into a recession.

The optimism is fuelling bets the Fed and other central banks, including the RBA, will start cutting rates next near. Money markets are pricing in six-and-a-half cuts from the US Federal Reserve in 2024, while in Australia, investors are tipping two-and-a-half cuts by next December.

Economists at the Commonwealth Bank are forecasting the RBA will cut the cash rate by 75 basis points, likely starting from September — which would see base rates fall from 4.35 per cent currently to 3.6 per cent. At AMP, Dr Oliver agrees on the magnitude of cuts but says they could start in June.

Momentum is building in business circles the RBA will begin cutting rates in 2024. Picture: Gaye Gerard

The end of year period is usually strong, but the recent dovish pivot from the Federal Reserve is “lifting all boats”, including asset prices in Australia.

“For as long as rate cuts keep getting priced in, and maybe even a steeper rate cutting cycle, that’s going to keep supporting equities pushing higher, both in Australia and overseas,” said Kyle Rodda, senior financial market analyst at Capital.com.

“It seems that in the short term there is a lot of momentum behind this.”

The S&P 500 ended the Friday session 0.16 per cent higher to top its longest eight consecutive week winning streak in over five years.

ASX futures last traded 3 points lower at 7486 on Friday night after the benchmark closed the week 0.8 per cent higher at 7501.6 points.

So far this month it has gained 5.8 per cent, outperforming the S&P 500 and MSCI World indices, which are up 4.1 per cent and 4.3 per cent respectively.

The Aussie sharemarket is also on track for its biggest monthly gain since January and the sharpest December rally since 1997, as investors expect deep interest rate cuts to fuel returns.

“The market could still have more upside from here before year end,” Dr Oliver said. “History would suggest that we might see modest gains in the last few days of the year, consistent with the normal Santa’s rally and in the absence of some sort of shock.”

The index is set to end the year 6.6 per cent higher, following 2022’s 5.5 per cent loss driven by investors who cut bets in anticipation of interest rate hikes last year.

While the recent Federal Reserve pivot triggered decidedly bullish sentiment among investors, economists and market analysts are warning markets will continue to be volatile as the risk of recession has not gone away. The potential escalation of geopolitical conflicts in the Middle East and Europe also remain front of mind.

Dr Oliver also warned the market rally had already factored in a lot of the positive news and expectations, and was looking vulnerable to a correction.

“Often when you get a technically overbought market, some investors take some profits and that tends to limit the market’s gains.”

Dr Oliver is forecasting the S&P/ASX 200 index will end 2024 at 7800 points to post a gain of 4 per cent.

“But you’re also going to see volatility next year because there’s still a risk of recession. We haven’t seen the full impact of the rate hikes so far and consumer spending is still vulnerable to further weakness,” he said.

“The risk of recession in the US, Europe, and Australia is still high.”

Market watchers are also wary of the seeming disconnect between the expectation of deep interest rate cuts in a soft landing scenario.

“There does seem to be a contradiction at the heart of things at the moment,” said Mr Rodda of Capital.com.

“If we are going to get deep rate cuts next year, that very well could mean that we are heading for a fairly meaningful slowdown in economic activity. And that hasn’t been discounted into expectations of company profits yet.”