Shares dive after shock US rates cut

Fear of a global recession caused by the coronavirus outbreak drove Australian shares and bond yields sharply lower.

US Federal Reserve Chair Jerome Powell. Picture: AP

Fear of a global recession caused by the coronavirus outbreak drove Australian shares and bond yields sharply lower while the Australian dollar rose after an emergency rate cut by the Federal Reserve to head off “evolving risks to economic activity” from the virus weakened the US dollar.

Australia’s S&P/ASX 200 share index sharemarket sank 1.7 per cent to 6325.4 points — its lowest daily closing level in the past nine months — after the US sharemarket tumbled despite the US interest rate cut as Fed chair Jerome Powell admitted it “won’t fix a broken supply chain”.

The Australian government 10-year bond yield fell 7 basis points to a record low close of 0.72 per cent, while the Aussie dollar hit a two-week high of US66.45c after a 50 basis point cut by the Fed.

The cut by the US central bank was the first such move between scheduled policy meetings since the 2008 global financial crisis. In debt markets, the yield on the benchmark 10-year US Treasury plumbed record lows of 0.95 per cent. This widely watched rate had fallen below 1 per cent for the first time on Tuesday as investors sought safe-haven assets.

A statement from group of seven central bank governors and finance ministers following an emergency teleconference re­affirmed the group’s “commitment to use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks”.

Australia’s sharemarket dived as much as 2 per cent intraday as major banks were belted after investors reassessed the outlook for the sector in the wake of Tuesday’s interest rate cut by the Reserve Bank, which was passed on in full to mortgage rates.

Stoking additional fears for bank investors was the prospect of a hike in the bank levy applied to the big four lenders and Macquarie Group.

The Australian on Wednesday revealed that in the days leading up to Tuesday’s RBA board meeting, senior figures in the Morrison government floated the option of a modest increase to the bank levy to raise additional funds.

UBS analyst Jonathan Mott has trimmed his earnings estimates for Australian banks, warning that net interest margins will remain under pressure, with the RBA expected to cut the official cash rate again in April before potentially moving to quantitative easing later this year.

“With rates likely to remain near zero for the foreseeable future, sector return on equity is likely to fall towards single-digit levels, placing further pressure on capital generation and dividends,” he said.

“Given that our forecasts were already substantially below market, we expect consensus downgrades to be significantly larger,” Mr Mott warned.

“Despite the pull-back, we remain cautious as consensus likely rebases.”

S&P 500 futures rose 1.3 per cent in Asian trading after Democrat moderate Joe Biden made a remarkable comeback in the presidential campaign with victories in nine states across the country.

But Asian markets were mixed, with China’s Shanghai Composite up 0.6 per cent, Japan’s Nikkei 225 up 0.1 per cent, the Hang Seng down 0.2 per cent, and South Korea’s KOSPI up 2.2 per cent on news of fiscal stimulus. Shares in Europe opened higher on Wednesday, with London’s FTSE 100 up 1.3 per cent while Germany’s Dax was up 0.9 per cent.

Australia’s economic growth accelerated to 2.2 per cent on a year-on-year basis in the December quarter from an upwardly revised 1.8 per cent in the September, beating market expectations.

But the composition of growth was “poor” as domestic final demand grew by just 0.1 per cent to be just 1.3 per cent higher than a year ago and it “remains very weak” according to Citi.

Growth was supported by a lift in mining and public inventories and a fall in imports that produced a lift in net exports of 0.2 percentage points of GDP despite flat export growth.

“These factors should not be relied upon to continue supporting growth,” said Citi Australia chief economist Josh Williamson.

Dwelling investment and private and public non-dwelling construction declined, while machinery and equipment investment were flat.

Consumer spending on household equipment, furnishings, clothing and footwear improved, but this was probably the result of pre-Christmas sales, according to Citi’s Mr Williamson.

“Even with this likely temporary boost, household consumption is growing very slowly and remains only a modest contributor to growth at around half of what is required to lift growth back to trend.”

State Street Global Markets global head of macro strategy, Michael Metcalfe, said his cyclical indicator of the Australian economy was suggesting a heightened probability of recession even before a potential hit from COVID-19 and its knock-on impact on other countries.

“Global growth expectations are already on the floor (and) a sizeable hit from the virus could easily result in a global recession,” Mr Metcalfe said.

“China’s PMI reading for February were the first hard data that seemed to confirm what commodity markets have been trying to say for a while — a global recession is coming — but action from the Fed this early in the year means that a recession, when it comes, is likely to be shallow and short-lived.”

If the risk of a longer economic downturn grows, “we can expect further aggressive easing from the Fed and even QE (quantitative easing),” Mr Metcalfe said.

“Given the timing of the move just after the G7 conference call we would assume other central banks will have been given an indication of what was to come, perhaps to give them time to prepare their own response in the next couple of days.

“The Fed has led but we doubt this will be the only policy support markets receive this month.”

Australian Treasury secretary Steven Kennedy will brief the Senate Estimates committee Thursday on the potential economic impact of the virus on the global economy after an overnight conference call with the International Monetary Fund and Josh Frydenberg.

“We will be having a targeted, a responsible, a scalable approach to what is a very serious economic impact as a result of the spread of the coronavirus,” Mr Frydenberg said on Tuesday.

Deutsche Bank said the Australian government now had a ‘‘green light’’ to suspend its surplus priorities and pursue more aggressive fiscal stimulus in the near term because of the virus.

“We think the rapid developments around the coronavirus, and limited scope for a monetary policy response, will see the government now pursue a targeted strategy of fiscal support in coming months,” Deutsche Bank Australia chief economist Phil Odonaghoe said.

UBS economist George Tharenou says the probability of a recession is “rising by the day” as travel bans continue to restrict movement into Australia.

Even before the outbreak of coronavirus, Mr Tharenou’s base case was for a negative GDP print in the first quarter, but he said that it was likely to extend into the second quarter now as tourism and education sectors particularly came under pressure.

“The longer you have physical bans on the movement of people, it is statistically more likely over time that the bounce-back we had expected in quarter two is less likely to occur,” he says.

“Add to that any supply chain disruption, as well as a fall in goods demand, and you get a more and more negative outlook … it will take cash handouts or tax cuts to provide any meaningful contribution to a more positive view.”