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Some resilience remains despite volatility

September 2008

The Australian share market has experienced significant volatility over the past 12 months. Despite this, it has at times shown some signs of resilience and so far resisted moving below the All Ordinaries 4800 level. More recently, the market experienced its largest one-day rise of 3.9 per cent in almost six months, achieved on 8 September.

This increase came in response to a move by the US Federal Reserve to take control of capital-constrained mortgage lenders Fannie Mae and Freddie Mac. Concerns that these two agencies – which account for almost half of the US home loan market – would collapse under the weight of the biggest rise in mortgage defaults in three decades, prompted the move. While Fannie Mae and Freddie Mac did not underwrite or guarantee sub-prime loans directly, they did acquire portfolios of these loans, which saw them lose tens of billions of dollars in value.

Under the plan the two are to be placed into conservatorship or under protection by the Federal Housing Finance Agency. This effectively means that the US tax payer is guaranteeing and backing all of Fannie Mae and Freddie Mac’s liabilities. The bail-out actions are designed to support the availability of mortgage finance in the US as well as provide stability to the broader financial markets.

So far this action has had the desired effect with global share markets responding positively. But while the bail-out ends the short-term risk of the situation deteriorating further, the recovery could be short lived if the market realises the rescue cannot resolve the major problems still facing the US housing market in particular, and global share markets in general.

As a result of several increases in the cash rate and tighter credit standards, financial conditions in Australia have become quite tough. Together with other factors including higher fuel costs and reduced asset values, the Reserve Bank of Australia (RBA) has indicated the necessary restraints have been placed on demand. While in the short-term inflation is expected to remain relatively high, it is looking more likely that household demand will remain subdued and overall economic growth will slow over the period ahead. This gave the RBA reason to cut rates by 25 basis points to 7.0 per cent in early September, as had been widely anticipated.

The rate cut has contributed to a fall in the Australian dollar to a 12 month low of 81 US cents (at the time of writing). This fall in the Australian dollar, makes it more attractive for companies with offshore earnings or international investments. The other major economic news was the GDP figure which grew by 0.3 per cent over the June quarter, which was below consensus expectations and highlights the weakening of the Australian economy and provides impetus for further rate cuts. The result, while weak, still compared favourably at a global level with 40 per cent of the Organisation for Economic Co-operation and Development (OECD) countries posting negative GDP growth in the second quarter.

RBA governor Glenn Stevens said at a House of Representatives Standing Committee on Economics that while he couldn’t rule out a recession completely, he indicated there is no evidence to suggest there would be one.