The Federal Reserve’s first major economic update since COVID-19 forced investors to reappraise expectations for a V-shaped recovery in growth and earnings.

“We’re not even thinking about thinking about raising rates.”
With the Fed set to keep interest rates at between zero and 0.25 per cent until 2023, yield curves flattened out, weighing heavily on the Australian banks. Westpac dropped 6.1 per cent, Commonwealth Bank fell 4.4 per cent, National Australia Bank tumbled 5.4 per cent and ANZ dropped 6.2 per cent.
Australian bank stocks had rallied 40 per cent from their March lows on optimism that an economic rebound would lower the risk of a sharp rise in bad debts.
“The steep yield curve was very much driven by markets that have been encouraged by the easing in restrictions and that are looking at a stronger economy. Thats really supported a broad risk complex and steeper curves,” said Su-Lin Ong, managing director of RBC Capital Markets. “We are a little cautious. I think theres still a fair degree of uncertainty.”
The yield curve flattening overnight was one reason for equity market losses, said Matthew Sherwood, head of head of investment strategy for multi asset, at Perpetual Investments, who also pointed out that the Australian stock market’s structure made it especially vulnerable to selling based on revised economic expectations.
“What happened last night was a rotation out of value and cyclicals and into growth and defensives,” Mr Sherwood said. Australia’s market is stuffed full of banks and resource companies – the ones most closely aligned with expectations about the economic cycle.
While the Federal Reserve’s comments on the economy unnerved investors looking for a swift economic rebound, any further signs that the V-shaped recovery that markets have priced in is in danger presents the risk that “stock prices could tumble very quickly,” he warned.
Hopes for a swift economic recovery in Australia have been supported by comments from policymakers, but Mr Mead warned that Australian policymakers have potentially been too upbeat on the economy.
“If you allow yourself to continually outdoved, which the Reserve Bank of Australia is doing at the moment by being upbeat on the economy, then you end up with tighter financial conditions at a time when you really don’t want them to tighten,” he said.
The Australian dollar is “one of the key [monetary policy] transmission mechanisms and the fact that it has strengthened is clearly a headwind at this stage,” said Giulia Specchia, rate specialist at UBS. “We are going through a recovery in the third quarter and the fourth quarter but the pace and the shape of this recovery is still very uncertain.’
The six-week risk rally took the Australian dollar to an 11-month high of more than US70¢ this week but it has since dropped to US69.27¢ by Thursday afternoon, pounded by the general market malaise.
Vimal Gor, head of bond, income and defensive strategies at Pendal Group said his base case is to be long bonds because market expectations for a bounce back in growth are “overcooked right now” and “being long bonds in Australia gives you good optionality”, Bloomberg reported.