Risks to Fed independence went up a notch this week following President Trump's actions to remove Governor Cook, though markets are reserving judgment. The US dollar index was essentially flat over the week, and long duration bonds were also little changed. The curve is steeper overall, with the short end firming in preparation for the Fed's easing cycle to recommence in September.
Despite US inflation remaining elevated, markets continue to expect a rate cut in September after Fed Chair Powell put increased focus on cooling labour market conditions at last week's Jackson Hole speech. The inflation measures that the Fed uses as its benchmark for its 2% target matched expectations in July. The headline PCE deflator held at 2.6%yr while the core rate (that excludes volatile food and energy prices) rose from 2.8% to 2.9%yr - its fastest since February. Inflation elevated to target - even before the full effects of import tariffs have flowed through to prices - is not expected to hold the Fed back from easing. That is because the labour market showed signs of weakening in July, with the unemployment rate rising to 4.2% on a slowing in hiring. The expectation is that next Friday's nonfarm payrolls report for August will reaffirm an easing labour market; however, if conditions were to rebound then cross-asset volatility would likely spike as the rates outlook is reassessed.
The account of the ECB's July meeting conveyed that the Governing Council voted to leave rates on hold as policy settings were 'in a good place'. Having delivered a total of 200bps of easing since June last year, the view was that rates were at a 'broadly neutral level'. Holding rates gives the ECB time to assess how the economic conditions unfold, with the outlook for the export-oriented euro area heavily clouded by the US's tariff regime. There is a wide range of views amongst Governing Council members on the skew of risks to the inflation outlook; some see downside risks to inflation, but others judge that inflation could come in hotter than forecast.
The unanimous decision (9-0) of the RBA's Monetary Policy Board to cut rates by 25bps to 3.6% earlier this month was reaffirmed in the meeting minutes. New staff forecasts prepared for the meeting gave the Board confidence to cut given the outlook was consistent with the RBA's dual mandate for 2-3% inflation and full employment - while keeping the economy on track with those objectives would 'likely require some further reduction in the cash rate over the coming year'. Markets anticipate a further 1-2 RBA rate cuts by year-end, pricing that was broadly unchanged despite an upside surprise in this week's inflation data.
Headline inflation accelerated from 1.9% to 2.8%yr in July according to the monthly CPI gauge, well above expectations for 2.3% (reviewed here). The various measures of underlying inflation also lifted, the key one being CPI ex-volatile items and holiday travel rising from 2.5% to 3.1%yr. A gap in the timing of electricity rebate schemes was the main driver behind higher inflation in July and will likely retrace somewhat in August. That as well as the RBA's antipathy towards the monthly CPI series meant the data had little impact on rates pricing. Next week's GDP growth figures for the June quarter could however move the dial. My Q2 GDP preview (see here) looks into the key dynamics in the domestic economy ahead of the report, where the focus remains around the emerging recovery in household spending. The growth profile is patchy overall, reflected in a stronger-than-expected 3%q/q rise in construction activity (see here) alongside a weak 0.2% lift in private sector capital expenditure (see here).
