Macro (Re)view (2/8) | US FOMC cuts by 25bps as trade tensions escalate; Australian inflation subdued

The US Federal Reserve's policy-setting committee, the FOMC, cut its benchmark interest rate for the first time since December 2008 this week, lowering fed funds target range by 25 basis points to 2.0-2.25% (shown as the chart of the week, below). The Committee also announced it would be ending its balance sheet normalisation (quantitive tightening) process in August, two months ahead of schedule. These outcomes had been widely anticipated, though markets are now in the process of recalibrating expectations for the future path of rates, as the Committee was seemingly reluctant to meet the sort of aggressive easing of around 3 to 4 rates cuts that had been factored into pricing out to December 2020.

Chart of the week

In his post-meeting statement to the press, Committee Chair Jerome Powell said that the basis for July's rate cut was to "insure against downside risks from weak global growth and trade policy uncertainty", and then later described it as "mid-cycle adjustment to policy" in response to a reporter's question, which seemed to leave markets questioning their assessment. However, the point that Chair Powell reiterated throughout his press conference was that the Committee had become progressively more accommodative in their commentary since the turn of the year, with this rate cut seen as the next step in within that overall shift. Accordingly, Chair Powell outlined that this change in direction had allowed the Committee to retain a constructive outlook, notably for economic growth to remain around its current pace (described as "solid") to support a continuation of robust conditions in the labour market, which in turn will help lift inflation towards its 2% target.

With markets barely having had time to absorb the details from the FOMC's meeting, early on Friday morning US President Trump announced that a 10% tariff would be levied on a $300 billion tranche of Chinese imports effective from 1 September, which could then potentially escalate to a rate of 25% and above, after bilateral negotiations earlier in the week had failed to achieve any substantive progress on reaching a trade deal. This tranche will largely target consumer-related goods that have been excluded from previous tariff announcements. Once again, China has indicated it is prepared to retaliate. Given that household consumption strongly contributed to US GDP growth coming in at an above-trend pace of 2.1% annualised in Q2, this latest development will likely add to the risks to the FOMC's outlook, which to date have mostly been focused around business investment weakening (mainly in the manufacturing sector) in response to the uncertainty caused by trade tensions and slower global growth. In support of households, Friday's employment data provided another decent result with non-farm payrolls rising by 164,000 in June (expected +165,000) and the unemployment rate remaining at 3.7%. Meanwhile, the pace of wages growth lifted from 3.1% to 3.2% over the year. 

In Europe this week, the advanced read on GDP growth showed that output slowed from 0.4% to 0.2% in Q2. Annual growth eased from 1.2% to 1.1% to be tracking at a 5½-year low and half the pace from a year ago. That slowdown over the past year reflects weakness in external trade, which is a significant component of the euro area economy, impacted by US-China tensions and has notably impacted manufacturing firms. Domestic demand has been more resilient, with the household sector supported by strengthening labour market conditions wherein the unemployment rate fell to an 11-year low of 7.5% in June. However, core inflation remained very subdued at 0.9% year-on-year emphasising the tone from the ECB's meeting last week that renewed stimulus measures were likely to be forthcoming.

With the increasing risk of a no-deal Brexit, markets were closely watching the Bank of England's meeting for signs of a shift to more accommodative policy. While the Bank lowered its GDP growth forecasts for 2019 (from 1.2% to 1.0%) and 2020 (from 1.7% to 1.4%), due to the intensification of uncertainties regarding Brexit and a weaker global economy (see here), it retained its guidance for "gradual" and "limited" interest rate increases to maintain inflation at the 2% target. However, that remains conditioned on a smooth withdrawal process from the EU, which is in contrast with current market sentiment.   

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In Australia, the highlight this week was Q2's Consumer Price Index data in which headline inflation lifted by 0.6% in the quarter and by 1.6% through the year, with both outturns 0.1ppt above the market forecast. The main measure followed by the Reserve Bank of Australia, the trimmed mean, met consensus at 0.4% quarter-on-quarter and 1.6% year-on-year, though the latter remains well below the Board's 2-3% target (for a full review see here). Over half of the 0.6% quarterly rise in headline inflation was accounted for by a strong increase in petrol prices, while there were also indications that a weaker domestic currency was feeding through to higher prices as tradables inflation lifted by 1.2% — its fastest quarter-to-quarter rise in 4 years. However, outside of those influences, inflationary pressures remain well contained and are broadly indicative of elevated spare capacity in the labour market restraining wages growth. The RBA is expected to remain on hold next week at 1.0%, though it will almost certainly lower the cash rate again before year's end, with the market having a 25 basis point cut fully discounted by December. 

Adding to the likelihood of further RBA easing, consumer retail demand softened further in Q2. In nominal terms, retail sales growth was slightly above consensus at 0.4% in June and was up by 0.6% over the quarter. However, after adjusting for an overall price increase of 0.4%, retail volumes lifted by a softer-than-expected 0.2% in Q2, prompting a sharp slowdown in the annual pace from 1.1% to 0.2% — its weakest pace since 1991 (see our review here). Demand is likely to receive support going forward from the RBA's easing cycle and the Federal government's tax relief measures, as well as improving sentiment in the housing market. According to CoreLogic, combined capital city house prices across the nation lifted by 0.1% in July, which was the first month-to-month rise since September 2017. Prices in the two major markets of Sydney and Melbourne were both up by 0.2% in the month, though the declines over the past year are still significant at 9.0% and 8.2% respectively. The residential construction outlook continues to remain weak with data this week showing that building approvals fell by 1.2% in June and by 7.3% in Q2 (reviewed here). That accelerated the decline from a year earlier from -19.2% to -25.6%, with the slowdown driven mostly by a rollover in high-rise units, though house approvals have also weakened notably.

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