While equity markets saw broad-based pullbacks this week, this was overshadowed by developments in the US Treasury market. The US 10-year yield traded near 12-month highs on news of a ramp-up in debt issuance at next week's refunding auctions and Fitch announcing a US ratings downgrade, while spillover effects from the BoJ's tweaking of Yield Curve Control may have also played a role. But late in the week, the US 10-year yield reversed course sharply after key employment data missed expectations.
US payrolls underwhelm
A fall in the unemployment rate from 3.6% to 3.5% in July reaffirmed that the US labour market remains robust; however, employment gains are moderating. Nonfarm payrolls lifted by 187k in the month - below the 200k figure expected - and downward revisions subtracted a combined 49k from payrolls in May and June. This has seen the average increase on payrolls over the past 3 months slow to just below 220k, its lowest since early 2021.
Average hourly earnings growth remained at a 4.4% annual pace - a clip too elevated to be consistent with the Fed's 2% inflation target - though this has slowed from 5.4% a year earlier. Key factors in this have been the moderation in employment gains and a recovery in participation (62.6%), with the major 25-54 years cohort (83.4%) well above pre-pandemic levels of participation.
RBA at the peak?
A pause on tightening from the RBA for the second meeting in succession left the cash rate at 4.1% (reviewed here). The fullness of the RBA's communications through the week - including the August Statement on Monetary Policy - confirms the Board is very much in a data-dependent mindset. The Board's key judgments are that rates are at a restrictive setting, the full effects of tightening have yet to materialise, and the data flow has been consistent with inflation falling back to the 2-3% target band, forecast to be achieved in the back half of 2025. Tightening is not off the table - the Board maintains the guidance that further tightening "may be required" - but for these reasons, the data will need to start painting a different picture for the RBA to recommence hiking rates. The revised forecasts in the August Statement remain consistent with a soft landing scenario in Australia - the economy and employment continuing to expand as inflation declines - so the Board will be wary of the risk of overtightening.
On the data front, there were a number of highlights. Headwinds from rising interest rates and cost of living pressures are weighing on household spending, retail sales volumes contracted by 0.5% in the June quarter, their third consecutive quarterly decline (see here). Increased activity and demand in the housing market were reflected in a further 0.7% lift in national housing prices in July, with housing finance commitments rising strongly in the June quarter (see here). Dwelling approvals rebounded in Q2, albeit off a low base (see here). A wider trade surplus in June to $11.3bn was driven by declining imports (see here).
Bank of England eases tightening pace
The Bank of England hiked rates by 25bps to 5.25% this week, with improved inflation data allowing the MPC to downshift from a 50bps hike in June. The decision was backed by 6 of the 9 MPC members; 2 members preferred another 50bps hike while there was a sole vote cast to leave rates on hold. How much further rates may rise remains an open question. The MPC's guidance that signs of persistent inflationary pressures would be met with "further tightening" was left intact, unchanged since the February meeting; however, in the post-meeting press conference, Governor Bailey said rates were already at a restrictive setting and this was having a notable effect on the economy.
An outlook for declining inflation in the Bank's August Monetary Policy Report projects a return to the 2% target in Q2 2025. Falling energy prices drive lower inflation in the near term, but the Bank notes the trajectory further out will to a large extent be determined by labour market conditions and wages growth. In this respect, the Bank is taking a cautious view - due to prior upside surprises on wages growth, the expectation is that these pressures will take longer to abate than they did to emerge. To that end, the message from Governor Bailey was that rates will be left at a "sufficiently restrictive" setting for a "sufficiently long" period to ensure the return to 2% inflation.