Rates pricing in the US shifted notably this week, with markets restoring the prospect of 2024 rate cuts following the Federal Reserve's policy meeting and softer-than-expected employment data. US bond yields rallied and the dollar declined. Most notably, the US dollar fell several figures against the Yen this week as the authorities in Japan intervened (yet to be confirmed) to push against the substantial depreciation in its currency.
Although the decision by the Federal Reserve's policy-setting FOMC to leave rates unchanged at 5.25-5.5% was seen as a foregone conclusion, the tone of Chair Powell's press conference defied expectations to push back more aggressively on prospects for near-term rate cuts in the US. As it was - and despite recent inflation readings - Chair Powell said the committee viewed monetary policy as well calibrated and that further rate hikes were "unlikely". Additionally, there were credible paths the US economy could take that would warrant rate cuts, despite the data currently not giving the FOMC adequate assurance that inflation is headed back to the 2% target on a sustainable basis. The one tweak the FOMC did make was to slow the pace of balance sheet reduction, from a cap of $60bn/mth to $25bn/mth for its Treasury holdings, effective from June.
Given the sentiment coming out of the meeting, a nonfarm payrolls report for April that was softer than expected gave markets the green light to renew pricing for rate cuts in 2024. Employment increased by 175k in the month, below estimates for 240k as a net 22k was subtracted off payrolls over February and March. This saw the unemployment rate tick up from 3.8% to 3.9% alongside an unchanged participation rate (62.7%). Perhaps the most impactful aspect of the report was the slowing in average hourly earnings growth from 4.1% to 3.9%yr, a sign that easing tightness in the labour market is reducing wage pressures - albeit that was not the signal markets had taken away from the Employment Cost Index (4.2%Y/Y in Q1) earlier in the week.
Last week, PMI data showed economic activity in the euro area was picking up following a lengthy period of stagnation since the back half of 2022. Consistent with that signal, GDP data for the March quarter came in above expectations expanding by 0.3% (vs 0.1%). Taken together, these are tentative signs that the weak growth over the past year (0.4%) is starting to turn. With the labour market having remained resilient to the economic slowdown (the unemployment rate held at a record low of 6.5% in March) and inflation declining materially, real household income dynamics have improved, likely supporting consumption growth - particularly in the services sector.
On inflation, the latest data was broadly as expected with the headline HICP printing at 0.6%m/m in April to leave the annual pace at an unchanged 2.4%. Core inflation remains firm to the headline rate at 0.7%m/m and 2.7%yr (vs 2.6%), though it eased slightly from 2.9%yr in March as prices in the key services basket cooled to 3.7%yr from 4%. Overall, markets saw this as validating a June rate cut from the ECB. The ECB's Chief Economist Lane spoke during the week highlighting that the Governing Council is moving towards dialing back restrictive monetary policy and in doing so it is managing "two-sided risks" from easing too quickly before inflation is well contained and staying overly restrictive for too long potentially leading to a downturn.
In Australia, attention turns to next week's RBA meeting. Rates are expected to remain on hold (4.35%), leaving much of the focus around the Board's messaging on the policy outlook that will accompany a revised set of growth and inflation forecasts. Different from the likes of the Fed and ECB, commentary from RBA officials is limited between meetings, so there is an element of uncertainty around whether the messaging that the Board "is not ruling anything in or out" from a policy perspective will be tweaked following the firmer-than-expected Q1 inflation report.
The activity data published this week suggests that monetary policy is restrictive and is working to slow demand. In a large downside surprise, March retail sales fell by 0.4% driven by a post-summer pullback in spending across discretionary-related categories (see here). Dwelling approvals rose by 1.9% in March but fell to their lowest quarterly total in 12 years, with higher interest rates, capacity pressures and weak sentiment all headwinds (see here). On the other hand, conditions in the established housing market remain hot: housing prices lifted for the 15th consecutive month in April, generating an associated upturn in housing finance commitments of 3.1% in March to a 19-month high (see here), though this more reflective of tight supply than the stance of monetary policy. Meanwhile, the trend of narrowing trade surpluses continued, with the surplus for March ($5bn) retracing to its lowest level in more than 3 years (see here).
