Independent Australian and global macro analysis

Friday, July 5, 2024

Macro (Re)view (5/7) | US data boosts Fed rate-cut prospects

Equities saw solid gains this week, underpinned by US tech, with lower bond yields and a weaker dollar supporting risk sentiment. The UK general election went as the polls had predicted and was a non-event for markets. Politics remains in focus over the weekend with the second round of the French elections taking place, though with Le Pen's RN party looking unlikely to secure a majority a tail risk in market pricing has reduced. Comments from Fed Chair Powell at the ECB's Sintra Forum that US disinflation is back on track as well as soft labour market and activity data moved markets closer to pricing in a September rate cut. This comes ahead of next week's key CPI and PPI reports for June. 


Signs of a cooling US labour market upped dovish bets on a Fed rate cut in September to a 75% chance, with markets close to discounting two cuts by year-end. Although the June employment report showed nonfarm payrolls increased by a stronger-than-expected 206k (vs 190k forecast), this was weighed by downward revisions subtracting a net 111k from employment over April-May. As a result, the 3-month average for nonfarm payrolls has slowed to 177k, its lowest since the start of 2021. The headline unemployment rate now stands at its highest level since late 2021 after rising from 4% to 4.1% in June; however, that came alongside an increase in the labour force participation rate from 62.5% to 62.6%. Reflective of easing tightness in the labour market and slowing inflation, annual growth in average hourly earnings moderated to a 2-year low at 3.9% from 4.1% previously. Meanwhile, weak readings in the ISM surveys for services (48.8) and manufacturing activity (48.5) in June were indicative of slowing growth momentum. 

Opening the ECB's Sintra Forum, ECB President Lagarde spoke about steering monetary policy through the current cycle. Unique to this cycle, the ECB's tightening has seen a faster pace of disinflation than previous episodes, but the labour market has remained significantly more resilient. The ECB cut rates in June and the account from the meeting cast more light on the decision. Easing monetary policy reflected increased confidence that inflation was headed durably back to the 2% target. This approach was characterised as a 'judgement call' intended to guard against the risk of rates remaining too high for too long. The fact there were dissenting views and that the inflation data remains elevated suggests that the ECB's easing cycle will progress at a measured pace. Inflation data for June this week showed the headline pace easing from 2.6% to 2.5%yr (vs 2.5%) and the core series remaining at 2.9%yr (vs 2.8%). 

Turning to Australia, confidence in the existing monetary policy strategy to return inflation to target saw the RBA Board holding rates steady last month. This was a key message conveyed in the June meeting minutes. The Board remains wary that upside inflation risks could prompt further tightening - a scenario markets price as around a 50/50 chance - but the RBA is reluctant to hike, unless the Q2 CPI report (due 31 July) forces its hand. At the June meeting, a hike was considered on the basis that rates weren't 'sufficiently restrictive' to bring inflation back to target 'within a reasonable trameframe'; however, policymakers did not see evidence to draw that conclusion. Instead, the view was that rates were working to slow the economy in a manner consistent with inflation back at target in 2026 while also preserving the post-Covid employment gains. 

Data to hand this week was on the strong side of expectations but noisy at the same time. End of financial year discounting drove a 0.6% rise in retail sales for May, their strongest increase since the start of the year (see here). Gains were broad-based across food and discretionary categories for the month, but sales momentum remains weak amid cost-of-living pressures and higher interest rates. Dwelling approvals posted their strongest rise since last October up by 5.5% in May but remain at low levels (see here). The fundamentals of tight supply amid strong demand continue to drive housing prices higher, up nationally for the 17th month running in June (0.7%) according to CoreLogic. Lastly, the monthly goods surplus narrowed to $5.7bn in May, a continuation of the recent momentum (see here). Iron ore boosted exports (2.8%) to their strongest rise since last August only to be outpaced by a lift in imports (3.9%).