The US dollar bounced off its year-to-date lows this week and the yield curve disinverted, leaving a near-flat spread across the 2-year and 10-year segments. Markets have fully absorbed the communication pivot from the Fed and are awaiting Friday's nonfarm payrolls data to determine whether the September cut will be either a 25 or 50bps move. Other highlights next week include a rate decision from the Bank of Canada, the ISM services survey (US) and the Q2 GDP report in Australia.
Pricing for an RBA rate cut before year-end reduced modestly to around a 90% chance after CPI inflation slowed by less than expected to 3.5% in July (vs 3.4% forecast) from 3.8% previously (reviewed here). The early effects of government rebates on electricity bills were the main driver behind the slowing in headline inflation, with declines in petrol prices also a factor. Softer readings across the various measures of underlying inflation suggested to markets that the disinflationary process is continuing, thereby justifying RBA easing trades being maintained. Trimmed mean inflation eased from 4.1% to 3.8% and CPI ex-volatile items and travel was down from 4% to 3.7%. However, the lack of service price updates in the July report means that it is unlikely to have moved the dial for a relatively hawkish RBA.
Data on Australian construction activity and capital expenditure came in weaker than expected, inputs that signal a subdued GDP growth outcome in the June quarter. My preview of Australian Q2 GDP (see here) covers the key details ahead of next week's national accounts release. The focus remains on the household sector that continues to adjust consumption in the face of cost-of-living pressures and higher interest rates. End-of-financial-year sales resonated with consumers through May and June before spending retraced to a flat outcome for July retail sales (reviewed here).
Construction activity was broadly flat in Q2 (0.1%) but declined through the first half of the year (-1.9%) as the uplift in non-residential and engineering work - supported by an expansive public infrastructure pipeline - lost momentum and the residential segment remained weak (reviewed here). Private sector capital expenditure - a key support to growth as the economy has slowed - rolled over by 2.2% in the June quarter, its weakest outcome since the pandemic (reviewed here). The details in the report reinforced the theme that non-residential construction pulled back (-3.8%q/q) while equipment investment also softened (-0.5%). Nonetheless, forward-looking investment plans still came across as upbeat, upgraded by around 10% to $171bn in 2024/25, a 12-year high.
A soft landing for the US economy appears to remain within reach for the Fed as Q2 GDP growth was revised up to an annualised pace of 3% (from 2.8%) and the latest inflation data was subdued. Headline PCE prices held at 2.5%yr in July (vs 2.5%) and the Fed's preferred core PCE index remained at 2.6% (vs 2.7%), slowing from 3.3% and 4.2% respectively a year ago. The overall picture painted is that economic growth is still resilient while inflation is making progress towards the Fed's 2% target. But, markets are clearly weary given the signals it has seen in the labour market, with employment slowing and unemployment rising. That in large part explains the aggressive easing cycle of 225bps of Fed cuts priced.
In the euro area, inflation data for August matched expectations, keeping the ECB on track to cut rates again in September. Beyond the next meeting however, ECB officials - Executive Board member Schnabel chief among them - delivered a message throughout the week of moving gradually, cautioning markets pricing 75bps of cuts into year-end. Headline inflation slowed from 2.6% to a 3-year low of 2.2%, the decline mainly being driven by energy prices. Speaking to the ECB's caution, core inflation remains more elevated and eased only slightly from 2.9% to 2.8%, with services prices firming in the month (4% to 4.2%), likely associated with the Paris Olympics.