Easing concerns around trade and geopolitics and a dovish repricing of the Fed outlook saw investors sending US equities to record highs and unlocked more downside in the USD to lows since 2022. As a result, the AUDUSD north of 0.65 is trading on its highs for the year - despite rising expectations for RBA easing - while the EURUSD through 1.17 is at levels last cleared in 2021. Euro appreciation could extend the ECB's easing cycle, though President Lagarde remained non-committal in her latest remarks to the EU Parliament. The weaker USD looks partly fundamental and partly sentiment driven. Lower treasury yields led by the front end reflect the fundamentals, with a case for Fed cuts building around weaking consumer demand. On the sentiment side, a WSJ report that President Trump may accelerate the timeline to announce a successor to Fed Chair Powell due to dissatisfaction over the Fed's patient approach to easing was a key factor.
Inflationary concerns from the impact of tariffs are keeping the Fed on hold for now but markets are increasingly confident that US monetary policy is too restrictive, pricing in 3 cuts by year-end. Fed Chair Powell held a cautious line in front of Congress this week reiterating that policy was "well positioned" and would be guided by the incoming data. The fact that the Fed's preferred inflation measure - the core PCE deflator - lifted from 2.3% to 2.7%yr in May - above expectations and only just after the liberation day tariffs were announced - speaks to Chair Powell's messaging.
But some Fed members (Waller and Bowman) have been vocal in disagreeing with that stance and lean towards cutting rates. The case for rate cuts is supported by signs of weakness in demand. March quarter GDP growth was revised from -0.2% to -0.5% (annualised) on the back of a sizeable downgrade to personal consumption growth (0.5% from 1.2%). This was followed up by a 0.3% contraction in real spending in May, pointing to increased caution from households.
Swaps pricing for an RBA rate cut in July has firmed to a near-lock (90%) after Australian inflation data for May cooled sharply. A total of 3 rate cuts are priced into the curve by year-end, which would bring the cash rate down to 3.1% from 3.85% currently. The central narrative is that constrained households will require more support if they are to underpin the pick-up in economic growth the RBA has forecast. Disinflationary progress gives the RBA scope to ease with the labour market still strong. This week, job vacancies were reported to have lifted by 2.9% for the 3 months to May to stand at 339k or 2.2% of the labour force - elevated levels however measured.
Headline inflation meanwhile has fallen to the bottom of the RBA's 2-3% target band printing at 2.1% in May from 2.4%yr in April, undershooting expectations to remain unchanged. Price declines in volatile items (fuel, fruit and holiday travel) were key drivers, but price pressures are also easing more broadly across the basket. This was reflected in core or trimmed mean inflation slowing from 2.8% to 2.4%yr, with services inflation down from 4.1% to 3.3%yr - both measures now at their weakest pace in at least 3 years. My review of the May inflation report has more detail here.
