Low cross-asset volatility driven by a view that tariff-driven inflation will not stand in the way of Fed rate cuts saw high-flying equities make further gains this week. On the back of US CPI data - despite being above the Fed's target - traders are weighing up 2-3 rate cuts before year-end. As a result, the 2-year Treasury yield touched lows since May seen in the aftermath of Liberation Day during the week. The US dollar declined, though the Australian dollar was weaker following a dovish rate cut from the RBA.
A Fed rate cut in response to labour market concerns firmed to a near lock in market pricing at the September meeting, with signs of tariff-driven inflation remaining inconclusive. Key inflation outcomes in July were on expectations at 0.2%m/m for headline CPI and 0.3%m/m on a core (ex-food and energy) basis. In annual terms, headline CPI held at 2.7% - a touch below the 2.8% consensus - while core CPI lifted from 2.9% to 3.1%, surprising to the upside (3%). Components exposed to tariffs (including appliances, furniture etc) showed limited signs of price rises, up 0.2%m/m. The annual pace firmed from 0.4% to 0.7%, a subdued pace but a contrast nonetheless on 12 months ago when core goods were pushing down on inflation (-0.6%).
Although consumer prices are yet to show the clear effects of tariffs, those pressures look to be building in the pipeline. Producer prices rose well above expectations from 2.3% to 3.3%yr (vs 2.5% exp), raising the likelihood that firms facing higher costs will start passing this through via price increases in order to preserve margins. The Fed does expect this process to play out, but it shouldn't overly hinder easing prospects, at least in the near term due to its view that tariffs are unlikely to spark a broader inflationary episode.
Over in the UK, further signs of weakness in the labour market were seen with payrolled employment falling for the 8th time in the past 9 months, down this time by 8k in July. The unemployment rate held at 4.7%. Much of the weakness in the labour market is being attributed to the government's increase in payroll tax and by a larger-than-usual rise in the minimum wage. Labour market conditions are likely to keep the BoE easing cycle rolling into next year. On a more positive note, June quarter GDP growth surprised to the upside at 0.3%q/q (1.2%Y/Y).
The RBA's decision to cut the cash rate by 25bps to 3.6% was expected, but the overall tone was a bit more dovish than anticipated (see here). Market pricing for the continuation of the easing cycle to a terminal cash rate in and around 3% was given soft validation by the RBA's new forecasts in the August Statement on Monetary Policy. Based on that market pricing for the cash rate, the RBA's revised forecasts have inflation holding around the midpoint of the 2-3% target and the unemployment rate remaining in the low 4s across the projections, an outlook consistent with both sides of its policy mandate. This was the main story from the RBA this week, despite questioning in the press conference focusing on a reduction in the central bank's assumption for productivity growth.
Australian data this week also helped shore up pricing for further rate cuts. Employment matched expectations rising by 24.5k in July, seeing the unemployment rate fall back to 4.2% after it had risen to a 3½-year high in June (4.3%). The report steadied the ship after the labour market looked to be softening more rapidly than expected through May and June (see here). Meanwhile, wages growth also matched expectations at 0.8%q/q, 3.4%Y/Y in the June quarter, a pace in the RBA's comfort zone (see here). In other news, housing finance showed signs of heating up posting a 2% rise in the June quarter (see here).
