Bank of Melbourne

Morning Report

The US Federal Reserve delivered a 25 basis point rate hike as widely expected, but in its forecasts brought forward another rate hike this year. The reaction in financial markets was mixed. Shares were lower and bond yields were slightly higher. The US dollar initially spiked, but then retreated to be lower over the session.
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Main Themes: The US Federal Reserve delivered a 25 basis point rate hike as widely expected, but in its forecasts brought forward another rate hike this year. The reaction in financial markets was mixed. Shares were lower and bond yields were slightly higher. The US dollar initially spiked, but then retreated to be lower over the session.

Share Markets: Share markets fell in reaction to the Federal Reserve’s meeting on the prospect of a faster pace of monetary tightening this year.  The Dow fell 0.5%, while the S&P500 dropped 0.4%.

Interest Rates: There was only a mild reaction to the Federal Reserve in the bond market, given the rate hike was widely expected. Nonetheless, the hawkish undertones saw US 2-year yields lift 3 basis points to 2.57%, as the Fed signalled a greater likelihood of an additional rate hike this year. Long-run expectations by the Fed however, remained unchanged, which was probably behind the more muted reaction at the longer-end of the curve. US 10-year yields initially spiked above 3% but then settled to be just 1 basis point higher in the session to 2.97%.

Foreign Exchange: The US dollar spiked initially after the Fed meeting, but then completely pared those gains as markets digested the statement and forecasts. While Fed expectations for rates lifted from 1 more hike to 2 this year, longer-run expectations were unchanged. The Australian dollar conversely dipped on the statement but then recovered to trade at close to 75.8 US cents this morning.

Commodities: Oil prices were slightly higher on a drawdown in US crude inventories. Gold prices initially dipped, but then lifted moving inversely with the US dollar.

Australia: Westpac-MI consumer sentiment edged up 0.3% in June, to a reading of 102.1. The reading is slightly further above 100 indicating more consumers are pessimistic than optimistic.

In a speech yesterday, RBA Governor Lowe reiterated that the “next move in interest rates will be up, not down.” He noted that any increase in interest rates, however, “still looks to be some time away”, noting there is not a strong case for a near-term adjustment in monetary policy. Low said some pick up in wages growth would be a “welcome development”, saying a sustained pick-up in inflation to around the midpoint of the RBA’s target band is “likely to require faster wages growth than we are currently experiencing”.

Europe: Industrial production fell 0.9% in April versus an expectation for a 0.7% decline. Weakness was across all major economies, including Germany, France, Italy and Spain. There remains optimism among ECB officials that the recent soft patch in economic activity is temporary and has been attributed to supply constraints, which suggests that the ECB will continue to be on track to halting its asset purchase program this year.

New Zealand: Food prices were flat in May, following a 0.1% lift in April. For the year to May, food prices fell 0.1%, down from an increase of 2.4% in the year to April. A decline in fruit and vegetable prices in May and over the past year has weighed on food prices.

United Kingdom: CPI was as expected, lifting 0.4% in May, and 2.4% in the year to May. Additionally, core inflation was as expected, steady at 2.1%, which was the lowest since early 2017. With inflation down from its peak, it does not suggest any urgency for the Bank of England (BoE) to hike rates, particularly given the lull in economic activity since the beginning of the year.

United States: The US Federal Reserve lifted the federal funds rate by 25 basis points to 1.75% to 2.00%. Given the decision was widely anticipated, focus was on the Fed’s forecasts and accompanying comments from the Fed. The median expectation for official interest rates was for two more 25 basis point hikes this year, taking total hikes to 4 this year. This was up from the total 3 hikes estimated in March, but reflected one additional Fed official forecast. The subtle hints from the forecasts 2019 and beyond in addition to the accompanying statement was however, more interesting. Most notable was the omission in the accompanying statement that economic conditions would “warrant further gradual increases in the federal funds rate” and that the “federal funds rate is likely to remain for some time below levels that are expected to prevail in the long run”. This reflects the recognition that the official interest rates are approaching “neutral” which Fed officials have continued to estimate as being at 3.0%. Moreover, there was a more hawkish tone in regards to economic growth, the labour market and inflation. Earlier commentary has suggested that the Fed would tolerate inflation overshooting its 2 percent. The Fed highlighted today of its “symmetric 2 percent inflation objective”. In the press conference, Chair Powell reiterated the upbeat tone, saying that “the economy is doing very well”. Powell also confirmed an earlier news report that Fed would begin holding news conferences after every policy meeting beginning January next year, suggesting that every meeting could become a “live” event.

 

Today’s key data and events

AU Labour Force May (11:30am)

  Employment Change exp 15.0k prev 22.6k

  UE Rate Mar exp 5.6% prev 5.6%

  Participation Rate exp 65.6% prev 65.6%

CH Retail Sales May y/y exp 9.6% prev 9.4% (12pm)

CH Industrial Production May y/y exp 7.0% prev 7.0% (12pm)

JN Industrial Production Apr final prev 0.3% (2:30pm)

German CPI May final y/y exp 2.2% prev 2.2% (4pm)

UK Retail Sales May exp 0.5% prev 1.6% (6:30pm)

EZ ECB Monetary Policy Meeting (9:45pm)

  Main Refinancing Rate exp 0.0% prev 0.0%

  Deposit Facility Rate exp -0.4% prev -0.4%

US Retail Sales May exp 0.4% prev 0.2% (10:30pm)

 

Times are AEST. All data forecasts are m/m or q/q and seasonally adjusted unless otherwise specified. Forecasts for Australian data are our forecasts and for other countries they are consensus forecasts.

 

Janu Chan, Senior Economist
Ph:02-8253-0898