Bank of Melbourne

Morning Report

Main Themes: Ahead of a long weekend in the US, US bond yields and major currencies largely stuck to narrow ranges. US share markets managed to close higher, despite weak US data and ongoing worries about trade.


Main Themes: Ahead of a long weekend in the US, US bond yields and major currencies largely stuck to narrow ranges. US share markets managed to close higher, despite weak US data and ongoing worries about trade.

Share markets: US share markets closed higher on Friday ahead of a long weekend. The Dow Jones ended up 95 points higher (or +0.4%) and the S&P 500 index finished up 4 points (or +0.1%).

Interest Rates: The US 10-year treasury yield ranged sideways in a 2.31%-2.33% range on Friday night and the 2-year bond yield ranged between 2.15% and 2.17%. The chance of a Fed rate cut by December, implied by Fed fund futures, remained at 130%. In Australia, interest-rate markets are currently attaching a 100% probability to an RBA rate cut of 25 basis points on June 4.

Foreign Exchange: The US dollar index weakened in Friday night’s session, as weak US economic data and ongoing worries over trade pulled the greenback lower. Against this backdrop, AUD/USD rose from a low of 0.6881 to a high of 0.6939 and us currently trading near the highs at the time of writing. Australia’s commodities-price basket has rebounded sharply since early April, underpinning demand for the AUD. However, rallies in the AUD are likely to be capped by the prospect of RBA rate cuts this year and by the deterioration in US-China trade relations. Interest-rate markets are already pricing in a cash rate below 1%, although not fully by end 2019 (which is our view). We expect the AUD/USD to end this year at 0.6600.

Commodities: The West Texas Intermediate price for oil closed higher on Friday, but ended the week 6.6% lower, which is the biggest weekly decline since late December. The weekly fall reflects investor worries over how the trade feud between the world’s top economic super powers will hit demand.

Australia: There was no major economic data released on Friday. The market continues to anticipate the next board meeting of the Reserve Bank (RBA) to take place on June 4.

Since February, our view has centred on the RBA cutting the cash rate twice this year. Our assessment of last week’s RBA board meeting minutes for May and the keynote address delivered by the RBA Governor has contributed to our decision to include in our projections a third rate cut this year.

We expect the RBA to cut the cash rate three times this year of 25 basis points each. These cuts will take the cash rate to 0.75% before the end of this year.

China: Guo Shuqing, head of the Chinese banking and insurance regulator, said that higher US tariffs would have "very limited" impact on China's economy. Shuqing also said the escalation of trade tensions will create volatility in global markets and hurt the world economy.

Europe: The citizens of 28 European Union (EU) member states have elected a new European Parliament. Based on the first estimates, the centre-right European People’s party and centre-left Socialists and Democrats look set to lose their combined majority for the first time since the inception of the European Parliament, although they remain the two biggest parties.

Japan: Consumer prices excluding fresh food and energy rose by 0.6% in the year to April, up from 0.4% growth in March. The outcome met market expectations and was the biggest annual gains since June 2016. However, inflation remains a long way from the central bank’s 2% target.

US President Donald Trump and Japanese Prime Minister Shinzo Abe will sit down in Tokyo for trade talks today, but Trump has said that a deal won't happen until after the Japanese elections in July. Japan's economy minister said negotiators so far have avoided contentious issues such as the US's threat to restrict car exports and apply a currency clause.

New Zealand: The merchandise trade surplus narrowed from NZ$824 million in March to NZ$433 million in April. Exports were up 12.0% on a year ago, led by dairy products. Imports were up 7.3% on the same time a year ago with aircrafts and parts leading the growth in imported items.

United Kingdom: UK’s Prime Minister Theresa May announced her resignation on Friday. May will step down as Conservative Party leader on June 7 and then act as caretaker PM until a new leader is elected. The process in selecting a new leader is hoped to be completed before the summer recess begins on July 20.

Cabinet ministers Michael Gove and Matt Hancock have thrown their hats in the ring along with former Brexit Secretary Dominic Raab. Andrea Leadsom will also run, but Boris Johnson appears to be the front runner. Meanwhile, Chancellor of the Exchequer Philip Hammond is not a candidate, but refused to rule out backing a no-confidence motion against the government if the next leader tries to force a no-deal Brexit on Parliament.

In terms of data, headline retail sales was flat in April, but retail sales excluding auto fuel fell by 0.2% in the month. The annual growth rate for retailing excluding auto fuel slowed from 6.3% in March to 4.9% in April. The outcome was above market expectations. Discounting and warmer weather in April helped deliver outcomes that were above market expectations. Meanwhile, online retailing had its strongest three-month period on record, up 9.4% over the three months to April.

United States: Durable goods orders fell by 2.1% in April and the March gain of 2.6% was revised lower to a rise of 1.7%. On a year ago, durable goods orders were flat. The weakness in April was broad-based and the revisions to March suggest a sluggish picture has developed for durable goods orders.

A sharp drop in civilian aircraft orders (-38.5%) was a significant factor driving headline weakness in April. However, durable goods orders excluding transportation was flat in April and March’s result was revised down from 0.3% growth to a contraction of 0.5%.

Moreover, orders for non-defence capital goods excluding aircraft, which is a closely watched proxy for business spending plans, dropped 0.9% last month. March’s result for this category was also revised down to 0.3% growth, from the originally reported gain of 1.0%.

The durable-goods sector, which accounts for about 12% of the economy, is being squeezed by businesses placing fewer orders while working off stockpiles of unsold goods in warehouses. The inventory overhang is concentrated in the automotive sector, which is experiencing slow sales. Boeing’s move to cut production of its troubled 737 MAX aircraft is also hurting manufacturing activity.


Today’s key data and events:

CH Industrial Profits Apr y/y prev 13.9% (11:30am)


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.


Besa Deda, Chief Economist