Bank of Melbourne

Morning Report

Main Themes: The US Federal Reserve cut its policy rate by 25 basis points to a 2.00%-2.25% band and left the door open for more easing. However, the Fed described the policy easing as an insurance cut rather than the beginning of a deep easing cycle. The tone disappointed markets which were positioned for a more dovish outcome. The US dollar appreciated and US equities fell as a result.
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Main Themes:The US Federal Reserve cut its policy rate by 25 basis points to a 2.00%-2.25% band and left the door open for more easing. However, the Fed described the policy easing as an insurance cut rather than the beginning of a deep easing cycle. The tone disappointed markets which were positioned for a more dovish outcome. The US dollar appreciated and US equities fell as a result.

Share Markets: The key US share markets fell by more than 1% overnight.

Interest rates: US 2-year treasury yields jumped from 1.81% to 1.96% in response to the Fed outcome, steadying around 1.87%. The US 10-year yield, which had earlier declined from 2.06% to 2.02% after some lukewarm economic data, jumped to 2.07% in response to the Fed. However, the US 10-year yield closed 5 basis points weaker at 2.01%.

Interest-rate markets are pricing 15 basis points of easing (or a 60% chance of a 25 basis point cut) at the September 19 meeting and a terminal fed funds rate of 1.45% (implying 70 basis points of further easing expected in total).

Australian 3-year government bond yields were volatile, fluctuating between 0.76% and 0.81% but little changed overall at 0.79%. The Australian 10-year yield has slipped from 1.21% to a record low of 1.18%.

Foreign Exchange: The US dollar index is up 0.5% on the day and at its highest level since May 2017. EUR/USD fell from 1.1160 to a 2-year low of 1.106, also underpinned by soft Eurozone GDP data. USD/JPY rose from 108.50 to a 2-month high of 109.00. Meanwhile, the AUD/USD fell from near 0.6900 to 0.6830 – matching the 18 June low. NZD/USD fell from 0.6610 to a 6-week low of 0.6543. The AUD/NZD pair mostly sustained yesterday’s gains, inspired by weak NZ business confidence data and ongoing subdued Australian inflation data.

Commodities: Oil and iron ore prices fell overnight.

Australia: Headline CPI rose 0.6% in the quarter, versus consensus expectations for a 0.5% increase. It was the strongest quarterly lift in headline CPI in 1½ years. The annual rate lifted from 1.3% in the March quarter to 1.6% in the June quarter.

Underlying CPI (trimmed mean) rose 0.4% in the June quarter. This outcome left the annual rate steady at 1.6%, but this was stronger than consensus expectations of 1.5%.

While inflation was a touch stronger than expectations, inflation outcomes were still weak. Both headline and underlying inflation are running below the RBA’s 2-3% per annum target band. Moreover, underlying inflation has been below the target band for 3½ years and is unlikely to return to the RBA’s target any time soon.

The stronger-than-expected result mostly reflected higher oil prices – automotive fuel rose 10.2% in the June quarter. There was also some pass-through of higher prices from the weaker Australian dollar, reflecting higher prices for clothing & footwear, furniture, international travel and tradables inflation.

Nonetheless, domestic price pressures remain very subdued reflecting weakness in the housing market and ongoing spare capacity in the labour market.

Credit growth to the private sector was anaemic in mid 2019 with housing weak in the wake of the sharp downturn and with business hitting a flat spot around the time of the Federal election. This is ahead of any boost from recent policy stimulus.

Total credit rose by only 0.1% in the month of June. That follows gains of 0.1% and 0.1% in April and May (revised down from 0.2% and 0.2%). In June, the mix of credit outcomes was: housing +0.2%; business -0.1%; and personal -0.2%.

Annual credit growth fell to 3.3% in June, the slowest pace since September 2013. Credit growth has progressively eased since expanding by 6.6% in 2015, with growth moderating to 5.6% in 2016, 4.8% in 2017 and 4.3% in 2018.

China: The non-manufacturing purchasing managers’ index (PMI) fell in July to 53.7, from 54.2 in June. The manufacturing PMI improved from 49.4 to 49.7, but remained under the key level of 50, suggesting that activity will contract in manufacturing in the period ahead.

Europe: GDP rose by 0.2% in Q2, matching consensus expectations. Annual GDP growth slowed from 1.2% in Q1 to 1.1% in Q2. Meanwhile, core inflation growth fell to 0.9% in the year to July, from 1.1% in the year to June, reflecting the weaker momentum in the Eurozone economy.

New Zealand: Business confidence improved in July, rising 6.2 points to -44.3.

United States: The Federal Reserve cut the federal funds target rate range by 25 basis points to 2.0%-2.25%. It is the first rate cut since its previous easing cycle ended in December 2008. The cut was fully expected by financial markets. The Fed cited “global developments” and “muted inflation pressures” as reasons behind the rate cut, although their reading of current conditions remained upbeat. The accompanying statement together with Chair Powell’s press conference placed this cut squarely in a risk management framework. The lack of any meaningful changes to the Fed’s assessment of current conditions underscores the point that despite external risks the economy continues to match expectations. The Fed continued to describe the labour market as “strong” and activity rising at a “moderate” rate.

In the press conference, Federal Reserve Chair Powell said the FOMC is thinking of the cut "as a mid-cycle adjustment to policy" designed to "insure against downside risks" rather than signal the start of a lengthy cycle of monetary policy easing. "It's not the beginning of a long series of rate cuts," he said, adding: "I didn't say it's just one" cut. The Fed Chair also tried to explain the move by describing it as in response to "threats to what is clearly a favourable outlook."

The employment cost index rose just 0.6% in Q2, below expectations and the weakest quarterly increase since late 2017. The annual pace eased a touch to 2.7%, underscoring the ongoing benign wage pressures despite a tight labour market.

The Chicago business PMI moved further into contractionary territory in July, to 44.4, from 49.7 in June.  The prices, employment and new orders sub-indices all fell in the month. This soft Chicago report matches the trends evident in other regional PMIs released in the latter part of the month, such as the Markit and Richmond Fed surveys.

Private payrolls grew by 156k in July, according to the payrolls-processing firm ADP. The outcome was close to consensus estimates and cemented expectations for a decent payrolls report later this week.

Today’s key data and events:

AU CoreLogic House Prices Jul prev -0.1% (10am)

AU Import Price Index Q2 prev -0.5% (11:30am)

AU Export Price Index Q2 prev 4.5% (11:30am)

CH Caixin Mfg PMI Jul exp 49.5 prev 49.4 (11:45am)

UK Markit PMI Jul exp 47.6 prev 48.0 (6:30pm)

UK Bank of England Policy meeting (9pm)

UK Bank of England Inflation Report (9pm)

US ISM Index Jul exp 52.0 prev 51.7 (12am)

US Construction Spending Jun exp 0.3% prev -0.8% (12am)

 

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 Ph: 02-8254-3251