Bank of Melbourne

Morning Report

Main Themes: Comments from US President Trump and China overnight kept investors on edge over trade tensions. However, US economic data was mixed. A strong retail sales report in the US was counterbalanced by a darker outlook for the manufacturing sector. The mixed data means and poorer world growth prospects should see the US Federal Reserve cut rates again next month.


Main Themes: Comments from US President Trump and China overnight kept investors on edge over trade tensions. However, US economic data was mixed. A strong retail sales report in the US was counterbalanced by a darker outlook for the manufacturing sector. The mixed data means and poorer world growth prospects should see the US Federal Reserve cut rates again next month.

Share Markets: US share markets finished higher overnight, underpinned by strong US retail-sales data and a strong Q2 earnings report from Walmart. The Dow Jones ended up 100 points higher (or +0.4%) and the S&P 500 bellwether rose 7 points (or +0.3%). Despite the firmer closes, it was a roller-coaster session.

Interest Rates: US 2-year treasury yields fell from 1.58% to 1.46% (lowest since 2017), the US 10-year yield declined from 1.58% to 1.50% (lowest since 2016) and the US 30-year yield dropped below 2% for the first time ever to close at 1.91%.

Interest-rate markets are pricing 34 basis points of easing at the 19 September Federal Reserve meeting and a terminal rate of 0.97% (Federal funds rate currently 2.13%).

The US 2-10-year yield curve closed at 4 basis points overnight, but in the previous session had inverted. This inversion is traditionally a precursor to recessions. Addressing these concerns, St. Louis Federal Reserve President James Bullard said the inversion of portions of the Treasury bond yield curve this week would "have to be sustained over a period of time" to be taken as a "bearish" signal for the US economy.

Australian 3-year government bond yields ranged sideways between 0.63% and 0.68%. The Australian 10-year yield fell 9 basis points to a fresh record low of 0.83%. Interest-rate markets are pricing 6 basis points of easing at the 3 September RBA meeting, and a terminal rate of 0.36%.

Foreign Exchange: The US dollar index is up modestly overnight. EUR/USD fell from 1.1160 to 1.1092, hurt by remarks made from a European Central Bank official. The Australian dollar outperformed, preserving gains following yesterday’s solid jobs data, between 0.6765 and 0.6790. NZD/USD ranged between 0.6430 and 0.6450. AUD/NZD preserved yesterday’s gain, ranging between 1.0510 and 1.0540.

Commodities: Crude oil prices fell overnight. Iron ore prices also fell to their lowest since April at US$89. Heightened risk aversion maintained demand for gold, a safe-haven asset.

Australia: The labour market has once again surprised with its strength; 41.1k jobs were added in July.  The solid increase indicates the labour market is not yet displaying the moderation that has been suggested by other leading indicators of employment. Moreover, it continues to be at odds with the below-trend pace of economic growth.

The unemployment rate held at 5.2% in July, but we continue to see a risk that the unemployment rate will lift. Forward-looking indicators of employment, including job ads, business conditions and job vacancies are pointing to a weaker pace of jobs growth. The workforce participation rate edged up 0.1 percentage points to hit a new record high in July of 66.1%. While a positive development, as it suggests greater productive capacity in the economy, it also lessens upward pressure on wages and inflation. The data alone does not justify a “need” as yet for a further easing of monetary policy next month. But with the outlook for softer employment growth, low inflation, weak wages growth and growing downside risks from the global economy, we continue to expect the RBA to cut the cash rate again.

In a speech yesterday, RBA Deputy Governor Debelle spoke of the risks to the outlook. On the risks from trade tensions, Debelle noted limited direct implications for the Australian economy because Australia it is not involved heavily in the global supply chain, particularly for technology. In fact, Australia has benefited from the fiscal stimulus in China in response to the downward impact from trade on Chinese economic growth, which has boosted demand for steel and infrastructure, and supported demand for commodities. Over the long-term, there are risks to the Australian outlook, given Australia has been a major beneficiary of the rules-based trading system. The key domestic risk discussed was the outlook for consumer spending, although Debelle said that “overall risks appear to be more balanced”. It was expected that low to middle income households would spend about half of their tax refunds. Households were also benefiting from lower interest rates. Debelle also drew attention to climate change, which was another major risk over a longer-term horizon.

China: New home prices rose by 0.6% in July, after a rise of 0.7% in June. On a year ago, new prices rose 9.7%. Prices are continuing to lift despite a range of government measures aimed at curbing the property market.

China yesterday vowed to counter the latest US tariffs on US$300 billion of Chinese goods but called on the United States to meet it halfway on a potential trade deal, as US President Donald Trump said any pact would have to be on America's terms.

Eurozone: The European Central Bank’s Olli Rehn wants an "impactful and significant" stimulus package too when the central bank meets next month. The policy maker said it was better to overshoot rather than undershoot market expectations when it comes to new support measures.

United States: Retail sales increased 0.7% in July, after gaining 0.3% in June. Excluding automobiles, gasoline, building materials and food services, retail sales jumped 1.0% last month after advancing by 0.7% in June. These so-called core retail sales correspond most closely with the consumer spending component of GDP. Solid retail sales were reinforced by strong second-quarter results from Walmart Inc.

The upbeat retailing report helped assuage financial market fears that the US economy was heading into recession. However, it is unlikely to change expectations that the Federal Reserve will cut interest rates again next month as news from the manufacturing sector remains dour, underscoring the darkening outlook for the economy against the backdrop of trade tensions and slowing growth overseas.

Solid consumer spending is blunting some of the hit on the economy from the downturn in manufacturing. The sector's struggles were highlighted by data that showed a 0.2% drop in industrial production in July and a 0.4% decline in manufacturing production in the same month. The decline in manufacturing was broad based in July. Manufacturing, which makes up about 12% of the US economy, is also being weighed down by an inventory overhang, especially in the automotive sector.

The manufacturing troubles appear to have continued into the third quarter. A report from the Philadelphia Federal Reserve overnight showed factory activity in the mid-Atlantic region slowed in August. The Philadelphia Fed index dropped from 21.8 in June to 16.8 in July. Within this survey, the measure of factory employment dropped to its lowest level since November 2016.

This weakness in factory employment in the region that covers eastern Pennsylvania, southern New Jersey and Delaware was mirrored by another survey from the New York Fed. Activity in New York State. The Empire manufacturing index rose from 4.3 in July to 4.8 in August, but the employment sub index deteriorated.

Today’s key data and events:

NZ BusinessNZ Mfg PMI Jul prev 51.3 (8.30am)

EZ Trade Balance Jun exp €18.5bn prev €20.2bn (7.00pm)

US Housing Starts Jul exp 0.3% prev -0.9% (10.30pm)

US Building Permits Jul exp 3.1% prev -5.2% (10.30pm)

US UoM Cons. Sentiment Aug exp 97.0 prev 98.4 (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