The biggest news overnight was the FOMC Minutes, which were interpreted cautiously by the market as confirming the likelihood of a June rate hike, but casting some uncertainty over the trajectory for rates thereafter. The US dollar fell on the news, while bond yields declined.
Overall the US Fed seems content to hike rates again in June, noting “most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate [to hike rates]”. Markets agree with market pricing for June sitting at around a 76% chance while around 1.4 rate hikes are priced by the years end.
However, the trajectory for rates thereafter seems slightly more uncertain after today’s Minutes – the key source of uncertainty coming from the inflation outlook. One camp (called the “couple”) is becoming concerned that the unemployment rate is running below the full‑employment level which could pose upside risks to inflation – their case reinforced by “several Districts reported a pickup in wage increases, shortages of workers in selected occupations, or pressures to train workers”. Another camp in contrast (“several others”) continued to see downside risks to the inflation outlook, particularly given the low inflation print and still-low measures of inflation expectations. They also view the possibility the labour market could tighten further without giving rise to inflationary pressures. Against such a backdrop it was deemed “prudent to await additional evidence indicating that the recent slowing in the pace of economic activity had been transitory”. The one point of agreement was that “most” saw the weak Q1 GDP data as “transitory” and likely to rebound.
Moves to unwind the balance sheet are likely to occur “this year” and The FOMC broadly supported a staff proposal for a gradual approach. “Under the proposed approach, the Committee would announce a set of gradually increasing caps, or limits, on the dollar amounts of Treasury and agency securities that would be allowed to run off each month, and only the amounts of securities repayments that exceed the caps would be reinvested each month. As the caps increased, reinvestment would decline” “The caps would initially be set at low levels and then be raised every three months, over a set period of time, to their fully phased-in levels.”
Markets emphasised slightly cautious tone and with the US dollar (DXY) falling0.3% across the board overnight. Correspondingly, most currency pairs were higher against the US dollar: EUR (+0.3%); JPY (+0.2%); AUD (+0.3%).
The Canadian dollar was the outperformer, up 0.7% following the Bank of Canada Meeting. Although rates were unchanged, the Statement was less dovish with an assessment that the “economy’s adjustment to lower oil prices is largely complete” and optimism on the global economy which will also help domestic growth.
The Australian dollar was a tale of two halves. The currency had fallen 0.5% by the time your scribe left the office yesterday following China’s credit rating downgrade, soft Aussie construction data and weakness in commodity prices (iron ore -2.4% to $60.5 a tonne). This was entirely reversed overnight, partly on the back of US dollar weakness, to end the day up 0.3%.
While the Aussie construction data did not have an enduring impact on the currency (-0.7% q/q v expectations of -0.5%), the sharp fall in residential construction (-4.7% q/q) has led many to wonder whether residential construction is topping out at high levels, and on this note the level of construction has been broadly unchanged since mid-2016. The data also feeds into Q1 GDP (out June 7) and combined with other partial data to date is suggestive of a real risk of a flat or even a small negative GDP outcome.
China’s credit rating downgrade by Moody’s to A1 from Aa3 did not ruffle too many feathers. The move reflects concerns over leverage, debt and shadow banking and a view that growth could suffer as China seeks to rein in these risks. Unsurprisingly, the Chinese authorities defended their reform policies and criticised Moody’s methodology and misunderstanding of the situation.
Finally the ECB released its latest Financial Stability report along with a speech by the ECB’s Draghi who downplayed the side effects from negative rates and that “there is no reason to deviate from the indications we have been consistently providing in our introductory statement”. All eyes will be on the June ECB meeting for any changes in policy guidance.
It’s a very quiet day ahead with little to trouble the scorers. Domestically the RBA Deputy Governor Debelle is launching the Global FX Code (6.00pm AEST), though this is unlikely to contain much in the way of comment on the domestic or international economies.
In the US we get the Advanced Goods Trade Balance for April where the market consensus sits at a $64.5bn deficit, while Thursday also brings Weekly Jobless Claims. The UK has the more detailed Q1 GDP result following the flash estimate earlier – markets expecting a 0.3% q/q and 2.1% y/y.
On global stock markets, the S&P 500 was +0.24%. Bond markets saw US 10-years -2.45bp to 2.25%. In commodities, Brent crude oil -0.35% to $53.96, gold+0.1% to $1,257, iron ore -2.4% to $60.52, steam coal +0.1% to $74.45, met. coal +0.0% to $174.00. AUD is at 0.7499 and the range since yesterday 5pm Sydney time is 0.7455 to 0.7508.
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