Key insights from the week that was.
The FOMC and President Trump stole the show this week, the former delivering a 25bp cut, the latter a new 10% tariff on $300bn of imports from China. Needless to say, markets have a lot to process.
Before we come to the US, there are a number of Australian developments of note.
Of these, the Q2 CPI was the focal point for the market ahead of the August RBA meeting and Statement on Monetary Policy (due next week). Q2 saw a little more pass-through of Australian dollar depreciation into clothing and footwear prices, while an increase in auto prices and the jump in petrol prices added to transport costs. Despite these supports, annual inflation remained contained well below the bottom of the RBA’s 2–3%yr inflation target range at 1.6%yr on both a headline and core (trimmed mean) basis. In terms of disinflationary pressures, housing remains the standout, with rents flat in Q2 and housing purchase costs and utilities both falling. Looking ahead to Q3, our preliminary view is that inflation on a headline and core basis will remain stuck around 1.5%yr, highlighting persistent slack in the economy.
This persistent slack ultimately relates to a lack of demand growth which was again evident in this week’s retail sales data as volumes grew just 0.2% in Q2, seeing annual growth slow to 0.2%yr – a weaker pace than the GFC, and the softest outcome since the early 90’s recession.
Turning to housing, from CoreLogic, the latest price data suggests the correction in dwelling prices has come to an end, home values in the 8 capital cities of Australia rising 0.1% in July after a cumulative 10.7% fall over the previous 21 months. Sydney and Melbourne continue to lead the other capitals, recording small gains over the past two months. Conditions elsewhere remain mixed, with prices rising in Brisbane in July, but falling in Perth and Adelaide. Ahead, price growth is set to be supported by the recent rate cuts and low turnover, though an increase in the latter into spring may test demand. On construction, dwelling approvals fell further in June. Additional weakness for high-rise approvals seems likely, though non high-rise approvals look to be stabilising – limiting the extent of further declines in total activity.
So given the persistent slack in the economy and a still stabilising housing market, we remain comfortable with our forecast for two additional 25bp cuts by the RBA in October and February, as set out by Chief Economist Bill Evans in his weekly essay. In regards to Tuesday’s decision, we believe it is quite unlikely the Board will adjust policy and so the key interest for us will be the updated forecasts in Friday’s Statement on Monetary Policy. The unemployment rate forecast is likely to be a problem for the RBA, who desire it to fall to 4.5%. At best, the RBA will be forecasting trend growth in 2020. That makes it very difficult to forecast a fall in the unemployment rate from the current level of 5.25%.
Across the Tasman, the RBNZ’s easing cycle is set to continue next week with a 25bps OCR cut at Wednesday’s meeting. The RBNZ is also likely to revise its near-term GDP forecasts lower, and to focus on signs the labour market is weakening. With that backdrop, we expect a follow-up cut in November, but acknowledge it may be brought forward to September.
Now back to the main drama this week, the US Federal Reserve and trade policy.
The FOMC meeting met Westpac and the market’s expectation for a 25bps cut. The Committee also announced that the balance sheet run-off would end two months earlier than planned. The headline message of Chair Powell in the press conference was that this is a “mid-cycle adjustment” and “not the beginning of a long series of rate cuts”.
Chair Powell’s guidance saw the markets temper their expectations for FOMC easing, but the pullback only lasted a day. Indeed, yields ended up taking another leg lower after President Trump announced that the US are adding a 10% tariff on the remaining $300bn of Chinese imports from September 1, in addition to the existing 25% tariff on the other $250bn of Chinese imports. China is yet to respond, but is likely to retaliate. Such a decision could see President Trump raise the stakes again, having already indicated that the tariffs can move “well beyond 25%”.
On the back of this development, we now forecast additional cuts from the FOMC. We see follow-up moves to July’s decision at each of the September, October and December meetings, taking the fed funds rate to 1.375%. While ahead of market pricing in terms of timing, participants have a similar view on the terminal rate to ourselves. The economic justification rests on the need to sustain growth at or above trend, and to see inflation return to the 2.0%yr target. In light of the scale of the risks, swift and significant easing is prudent.
Over in Europe, Q2 GDP growth printed at 0.2%, 1.1%yr — the slowest annual pace since 2013 — as manufacturing remained in contraction. While domestic demand has held at a decent pace, coinciding with a continued downtrend in the unemployment rate to 7.5% — 0.2ppt from its historic low — Europe’s internal resilience to global uncertainties is looking more and more vulnerable. With Thursday’s CPI indicating core inflation fell to 0.9%yr in July, and in light of global developments, imminent and decisive ECB action is all but confirmed.