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Soft activity data highlight that risks around the path for the RBA cash rate are skewed down. This has less to do with changes to the RBA’s models of the neutral interest rate and more about the risk that it will again be surprised by the domestic economy.

Soft GDP data for Q1 has again raised questions of whether the RBA is behind the curve and has left policy too tight for too long. As we have been highlighting for some time, underlying growth in Australia remains weak and sensitive to pauses in the expansion in the care economy. With inflation in the 2–3% target range already, and likely to stay there, why wouldn’t the RBA cut further and faster than previously believed?

Certainly, this is the question we keep asking ourselves and are hearing from clients. The risks to our current policy view are clearly to the downside, as we have previously highlighted. Yet a headlong switch into a more dovish near-term path for policy sits awkwardly against the Board’s own words in the minutes. The Board expressed ‘a preference to move cautiously and predictably when withdrawing some of the current policy restriction.’ And just before that sentence: ‘They also judged that it was not yet time to move monetary policy to an expansionary stance, taking account of the range of estimates involved, given that inflation was yet to return sustainably to the midpoint of the target range and the staff’s assessment that the labour market was still tight.’

Recall also the Governor’s response to Michael Pascoe’s question at the media conference, ‘We get quarterly inflation rates in this. We don’t get monthly. We get the monthly indicator, which is very volatile. We get four readings on inflation a year. Other countries get them 12 times a year.’ We read this as saying that the Board (or at least the Governor) wants to wait for the June quarter CPI, ahead of the August meeting, not the July meeting. The irony is that by late this year, Australia will have a full monthly CPI.

Predicting the movement of the stars

Part of the art of predicting what central banks will do with their policy rates goes beyond forming a view about where the economy is headed. There is also an element of forecasting future shifts in the central bank’s beliefs about how the economy works. This includes their beliefs about where the ‘star variables’ such as the neutral real interest rate (r*) and full-employment rate of unemployment (NAIRU) are, and the weight they put on these assessments in their policy deliberations. Both the location of and the reliance on these estimates can change, sometimes quite abruptly.

Ideally, the policymaker would communicate these evolving beliefs. Some of the detail is only for the aficionados, though, and therefore is sometimes – understandably – left on the cutting-room floor when putting together flagship documents intended for a broader audience. It is therefore left to those aficionados to interpret, and indeed forecast, where policymakers’ views are headed.

For example, at the beginning of this year, our views about the path of Fed policy was partly shaped by our assessment that the Fed staff view of the neutral rate was still too low and that they would progressively revise it up. There was therefore some chance that the Fed would end up lowering the Fed funds rate below neutral and have to backtrack as this view was revised. In the event, the Fed view caught up with our expectations soon enough that this backtrack did not occur. But the underlying (and out-of-consensus) view that the Fed would not end up cutting as far as had previously been priced in was sound.

Of course this was not just about judgements about where neutral is. As that earlier note discussed, there is also the question of whether there are other factors working against a ‘glide to neutral’ path for policy. Differing fiscal stances across countries is an obvious example, particularly when the parlous state of the US fiscal position is such an outlier. Working in the other direction, policy uncertainty around tariffs and other chaotic policy decisions of the Trump administration is clearly weighing on US growth prospects more than they do on countries such as Australia.

In Australia, these assessments and their likely direction of travel are also key inputs into any view of future RBA policy. For example, it is hard to shake the impression that, whatever more nuanced language about full employment being multidimensional, the RBA’s view of the upside risks to inflation are coloured by their model-based assessments (released under FOI) that the unemployment rate is below the NAIRU. The revision of the RBA’s forecasts for trimmed mean inflation from not-good-enough-dead-flat-at-2.7% to good-enough-now-dead-flat-at-2.6% is absolutely a judgement. And while it was not directly driven by models, that judgement to write down 2.6% and not 2.5% anywhere in the forecast horizon was likely shaped by the RBA’s view that the labour market is still tight and productivity growth weak.

Against that, though, we have been getting questions about an apparent downward shift in the RBA’s view of where neutral is, evident through a comparison of graphs showing estimates of the nominal neutral in a sequence of documents. A year ago, the RBA’s view was coloured by surprisingly convergent estimates of r* well above 3%, implying that monetary policy was restrictive, but perhaps not that restrictive. This, along with its analysis of productivity trends, contributed to the hawkishness of RBA decisions and communications in the latter half of last year and at the February meeting.

However, new models were introduced between November last year and February this year that were at the lower end of the existing range of models. (We understand that these were based on recent work at the New York Fed.) And unlike all the other models, these new ones did not show an upturn in estimates post-pandemic. The average of all these estimates is now in the high 2s rather than the low-to-mid 3s range we have favoured for both the US and Australia. This means that the neutral real cash rate is estimated to be barely above zero. You don’t need to look at 700 years of data to worry that such an estimate is on the low side.

At this stage, though, we assess that, while the weight of those r* estimates is indeed lower than a year ago, the weight that the policymakers put on the central estimate has also declined. There are a couple of straws in the wind supporting this conclusion, including comments by the Deputy Governor following the February Board meeting. We will be watching closely for signs that the RBA is taking these models more seriously than we currently think. More pertinently, though, we will also be watching for signs that the labour market and inflation are softer than the RBA currently expects. If the downside risks around the policy path are to come true, it will require the RBA to change its mind about how the economy is traveling.

Markets

The May US payrolls report wrapped up a week of overall disappointing economic data. US JOLTS (job openings) were the proverbial exception to the rule. Monday’s manufacturing ISM and Wednesday’s services gauge painted an ugly stagflationary picture. And the poor ADP job report (a mere +37k) on Wednesday and Thursday’s higher-than-expected weekly jobless claims did not go unnoticed either. In fact, the data posed downside risks for today’s payrolls report. Those didn’t quite materialize with a job growth of 139k. The slight beat of consensus (126k) was offset by the -95k two-month revision though. The services sector (+145k) provided for all of the jobs created, led by private education & health and leisure & hospitality. The federal government shed another 22k jobs, the fourth decline in a row. Earnings growth came in to the high end of expectations (+0.4% m/m and 3.9% y/y) while the participation rate eased to 62.4%. The unemployment rate was at an unchanged 4.2%. This metric is getting close attention ever since the Fed last year started cutting rates aggressively after rising unemployment triggered the Sahm rule.

The labour report was except for next week’s CPI the final input for the Fed June 18 meeting. All in all it offered nothing spectacular and won’t nudge the debate in either direction. It’s “hold your horses” for the time being and “go all in” if needed. That was the Fed’s playbook end 2024 and the preferred approach by amongst others Fed’s Hammack. In an interview with the New York Times she said she “would rather wait and move quickly to play catch-up if I really don’t know what the right next move is”. And for the record: she really doesn’t know what the right next move is. Yet, US yields surge more than 8 bps at the front end of the curve. This is more of a kneejerk reaction than anything else. Following the ADP and jobless claims, markets were bracing for a softer than expected reading. Some extra market optimism creeped in as well after US trade advisor Navarro flagged a meeting between US and Chinese officials potentially already next week. Just yesterday, the respective presidents had their first formal contact since Trump took office. The dollar strengthens to sub EUR/USD 1.14 but the short-term upward sloping trend channel remains in tact for now. DXY bounces back to 99.17 and USD/JPY aims for 145.

News & Views

Czech industrial production (adjusted for the number of working days ) in April rose 0.9% M/M and 2.0% Y/Y, it’s statistical office reported. Admittedly, the improvement was mainly due to a strong performance of electricity producers and the improved situation in the mining industry. The manufacturing industry is lagging, stagnating year‐on‐year. Even so, the trend for the most cyclical parts of the Czech industry, led by engineering and basic metals producers, also shows a slow reversal for the better. This is confirmed by new orders ‐ base metal producers +3.2% YoY, engineering +2.0% and fabricated metal products +8.6%. On the other hand, production in the automotive segment will undoubtedly grow more slowly this year as it is bumping up against a relatively high comparison base versus last year and relatively high‐capacity utilization. Overall, the better industrial figures in April, together with very strong retail sales, show that, at least at the start of Q2, the Czech economy has been still in good shape. This comes on the back of a very strong first quarter, when it grew by 0.8% Q/Q. So, for now, we haven’t seen a significant impact of the higher US tariffs. The Czech koruna remains well bid, with EUR/CZK at 24.75, touching the best levels in almost a year’s time.

According to Bloomberg reporting referring to people familiar with the matter, Bank of Japan officials are likely considering slowing the pace of its pullback from buying government debt at the June 17 policy meeting. Officials are said discussing making smaller reductions to the BOJ’s bond buying program from current pace reducing net purchases by JPY 400 bln per quarter scheduled to be in place until March next year. From then, aside from keeping current pace of a JPY 400 bln reduction, options of reducing the pace of the slowdown to JPY 200 bln or between JPY 200 bln and 400 bln are said to be on the table. The debate on the pace/amount of BOJ bond buying recently intensified due to rising pressure at the long end of the Japanese government bond curve as investor appetite was low to pick supply in these longer tenors, sharply rising yields at those longer maturities.

The Canadian labour market basically tread water again in May, adding only 8.8k net new positions (+0.0% month/month). The details were slightly better, with the private sector up 61k positions (+0.4% m/m), and solid gains in full-time jobs (58k). However, these were mostly offset by losses in part-time jobs (-49k).

The unemployment rate rose for the third consecutive month to 7.0%, the highest rate since September 2016 (apart from the pandemic). The labour force grew by 0.2% m/m. Growth in the labour supply has slowed in recent months, but employment growth has slowed further.

The job market is even tougher for students. The unemployment rate for returning students (aged 15-24) was 20.1% -- the highest since the 2009 recession (excluding the pandemic).

The impact of tariffs shows up in the industry pattern and regional unemployment pattern. The manufacturing sector was down (-12.2k), as was transportation and warehousing (-15.5k). Manufacturing has lost jobs for four months now, totaling 55k. That said, the wholesale and retail trade sector recouped some (+43k) of the 55k jobs lost through march and April. The highest unemployment rates across CMAs were in Windsor (10.8%), Oshawa (9.1%) (three-month moving averages), which have both seen significant increases since January.

Wage growth was steady in May. Average hourly wages rose 3.4% versus a year ago, matching April's pace. Lastly, total hours worked were flat.

Key Implications

Canada's labour market continued to soften in May. The unemployment rate continued to rise, and the impact of U.S. tariffs is clearly evident in industry and regional patterns. Wage gains were steady in May but have cooled from a roughly 5% pace a year ago.

On Wednesday, the Bank of Canada opted to wait and see how tariffs would impact the Canadian economy, while also weighing recent hotter than expected inflation readings. May's jobs report puts another mark in the economic weakness tally. We think this will ultimately lead to further rate cuts from the Bank of Canada.

The U.S. economy added 139k jobs in May, slightly above the consensus forecast of 125k. But revisions for the prior two months subtracted a meaningful 95k jobs.

• Smoothing through the volatility, non-farm payrolls averaged 135k over the last three-months, only a touch lower than the 144k averaged over the twelve-month period.

Private payrolls rose 140k – nearly matching April's downwardly revised gain of 147k (previously 167k) – with the largest gains seen in health care & social assistance (+78.3k) and leisure & hospitality (+48k). Trade exposed industries like manufacturing (-8k) and retail trade (-6.5k) both shed jobs. Federal hiring declined by 22k and has now lost 59k jobs since February.

In the household survey, both civilian employment (-696k) and the labor force (-625k) plummeted, resulting in the unemployment rate holding steady at 4.2%. The labor force participation rate ticked down 0.2 percentage points to 62.4%.

Average hourly earnings (AHE) rose 0.4% month-on-month (m/m) – following a gain of 0.2% m/m in April. On a twelve-month basis, AHE earnings are up 3.9%.

Aggregate weekly hours rose 0.1% m/m, down from April's gain of 0.2% m/m.

Key Implications

Non-farm payrolls remained resilient last month despite heightened trade policy uncertainty. While weakness in the household survey coupled with the significant downward revisions to prior months helped to take some of the shine off the headline payrolls print, it's fair to say that the labor market is holding up better than expected.

Heightened uncertainty surrounding trade and fiscal policy alongside still elevated inflation has left policymakers in no rush to cut rates. While the labor market is showing signs of cooling, job creation is still running at a healthy pace and underscores the ongoing need for patience. Interest rate futures are currently pricing in just 20 bps of policy easing by September and only two quarter-point cuts by year-end.

Daily Pivots: (S1) 0.8174; (P) 0.8195; (R1) 0.8217; More….

No change in USD/CHF's outlook and intraday bias stays neutral. Fall from 0.8475 could extend lower, and break of 0.8156 will target 0.8038 low. But strong support should be seen from there to bring rebound, at least on first attempt. On the upside, break of 0.8346 resistance will extend the corrective pattern from 0.8038 with another rising leg.

In the bigger picture, long term down trend from 1.0342 (2017 high) is still in progress and met 61.8% projection of 1.0146 (2022 high) to 0.8332 from 0.9200 at 0.8079 already. In any case, outlook will stay bearish as long as 55 W EMA (now at 0.8732) holds. Sustained break of 0.8079 will target 100% projection at 0.7382.

Daily Pivots: (S1) 142.75; (P) 143.36; (R1) 144.20; More...

USD/JPY's is staying in established range despite today's rebound. Intraday bias remains neutral. On the upside, above 146.27 will target 148.64 resistance first. Firm break there will resume the rebound from 139.87. Nevertheless, break of 142.10 will bring deeper fall back to 139.87 low.

In the bigger picture, price actions from 161.94 are seen as a corrective pattern to rise from 102.58 (2021 low), with fall from 158.86 as the third leg. Strong support should be seen from 38.2% retracement of 102.58 to 161.94 at 139.26 to bring rebound. However, sustained break of 139.26 would open up deeper medium term decline to 61.8% retracement at 125.25.

Daily Pivots: (S1) 1.3536; (P) 1.3577; (R1) 1.3612; More...

Intraday bias in GBP/USD is turned neutral with current retreat. Some consolidations could be seen but further rally is expected as long as 1.3414 support holds. Break of 1.3615 will resume larger rally to 100% projection of 1.2706 to 1.3442 from 1.3138 at 1.3874. However, break of 1.3414 will turn bias back to the downside for deeper pullback to 1.3138 support.

In the bigger picture, up trend from 1.3051 (2022 low) is in progress. Next medium term target is 61.8% projection of 1.0351 to 1.3433 from 1.2099 at 1.4004. Outlook will now stay bullish as long as 55 W EMA (now at 1.2866) holds, even in case of deep pullback.

Daily Pivots: (S1) 1.1401; (P) 1.1448; (R1) 1.1491; More...

Intraday bias in EUR/USD is turned neutral with current retreat. While another rise might be seen, strong resistance could emerge from 1.1572 to limit upside, at least on first attempt. On the downside, break of 1.1356 support will indicate that the corrective pattern from 1.1572 might have started the third leg, and target 1.1209 support for confirmation.

In the bigger picture, rise from 0.9534 long term bottom could be correcting the multi-decade downtrend or the start of a long term up trend. In either case, further rise should be seen to 100% projection of 0.9534 to 1.1274 from 1.0176 at 1.1916. This will now remain the favored case as long as 55 W EMA (now at 1.0856) holds.

Dollar staged a firm comeback today following slightly better-than-expected non-farm payroll figures, with job growth at 139k and wage growth coming in strong at 0.4% mom. While not a blowout report, the data was enough to alleviate immediate concerns of a sharp labor market slowdown. Stock futures also advanced, suggesting that investors are reassessing the near-term risks from tariffs and focusing instead on the resilience in headline economic indicators.

Despite ongoing caution over the economic toll of US trade policy, particularly with the expiration of the 90-day tariff truce looming in July, the effects haven’t yet registered decisively in labor markets. In fact, the stronger-than-expected wage growth might reinforce some Fed officials’ inflation concerns, supporting the market consensus that the next rate cut, if any, is unlikely before September.

Outside of the US, Loonie is also showing strength, underpinned by solid domestic jobs data. Aussie and Kiwi are mildly firmer too, buoyed by broader risk appetite. Meanwhile, safe havens are under pressure, with Yen and Swiss Franc the weakest of the day as investors rotate into higher-yielding and risk-correlated assets. Euro and Sterling are softer, but holding within familiar ranges.

In Europe, at the time of writing, FTSE is up 0.10%. DAX is down -0.15%. CAC is up 0.14%. UK 10-year yield is up 0.03 at 4.656. Germany 10-year yield is down -0.11 at 2.573. Earlier in Asia, Nikkei rose 0.50%. Hong Kong HSI fell -0.48%. China Shanghai SSE rose 0.04%. Japan 10-year JGB yield fell -0.002 to 1.459.

US NFP grows 139k in May, unemployment rate steady at 4.2%

US non-farm payroll employment rose 139k in May, above expectation of 130k. That's slightly below average monthly gain of 149k over the prior 12 months.

Unemployment rate was unchanged at 4.2%, matched expectations. Participation rate fell from 62.6% to 62.4%.

Average hourly earnings rose 0.4% mom, above expectation of 0.3% mom. Over the past 12 months, average hourly earnings have increased by 3.9% yoy.

Canada's employment grow 8.8k in May, unemployment rate rises to 7%

Canada's employment grew 8.8k in May, better than expectation of -11.9k fall. Growth in full-time employment (+58k; +0.3%) was offset by a decline in part-time work (-49k; -1.3%).

Unemployment rate rose from 6.9% to 7.0%, matched expectations. Employment rate held steady at 60.8%.

Average hourly wages among employees increased 3.4% you, same as in April.

ECB officials signal pause yesterday's rate cut, emphasize flexibility

One day after ECB delivered its eighth rate cut in this easing cycle, a coordinated message emerged from several Governing Council members: ECB is not committing to further immediate action.

Latvian central banker Martins Kazaks was particularly blunt, stating that markets should not expect a rate cut at every meeting. He emphasized the value of preserving "policy space".

"We don’t get much data between now and the July meeting so it may well be the case that we pause," Kazaks said. "But uncertainty remains very high, the political situation may change every day. So forward guidance isn’t your friend in these circumstances."

Greek central bank chief Yannis Stournaras echoed this sentiment, calling ECB’s work on inflation “nearly done,” while warning that further cuts would require growth to fall short of current forecasts.

Estonian Governor Madis Muller also struck a cautious tone, suggesting the rate-cutting cycle may be “almost finished,” but acknowledged that visibility is limited. All three policymakers stressed that decisions ahead would remain data-driven, and that it was too early to rule out any scenario.

French Governor François Villeroy de Galhau and Lithuania’s Gediminas Šimkus declared victory over inflation. However, both underlined the importance of maintaining flexibility in the face of mounting global uncertainty. Villeroy also reassured that “We have tools to react if there's deflation.”

Eurozone retail sales inch up 0.1% mom April, mixed national trends

Eurozone retail sales rose just 0.1% mom in April, falling short of expectations for a 0.2% mom rise. Modest gains in food, drink, and tobacco sales (+0.5%) and a solid rebound in automotive fuel purchases (+1.3%) were offset by a -0.3% decline in non-food product sales.

Across the EU, retail sales rose a more robust 0.7% mom, but the underlying data painted a sharply divided picture. Poland led with a remarkable 7.5% surge, followed by Slovakia and Sweden at 2.4%. In contrast, Germany—the region’s largest economy—saw a -1.1% drop, dragging on the overall Eurozone figure.

EUR/USD Mid-Day Outlook

Daily Pivots: (S1) 1.1401; (P) 1.1448; (R1) 1.1491; More...

Intraday bias in EUR/USD is turned neutral with current retreat. While another rise might be seen, strong resistance could emerge from 1.1572 to limit upside, at least on first attempt. On the downside, break of 1.1356 support will indicate that the corrective pattern from 1.1572 might have started the third leg, and target 1.1209 support for confirmation.

In the bigger picture, rise from 0.9534 long term bottom could be correcting the multi-decade downtrend or the start of a long term up trend. In either case, further rise should be seen to 100% projection of 0.9534 to 1.1274 from 1.0176 at 1.1916. This will now remain the favored case as long as 55 W EMA (now at 1.0856) holds.

Canada's employment grew 8.8k in May, better than expectation of -11.9k fall. Growth in full-time employment (+58k; +0.3%) was offset by a decline in part-time work (-49k; -1.3%).

Unemployment rate rose from 6.9% to 7.0%, matched expectations. Employment rate held steady at 60.8%.

Average hourly wages among employees increased 3.4% you, same as in April.

Full Canada employment release here.