Morning Report
Today's economic developments and market movements.
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Key themes: Lackluster demand for another US treasury auction soured the mood in markets overnight, prompting a sell-off in bonds and equities.
Treasury yields rose, the curve bear-steepening as the long-end was sold off.
The higher rates structure was a tailwind for the US dollar which gained against every G-10 major.
The Aussie dollar intially built upon its solid momentum following a stronger-than-expected headline inflation read. But the momentum shifted after the nuance of the report was fully digested. The inflation result not enough to offset US dollar strength overnight.
Share markets: Higher bond yields proved a headwind for equity markets. The S&P 500 fell 0.7%, while the NASDAQ slipped 0.6%. The mood in European equities was similarly sour, the Euro Stoxx 50 fell 1.3%, while the FTSE 100 was 0.9% lower.
The ASX 200 fell 1.3% yesterday joining in on a broad-based sell-off in Asian markets. The daily fall was the largest in four weeks. Trading got off to a weak start before a mix of domestic data knocked shares down another peg. Futures fell 0.7% overnight, pointing to a weak open this morning.
Interest rates: A third poor bond auction in the US weighed on sentiment extending the recent move higher in treasury yields. The sell-off was concentrated in the longer-end of the yield curve with the 10-year yield rising 6 basis points to 4.61% - popping above 4.50% for the first time since early May. The 2-year yield was unchanged at 4.97% after failing at a run at the 5.00% level.
The implied odds of a second rate cut from the Fed this year has been trimmed to around 10%. There remains one 25-basis point rate cut priced into the swaps curve.
Aussie bond yields gapped higher at the open yesterday before a solid monthly inflation read deepened the sell-off. 3-year yields finished up 12 basis point while 10-year yields jumped 14 basis points. Momentum continued overnight, supported by softer sentiment in offshore markets. The 3-year futures yield rose a further 4 basis points to 4.11%, while the 10-year futures yield increased 5 basis points to 4.46%.
The Aussie rates curve is flat across the remainder of 2024 as traders trimmed the odds of a rate cut from the RBA this year. There is currently close to zero chance of a rate cut priced into swap markets.
Foreign exchange: The domestic inflation report prompted a knee-jerk jump in the Aussie dollar during Asian trade yesterday but the move was quickly unwound with the AUD pushing lower overnight. The AUD/USD paird fell from a high of 0.6666 to a low of 0.6610 - towards the bottom of this months trading range as higher yields in the US are sapping the Aussie’s momentum.
The USD was supported by higher treasury yields. The DXY jumped from a low of 104.59 back above the 105 handle to a high of 105.14.
The euro (-0.5%) and the British Pound (-0.5%) were lower against the US dollar, largely unwinding gains over the last two weeks.
The Japanese Yen (-0.3%) also slipped against the greenback. The USD/JPY broke through what appeared to be pretty tough resistence around 157.20 on its way to a high of 157.71 - not far from the level which triggered the second suspected Ministry of Finance (MOF) intervention earlier in May.
Commodities: Crude oil pulled back largerly unravelling a jump higher in the previous session. The West Texas Intermediate (WTI) price of oil fell 0.8% to US$79.23 as inflation angst continues to present a potential risk to global oil demand should central banks maintain restrictive policy for longer.
Gold (-1.0%) and copper (-0.5%) also softened while iron rose rose 1.0%.
Australia: The Monthly consumer price index (CPI) Indicator gained 3.6% in the year to April compared to 3.5% in March and 3.4% in both February and January. The headline acceleration did not come as a surprise, however, the underlying composition of price pressures does present some upside risk to our forecasts.
Price updates in the April inflation indicator are heavily weighted towards goods, whereas the more important services categories are back-loaded into the second and third months of the quarter. The RBA will take some signal from April’s reading, but they will be more interesed in the services prices updated in the May release.
Construction activity declined 2.9% in the March quarter following a 1.8% lift in the December quarter (revised up from 0.7%). That leaves construction activity up just 1.8% versus March 2023.
The ABS have been consistently highlighting the impact of shifting seasonal patterns in the labour force survey, and it is possible that this is also impacting the construction industry. If people are indeed taking longer than usual breaks over the first quarter of the year, or are shifting their holidays from December to January, then construction activity may well have been slow to pick up again in the new year. This would imply that the weakness in part reflects this shifting volatility rather than signalling a broad-based downturn in activity.
This interpretation is consistent with the sizeable pipeline of construction projects, particularly non-residential projects, that are still being worked through. This pipeline received a boost with Federal and state governments using recent budgets to top up infrastructure funding. Going forward we expect activity to remain elevated as the infrastructure pipeline is worked through, with residential construction continuing to drag.
The six-month annualised growth rate in the Westpac-Melbourne Institute Leading Index, which indicates the likely pace of economic activity relative to trend three to nine months into the future, improved slightly to -0.01% in April from -0.08% in March. Some of the growth drags are dissipating but the index suggests momentum is set to remain soft in 2024.
Eurozone: Inflation in Germany came in broadly in line with expectations in May. The CPI rose 0.1% on the month, slowing markedly from a 0.5% gain in April. Annual inflation ticked up to 2.4% from 2.2% owing to unfavourable base effects. The step down in inflation momentum in May is encouraging, but further evidence will be needed to confirm the weaker pace of inflation is a sustainable shift in the inflation pulse, rather than another bout of volatility.
New Zealand: Business confidence slipped for a fourth consecutive month in May falling from 14.9 to 11.2. Confidence is in a clear downswing after a solid improvement over the course of 2023. Inflation is proving persistent, delaying anticipated rate cuts, while weak economic activity is also souring the mood.
United States: The Federal Reserve’s May Beige Book pointed to benign conditions across the economy. 10 of 12 districts reported “slight or modest growth”. Retail spending was little changed, with “lower discretionary spending and heightened price sensitivity among consumers”.
The Beige Book view on labour market momentum remains at odds with nonfarm payrolls but in line with the household survey. Eight districts reported “negligible to modest job gains, and the remaining four districts reported no changes in employment”. On inflation, “price increases were modest”, as consumers push back against additional price rises. This drove smaller profit margins as input prices rose on average. Discounts are becoming necessary to entice consumers.
The Richmond Fed manufacutring index rose to a 7-month high of 0 in May. This was up from of -7 in March and a low of -15 in January. Manufacturing activity in the Richmond district improved through the start of 2024 but remains modest.
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