Morning Report
Today's economic developments and market movements.
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Key themes: US inflation data supported expectations for a rate cut in September, but did little to advance the view that the Fed could move by 50 basis points.
Equities were in the green in both the US and in Europe, while shares were mixed in Asian trade yesterday.
US treasury yields were mixed, edging higher in the 2-year tenor and lower in the 10’s. UK Gilts outperformed, rallying on encouraging inflation data. Aussie bond futures gained overnight, extending a solid move lower in yields yesterday.
The US dollar was flat. The euro gained, reaching it’s highest since January while the New Zealand dollar rounded out the bottom of the G10 basket.
Iron ore markets finally nose-dived as warnings from Chinese steel producers rattled traders.
Share markets: US equities were broadly higher, rising for a fifth consecutive session. The improvement in risk sentiment is perhaps best reflected in the VIX volatility index, which has dropped back to the levels prevailing before equity markets imploded. However, implied volatility is still trading higher than the year to date average.
The S&P 500 rose 0.4% and is now just 1.2% below its close on 31 July, before the deep sell-off which commenced on 1 August. The Dow Jones gained 0.6%, while the NASDAQ was flat.
European equities also extended gains. The Euro Stoxx 50 rose 0.7%, London’s FTSE 100 lifted 0.6% and the German Dax was up 0.4%.
It was a mixed bag in Asian trade yesterday. The ASX 200 closed up 0.3%, partially unwinding early gains throughout the day. Japan’s Nikkei rose 0.6%, while shares in Hong Kong and Shanghai were weaker.
Interest rates: The odds of a larger 50 basis point rate cut from the Fed in September was trimmed to around 30% post US inflation data with around a 40% chance built into prices beforehand.
The 2-year US treasury yield rose 3 basis pionts to 3.96%, while the 10-year yield edged 1 basis point lower to 3.84%, the curve flattening modestly.
UK Gilts outperformed overnight, with encouraging inflation data spurring a solid rally, driving yields 5-7 basis points lower across the curve.
The Reserve Bank of New Zealand’s (RBNZ) decision to cut rates supported a rally in Aussie rates yesterday as traders firmed bets the RBA will have to cut this year. Futures are back to fully pricing a rate cut in December.
The Aussie 3-year bond yield dropped 10 basis points to 3.65% yesterday, while the 10-year was down 7 basis points to 3.93%. Futures extended gains overnight, with the 3-and-10-year futures yields down a further 2 and 3 basis points, respectively overnight.
Foreign exchange: The US dollar was little changed, the DXY index trading a range of 102.27 to 102.72 and finishing towards the top of the range at 102.59.
The New Zealand dollar underperformed. A rate cut was not fully built into prices coming into the RBNZ meeting, leaving the currency sharply lower after the decision. The NZD/USD fell from a high of 0.6084 to a low of 0.5995 and finished only slightly above the day’s low.
The Aussie dollar was also softer, giving back all of the previous days gains above 66 cents to finish around 0.6596. The British Pound and the Japanese Yen were also slightly softer against the Greenback, the euro bucking the trend to grind higher through 1.10 to a high of 1.1047 - its highest level since January. The EUR/USD has since pulled back slightly, to close at 1.1014.
Commodities: Crude oil prices pushed lower for a second consecutive day. Energy Information Agency (EIA) data showed that US crude stockpiles unexpectedly rose by 1.36m barrels last week, the first gain in seven weeks. The West Texas Intermediate (WTI) futures contract fell 1.7% to US$76.98 per barrel.
Iron ore markets finally nose-dived towards US$95 as warnings from Chinese steel producers rattled traders. Futures in Singapore are down 3.0% to US$95.60.
The world’s largest steel producer, Baowu Steel, warned that conditions in China’s steel sector are like a “harsh winter” that will be “longer, colder and more difficult to endure than we expected”.
The comments were made at the half year results with the Chairman warning that the challenge could be worse than the “major traumas in 2008 and 2015”. At the end of 2015, iron ore prices traded below $40.
Australia: There were no major economic data releases yesterday.
Eurozone: The second estimate of June quarter GDP growth was unchanged at 0.3% and 0.6% in annual terms. Quarterly GDP growth matched the same pace as the March quarter, but employment growth slowed a touch from 0.3% to 0.2%, leaving the annual rate at a modest 0.8%.
Industrial production disappointed in June, falling 0.1% compared to expectations for a 0.5% gain. May was also revised lower from -0.6% to -0.9%, leaving production 3.9% lower than a year ago.
New Zealand: The RBNZ cut the Official Cash Rate (OCR) to 5.25% yesterday by unanimous decision. Markets were pricing in around a 70% chance of a cut, while economists were split almost 50/50 with a slight majority favouring a hold.
The RBNZ lowered their projections for the OCR significantly, pivotting their strategy towards easing policy more quickly over the next 6-12 months. The new profile implies the next cut will be at the October meeting, and a total of 75bp of cuts are forecast by the end of 2024.
The RBNZ’s near-term forecasts for economic growth have been revised down significantly. A wider output gap and a looser labour market gives them confidence that inflation will ultimately fall. Based on this, the RBNZ assesses the risk profile as two sided i.e. balanced between inflation and growth.
United Kingdom: The consumer price index (CPI) surprised to the downside in July, falling 0.2% in the month. Annual headline inflation edge up from 2.0% to 2.2% due to base effects, but annual core inflation slowed from 3.5% to 3.3%.
Critically, annual services inflation came in well below expectations, decelerating from 5.7% to 5.2% against an expectation of 5.5%.
The downside surprise comes against the backdrop of what has been very sticky core and services inflation in the UK. These outcomes will give the Bank of England more confidence in inflation’s downtrend and will support further policy easing in the coming months.
United States: The CPI was in line with expectations in July. Prices gained 0.2% in the month on both a headline and core basis.
Annual inflation edged lower to 2.9% and 3.2% for headline and core, respectively. Food away from home and services ex-shelter components were both benign, signalling wage pressures are not a concern and nor is the discretionary demand impulse.
Core goods prices continued to fall, exhibiting broad based weakness. Shelter inflation, which has been a the heart of sticky prices pressures, surprised to the upside in July. However, with the labour market cooling and households financially constrained, this momentum is highly unlikely to persist.
The Bureau of Labour Statistics’ real-time measures of rents are materially weaker, pointing to flat outcomes instead of shelter’s ~5% annualised pace in July.
The inflation report is further evidence that the risks around inflation and grwoth are increasingly leaning towards downside growth outcomes and support the assessment that restrictive policy conditions should be gradually unwound.
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