Softer US inflation takes the wind out of the USD’s sails

USD: PCE deflator report provides encouragement that inflation is slowing

The US dollar has continued to trade at weaker levels during the Asian trading session after selling off at the end of last week following the release of the weaker than expected US PCE deflator report for May. After falling to an intra-day low of 1.0835 last week, EUR/USD has climbed back above the 1.0900-level as the pair continues to trade towards the top of this year’s range between 1.0500 and 1.1000. The main trigger for the US dollar sell-off at the end of last week was the release of the latest PCE deflator report that provided some relief for the Fed by showing that underlying inflation pressures are beginning to ease. Over the past month, Fed officials have expressed disappointment over the lack of progress in bringing core inflation back towards their target. The Fed has been focusing on the PCE core services less housing measure of the deflator which has been running at an annual rate of around 4.5% for around a year and a half now. While the annual rate remained at 4.5% in May, there was a clear slowdown in the monthly rate of change. The PCE core services less housing deflator increased by 0.23%M/M in May which was the slowest monthly increase since July of last year. If the weaker monthly reading is followed up by further weaker readings in the coming months, it should give the Fed more confidence that they are getting closer to the point where they have delivered sufficient monetary tightening. It supports our view that the Fed will not follow through with current plans to deliver two further rates hikes this year.

However, one weaker reading on its own is unlikely to prevent the Fed from delivering one final rate hike this month. For the Fed to skip the July FOMC meeting and leave rates on hold it would also require a much weaker NFP report for June (released on Friday), and US CPI report for June (release don 12^th July). In these circumstances, the US rate market remains confident that the Fed will deliver a final 25bps hike this month (there are currently 21bps of hikes priced in for this month ) but is more reluctant to price in second hike later this year (there are currently 34bps of hikes priced in by the November FOMC meeting). At this stage, the softer US PCE deflator report has mainly put a dampener on upward momentum for the US yields and in the US dollar in the near-term rather than triggering a more sustained reversal lower. Further weaker US inflation data will be required to trigger a more sustained reversal lower.                 

MORE EVIDENCE OF SLOWING INFLATION PRESSURES IN THE US

Source: Bloomberg, Macrobond & MUFG GMR

AUD: RBA rate hike expectations pared ahead of tomorrow’s policy meeting

The RBA is the next G10 central bank to provide a policy update tomorrow morning. The Australian dollar has been trading on a softer footing going into tomorrow’s RBA policy meeting after correcting lower throughout the second half of last month. The release of the less hawkish minutes from the last RBA meeting on 20^th June and weaker than expected Australian CPI report for May on 28^th June have dampened expectations for the RBA to deliver another hawkish  policy update after they surprisingly hiked rates at the start of last month by 25bps to 4.10%. The probability of the RBA delivering back to back 25bps tomorrow has been scaled back. The Australian rate market is currently pricing in only 4bps of hikes for tomorrow’s RBA policy meeting. We agree with current market pricing and expect the RBA to leave rates on hold tomorrow. The minutes from the June policy meeting revealed it was a close call to hike rates and with inflation surprising to the downside in May, there is not a compelling case for back to back hikes. As Bloomberg has highlighted though the decision is judged as  a closer call amongst Australian economists with 14 economists expecting the RBA to remain on hold and 13 forecasting another 25bps hike. In  comparison to current market pricing, it poses some upside risk for Australian yields and the Australian dollar tomorrow. If the RBA leaves rates on hold as we expect, then market attention will quickly shift to future rate guidance from the RBA. The Australian market is pricing in around 40bps of hikes by the end of this year with the next hike expected in either August or September. Current pricing highlights that a hawkish hold is expected, and anything less would weigh on the Australian dollar.            

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	09:00	HCOB Eurozone Manufacturing PMI	Jun F	43.6	43.6	!!
UK	09:30	S&P Global/CIPS UK Manufacturing PMI	Jun F	46.2	46.2	!!
DE	13:00	Bundesbank's Nagel Speaks in Frankfurt				!!!
US	14:45	S&P Global US Manufacturing PMI	Jun F	46.3	46.3	!!
US	15:00	Construction Spending MoM	May	0.5%	1.2%	!!
US	15:00	ISM Manufacturing	Jun	47.2	46.9	!!!

Source: Bloomberg