Will Fed policy update prove pivotal for USD performance?

AUD: Softer CPI report dampens expectations for an August RBA hike

The Australian dollar has been one of the biggest movers overnight in the foreign exchange market as it has given back some the gains recorded yesterday. After rising to an intra-day high yesterday at 0.6795, the AUD/USD rate fell back to an intra-day low overnight of 0.6725. The main trigger for the setback for the Australian dollar was the release of the softer than expected Australian CPI report for Q2. The report revealed that headline inflation slowed to an increase of 0.8%Q/Q in Q2 down from 1.4%Q/Q in Q1 providing further evidence that inflation peaked in Australia at the end of last year. It resulted in the annual rate of headline inflation slowing to 6.0% in Q2 as it moved further below the peak of 7.8% in Q4 2022, and came in below the RBA’s own forecast of 6.3% for Q2. There was also further encouragement for the RBA as the trimmed-mean measure of inflation slower further to 0.9%/QQ in Q2 down from 1.2%Q/Q in Q1 although the slowdown in underlying price pressures in Q2 was less pronounced than recorded in Q1 from Q4 2022. The breakdown of the inflation data revealed that the slowdown in Q2 was mainly driven by disinflation in the goods sector while services inflation is proving sticky. Market services inflation remained elevated at an annual rate of 7.0% in Q2. The stickiness of services inflation will remain a concern for the RBA and continues to cast doubt on whether inflation will fall back to target in line with the RBA projections.

Overall, the softer headline and core inflation prints have dampened expectations for the RBA to hike policy again as soon as at next week’ s policy meeting on 1^st August which has weighed down on the Australian dollar. The Australian rate market is currently pricing in around 8bps of hikes for next week’s policy meeting and 25bps of hikes by the end of this year. However another hike as soon as next week can’t be completely ruled out in light of sticky services inflation and the stronger labour market for June. It is still too soon to call an end to the RBA’s hiking cycle at the current juncture unlike the RBNZ. As a result, we continue to favour further upside for the AUD/NZD rate driven by monetary policy divergence despite today’s setback. At the same time, the Australian dollar should benefit from a stronger economic recovery in China in the 2H of this year if Chinese policymakers follow up yesterday Politburo meeting by implementing more forceful stimulus measures. As we highlighted yesterday the initial market reaction showed that market participants were optimistic about the outcome from the Politburo meeting.  

INFLATION HAS PEAKED IN AUSTRALIA BUT REMAINS ELEVATED

Source: Bloomberg, Macrobond & MUFG GMR

USD: Will the Fed signal that rate hike cycle is coming to an end?

Market attention will now turn to the Fed’s latest policy update tonight. The US dollar has staged a modest rebound ahead of tonight’s FOMC meeting supported both by a pick-up in US yields on the back of stronger US activity data, and less favourable developments overseas (weaker growth in the euro-zone and market expectations for an adjustment to the BoJ’s YCC policy settings as soon as this week have been scaled back). The release yesterday of stronger US consumer confidence and the ECB’s Bank Lending Survey revealing that corporate loan demand had fallen to the lowest on record. The drop in corporate loan demand was “substantially stronger” than lenders had expected, and provides provides further evidence to the ECB that policy tightening is feeding through to the economy. It has made market participants more wary of the risk of a less hawkish policy update from the ECB on Thursday.

Whether the US dollar rebound will extend further in the near-term will depend upon today’s Fed policy update. The Fed is expected to deliver another 25bps hike today which is viewed as a done deal. The market reaction to the tonight’s policy update will be driven by the Fed’s forward guidance. Will the Fed stick to current plans and indicate that they are still planning one more hike later this year? Or will the Fed acknowledge that there has been more progress recently in bringing down inflation which gives them more confidence that policy is sufficiently restrictive? The worst outcome for the US dollar would be if the Fed gives any indication that tonight’s hike could be the last in the cycle triggering a renewed sell-off. On balance, we believe it is still likely a little premature to expect such a dovish signal while the US economy is proving resilient and the Fed would likely want to see more evidence of slowing inflation. If the Fed sticks to current hiking plans the US dollar could stage a modest relief rally

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	09:00	M3 Money Supply (YoY)	Jun	1.0%	1.4%	!
US	13:00	Building Permits	--	1.440M	1.496M	!!!
US	15:00	New Home Sales	Jun	725K	763K	!!!
US	19:00	FOMC Statement	--	--	--	!!!
US	19:30	FOMC Press Conference	--	--	--	!!!

 

Source: Bloomberg