Markets greet US Fed rate cut with sharp equity falls, a rising USD, and a flattened US Treasury yield curve. The NZD/AUD cross pushed lower on better AU data and weaker NZ data

As widely expected, the Fed cut rates 25bps a short while ago, its first rate cut in over 10 years.

The policy outlook suggests the Fed retains an implicit easing bias.But Powell said in the press conference that the cut wasn’t necessarily the start of an easing cycle.

Equities have fallen sharply, the USD has risen and the US Treasury curve has flattened, with the market interpreting the decision and comments as more hawkish than expected. 

The FOMC reduced its target range for the effective Fed funds rate by 25bps, to 2.00% - 2.25%, and said it would immediately stop its balance sheet reduction.  The move was widely expected by the economics community and the market had priced-in around 30bps immediately prior to the rate decision.  While the description of the US economy was relatively upbeat, and little changed from the June statement, the Fed justified the cut “in light of the implications of global developments for the economic outlook as well as muted inflation pressures.”  The Fed retains an implicit easing bias, saying that “it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.”  In June, the Fed said it would “closely monitor” developments, and the removal of the word “closely” in this statement has been interpreted as a hawkish tweak.  Powell said in the press conference that the rate cut wasn’t necessarily the start of an easing cycle, and the Fed was thinking of it as a “mid-cycle adjustment”.  Two FOMC members, George and Rosengren, dissented in favour of no change. 

The initial reaction shows the market took the statement as more hawkish than expected, with the USD rising, equities falling and the US Treasury curve flattening, although the market is still digesting the statement and Powell’s press conference.  The DXY dollar index is around 0.4% stronger than its pre-statement levels and has moved up to its highest level since mid-2017.  The S&P500 is currently down 1.8%, having been up marginally beforehand.  It moved sharply lower after Powell’s comment that the rate cut wasn’t necessarily the start of an easing cycle. 

The US 2 year Treasury yield, which is more sensitive to the near-term monetary policy outlook, is 8bps higher on the day, 11bps higher than its pre-statement levels (a much weaker Chicago PMI – see below – had caused yields to fall earlier).  The US 10 year Treasury yield in contrast is flat on the day, at 2.05%, up 3bps from the levels immediately prior to the statement.  The flattening in the US curve is consistent with the fall in equities and market perceptions of a less accommodative Fed than had been expected. 

The NZD has fallen sharply to 0.6550 and has underperformed most of the G10 currencies.  It was trading around 0.66 immediately prior to the Fed decision.  Yesterday’s disappointing ANZ business survey, which points to growth well below the RBNZ’s forecasts, appears to be the main reason for the NZD underperformance.  While business confidence and own activity expectations were no worse than last month’s readings the depressed level of sentiment has now been entrenched at current levels for around twelve months and shows no sign of a pick up.  We changed our OCR forecast after the ANZ data and now expect the RBNZ to cut in November, in addition to August. 

The AUD has performed better than the NZD over the past 24 hours after both headline and the trimmed mean CPI – the RBA’s preferred measure of underlying inflation – beat expectations, albeit slightly.  The AUD is 0.5% lower currently, at 0.6835, and trading near its year-to-date (ex-flash crash) lows.  Annual core inflation was 1.6%, marginally above the multi-decade low of 1.5% reached in 2016.  The market reduced the probability of a rate cut at the RBA’s next meeting in August, with CPI only marginally below the central bank’s forecasts.   The market now attributes a less than 10% chance to an August rate cut, down from almost 30% pre-CPI.  Our NAB colleagues expect the RBA to remain on hold next week and signal a willingness to cut again if needed, although it might trim its near-term forecasts for core inflation that will be published in the August SoMP on Friday week. They still expect the RBA to cut rates again by November, after it receives more information on the labour market, growth and the initial impact of both the government’s tax refunds and the June/July rate cuts.

The slightly stronger Australian CPI release and disappointing ANZ business survey combined to push the NZD/AUD cross lower.  The cross had touched a four month high of 0.9628 immediately prior to the data but now sits at 0.9580. 

In economic data, the Chicago PMI fell sharply in July, with the 44.4 reading its lowest since December 2015 (and before that, July 2009).  The Chicago PMI tends to be more volatile than the other regional Fed surveys, and its possible that the ongoing woes at Boeing, which is headquartered in the city, have exacerbated the weakness in Chicago manufacturing relative to other districts.  The ADP employment survey was close to expectations (+156k), at a similar level to the market consensus for nonfarm payrolls which is released on Friday night (+165k).  Finally, the employment cost index, a broader measure of wage growth than average hourly earnings, was slightly lower than expected.  Private sector wages rose at a 3% year-on-year pace in Q2, the same rate of growth in 2018, and suggesting overall wage growth remains in check, despite the tightness of the labour market. 

On the trade front, US-China trade talks ended yesterday.  There was no sign of a breakthrough, although Chinese state media described the talks as “frank, effective and constructive” and the two sides have agreed to meet again in Washington in September.  The White House also described the talks as “constructive” and said that the range of topics discussed included forced technology transfer, intellectual property rights and China’s commitment to increase purchases of agricultural goods (recall that Trump lashed out on Twitter the previous night about China’s failure to fulfil previous commitments to buy farm goods). 

Elsewhere, the Chinese manufacturing PMI bounced slightly, but remained in contractionary territory (albeit only marginally).  There were signs that stimulus measures from the Chinese authorities were starting to gain traction, with the index holding up relatively well in the face of the latest tariff hikes from the US (which took effect in mid-May).  The non-manufacturing survey fell to its lowest level since November last year, albeit it remains comfortably in expansionary territory suggesting the effects of the trade-war remain mostly isolated to the manufacturing sector to date.  

The highlight in the session ahead is the release of the ISM manufacturing survey, which is expected to increase slightly.  Ahead of nonfarm payrolls tomorrow night, there will also be a focus on the employment sub-index.  The final estimates of the European PMIs are also released and the BoE has its rate decision (expected to keep rates on hold amidst the Brexit uncertainty).