Bolt From Down Under
US
USD pared back some of yesterday’s gains, global equity markets are trading with some modest optimism, and bond yields are drifting higher. As previously flagged, President Donald Trump signed yesterday an Executive Order extending the deadline for the higher ‘reciprocal’ tariff rates from July 9 to August 1. The White House also sent letters to 14 countries outlining the new ‘reciprocal’ tariff rates they risk from August 1:
Japan (25%, up from 24%), South Korea (25%, no change), Malaysia (25%, up from 24%), Kazakhstan (25%, down from 27%), Tunisia (25%, down from 28%), South Africa (30%, no change), Bosnia (30%, down from 35%), Indonesia (32%, no change), Bangladesh (35%, down from 37%), Serbia (35%, down from 37%), Cambodia (36%, down from 49%), Thailand (36%, no change), Laos (40%, down from 48%), and Myanmar (40%, down from 44%).
As of July 7, the overall US average effective tariff rate is estimated at 17.6%, the highest since 1934 and up from 2.4% in January. In our view, US protectionist trade policy will continue to weigh on USD for three reasons: First, higher US levies is a downside risk to US growth and upside risk to inflation. Second, the ongoing trade war threatens to accelerate the dollar’s declining role as the primary reserve currency as countries reassess their economic dependencies on the US. Third, effort to narrow the US trade deficit mean fewer dollars will flow overseas, reducing the need for those funds to be recycled back into US securities.
Today, the US data highlights are the June NFIB small business optimism index (11:00am London) and June New York Fed inflation expectations (4:00pm London). Inflation expectations are contained and leaves room for the Fed to ease policy. Fed funds futures are pricing in 100bps of cuts over the next twelve months to a target range of 3.25% to 3.50%.
AUSTRALIA
AUD rallies against most major currencies and Australia bond underperform. RBA surprises by keeping the cash rate target at 3.85%. The swaps market had virtually fully priced-in a 25bps cut ahead of today’s policy rate decision. The RBA noted that “it could wait for a little more information to confirm that inflation remains on track to reach 2.5 per cent on a sustainable basis.”
More RBA cuts are in the pipeline, but the threshold for additional easing is higher. The RBA noted the recent monthly CPI Indicator “were, at the margin, slightly stronger than expected” and that “various indicators suggest that labour market conditions remain tight.” Moreover, the RBA voted by a solid majority of 6-3 to hold rates steady.
There are no new economic projections associated with this policy-setting meeting. The next Statement on Monetary Policy will be published at the August 12 meeting. By then, we’ll have Australia’s June employment and Q2 CPI reports. That data will steer near-term rate expectations. For now, a less dovish RBA bodes well for AUD.
JAPAN
Super long-term Japanese yields are soaring again in part because of concerns over fiscal expansion ahead of Japan’s July 20 Upper House elections. 30 and 40-year JGB yields rose as much as 13bps, coming within striking distance of their May 22 highs at 3.17% and 3.68%, respectively.
Rising JGB yields is pushing up Japan’s debt servicing costs, limiting the BOJ tightening capacity and posing a headwind for JPY. The swaps market is pricing-in less than 50% odds of a 25bps rate hike by year-end and a total of 50bps of tightening to 1.00% over the next three years.