Bullseye
- UK inflation hit the Bank of England’s 2% target for the first time since July 2021.
- The European Commission is expected to reprimand France and Italy for breaching EU deficit rules.
- US financial markets are closed today in observance of Juneteenth Independence Day
USD is consolidating near its post-US retail sales data lows. US nominal retail sales undershot forecasts in May and the prior month’s print was revised lower consistent with moderating consumer spending activity. Total retail sales rose 0.1% m/m (consensus: 0.3%, prior -0.2pts to -0.2%). Sales excluding cars and gasoline increased only 0.1% m/m (consensus: +0.4%, prior -0.2pts to -0.3%). Control group sales used for GDP calculations grew 0.4% m/m (consensus +0.5%, prior: -0.2pts to -0.5%).
Odds of a September Fed funds rate cut rose 10pts to 74% after the disappointing retail sales data. Fed funds futures also firmed up expectations for 50bps of total rate cuts this year.
Nevertheless, we still see room for a reassessment in Fed funds rate expectations in support of a higher USD and Treasury yields. The US economy and demand for labour market are strong. In fact, the Atlanta Fed's GDPNow model is still tracking Q2 growth at 3.1% (seasonally adjusted annual rate), unchanged from June 7. Next update comes tomorrow after the housing starts data. Meanwhile, Fed officials continue to urge patience before easing:
Dallas Fed President Lorie Logan noted that “from a monetary policy perspective, we’re in a good position, we’re in a flexible position to watch the data and be patient.”
St. Louis Fed President Alberto Musalem warned it “could take months, and more likely quarters” to see data supporting a rate cut.
Fed Governor Adriana Kugler cautioned that inflation “it is still too high, and it is moving down only slowly” adding, “if the economy evolves as I am expecting, it will likely become appropriate to begin easing policy sometime later this year.”
Boston Fed President Susan Collins emphasized “the appropriate approach to monetary policy continues to require patience” and “we should not overreact to a month or two of promising news.”
The US TIC data continues to show that underlying demand for USD remains robust. Net foreign purchases of long-term US securities (Treasury Bonds, gov’t bonds, corporate bonds & stocks) totalled over US$1193.5bn in April, eclipsing the cumulative US April trade deficit of US$790.4bn.
GBP/USD edged a little higher towards 1.2730 after the UK May CPI report showed further progress on inflation, which will be welcomed by the BOE. In line with consensus and BOE projections, annual headline CPI inflation slowed to 2% in May from 2.3% in April while core CPI inflation eased to 3.5% y/y (lowest since October 2021) versus 3.9% y/y in April. The swaps market pared rate cut bets for August (from 52% to 36%) because services inflation was stickier than expected falling only 0.2pts to 5.7% y/y in May (consensus: 5.5%, BOE projection: 5.3%).
Tomorrow, the BOE is widely expected to leave the policy rate at 5.25%. A surprise rate change during an election campaign is unlikely. Importantly, we anticipate the MPC vote split to remain 7-2 in favour of no rate change with Dave Ramsden and Swati Dhingra voting again for a 25bps rate cut. We also expect the BOE to reiterate that “monetary policy will need to remain restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term.” Our base case remains for the BOE to start easing in August which is a near-term headwind for GBP.
EUR/USD is trading sideways near 1.0740. The European Commission is expected to launch today excessive deficit procedures (EDP) against seven EU countries including France and Italy for running budget deficits larger than the 3% of GDP threshold. Countries in EDP are given a deadline of six months (or three for a serious breach) to comply with recommendations that provide them with a concrete path for correcting their excessive deficit within a set timeframe. Countries in the Eurozone that don’t course-correct could face fines of 0.2% of GDP. The Eurozone April current account data is up next (9:00am London).
NZD/USD is range-bound near yesterday’s high around 0.6150. RBNZ Chief Economist Paul Conway struck a balanced tone in his speech titled “The road back to 2% inflation”. According to Conway the progress on inflation “could occur more quickly or slowly than currently projected”. Overall, a period of restrictive policy is necessary to give us confidence that inflation will return to target over a reasonable timeframe.”
New Zealand’s annual current account deficit narrowed to 6.8% of GDP in Q1 from 6.9% in Q4 2023. Nevertheless, the current account deficit remains high by historical standards, suggesting NZD needs to keep trading at a discount to fundamental equilibrium to attract foreign investments and finance this deficit. We estimate long-term fundamental equilibrium for NZD/USD at 0.6640. New Zealand’s Q1 GDP report is the next domestic data highlight (11:45pm London).
