Fed Decision Day

• The Fed is expected to keep rates on hold today and tee-up for a September cut.

• Bank of Japan surprises with a hawkish hike. USD/JPY whipsawed and JGB yields up.

• AUD hit by a triple whammy of softer Australia underlying inflation, poor retail sales and soggy Chinese economic activity.

USD is trading on the defensive against most major currencies and global stock markets are rallying. Today, the FOMC is expected to deliver a dovish hold, validating the case for a September cut.

Virtually all market participants anticipate the target range for the Fed funds rate to remain steady at 5.25-5.50% today (7:00pm London). The post meeting press release and/or Fed Chair Jay Powell will likely hint that the time to lower the policy rate is drawing closer given the progress with inflation. The swaps market has more than fully priced-in a 25bps Fed funds rate cut in September and a total of 68bps of easing by year-end. The FOMC will produce their next quarterly forecasts at the September meeting.

In our view, solid US economic activity and modest disinflation suggest the Fed is unlikely to cut the funds rate as much as is currently priced-in. Indeed, yesterday’s JOLTS print reinforces the case the Fed can achieve a soft landing in the labour market without a material increase in the unemployment rate. In June, the JOLTS layoff rate dipped 0.2pts to 0.9%, matching the April 2022 low, and the job openings rate remained steady near pre-pandemic levels at 4.9%. Bottom line: there is room for an upward reassessment in Fed funds rate expectations in favour of USD and Treasury yields.

The US July ADP employment report and Q2 employment cost index (ECI) are today’s domestic data highlights (1:15pm and 1:30pm London, respectively). ADP employment is expected to rise 150k vs. 150k in June while ECI is projected to increase 1% q/q vs. 1.2% q/q in Q1.

USD/JPY whipsawed between a low of 151.64 and a high of 153.88 and 10-year JGB yields rose 7bps to 1.06% rafter the Bank of Japan (BOJ) surprises with a hawkish hike. The BOJ decided by a 7-2 majority vote to raise the policy rate 15bps “to remain at around 0.25%” from a target range of 0% to 0.10%. Ahead of the BOJ meeting, the swaps market implied about 70% odds of a 10bps rate hike while most analysts polled by Bloomberg expected the BOJ to keep the policy rate steady.

The BOJ also decided, by a unanimous vote, on a plan to reduce the amount of its monthly outright purchases of JGBs from roughly ¥6 trillion to about ¥3 trillion by January-March 2026. This was in line with consensus. In principle, the BOJ plans to cut the amount by about ¥400 billion each calendar quarter.

The BOJ signaled it plans to tighten policy further. According to the BOJ “if the outlook for economic activity and prices presented in the July Outlook Report will be realized, the Bank will accordingly continue to raise the policy interest rate and adjust the degree of monetary accommodation.” Moreover, the BOJ warned that risks to Japan economic activity and prices are skewed to the upside for fiscal 2025.

Nonetheless, the swaps market continues to imply a modest BOJ tightening cycle with 30bps of hikes priced-in over the next 12 months. We agree. Japan underlying inflation is in a firm downtrend, and negative real cash earnings points to ongoing weakness in consumption spending activity. Bottom line: we doubt the BOJ will tighten more than is currently priced-in which will limit JPY upside.

AUD underperformed and Australian bonds surged on cooler Australia underlying inflation. The policy-relevant trimmed mean CPI rose 0.2pts less than expected by 0.8% q/q (consensus: 1.0%, prior: 1%) to be 3.9% y/y (consensus: 4.0%, prior: 4.0%).

Australia headline CPI matched consensus. Headline CPI rose 1% q/q (consensus: 1.0%, prior: 1.0%) driven by Housing (rents and new dwellings purchased by owner-occupiers) and Non-alcoholic beverages. Annually, the CPI inflation quickened to 3.8% from 3.6% in Q1. The monthly CPI indicator was also in line with expectations. In June, headline inflation eased 0.2pts to 3.8% y/y while the trimmed mean inflation slowed 0.3pts to 4.1%.

Meanwhile, Australia households continue to curb spending. In volume terms, retail turnover fell more than expected in Q2 by -0.3% q/q (consensus: -0.2%) following a -0.4% q/q decline in Q1. In nominal terms, retail sales growth overshot expectation rising 0.5% m/m in June (consensus: +0.2, prior: +0.6%) as mid-year sales boosted spending on discretionary items.

Bottom line: softer Australia underlying inflation and poor retail sales activity mean RBA rate hikes are off the table. Cash rate futures went from pricing a small probability of an RBA rate hike by year-end to 70% odds of a 25bps rate cut after today’s data. We expect the RBA to stay on hold the rest of this year because inflation remains above the RBA’s 2-3% target.

NZD/USD is firmer above 0.5900. New Zealand’s ANZ business confidence index rose 21 points to a four-month high of +27 in July and the forward-looking Own Activity Outlook index lifted 4 points to a four-month high of +16.3. The swaps market implies over 60% probability of an RBNZ rate cut at the next August 14 meeting. We think the RBNZ can afford to wait for October before slashing rates because New Zealand non-tradeable CPI inflation remains sticky and business confidence is improving.

China’s July PMIs point to a sluggish growth outlook. In July, the manufacturing PMI fell 0.1 point to 49.4 (consensus: 49.4) and the non-manufacturing PMI dropped 0.3 point to 50.2 (consensus: 50.3). As a result, the composite PMI dipped to 50.2 from 50.5 in June.

China’s Politburo pledged this week to boost consumer spending. As we’ve been saying for some time now, the steady drip feed of stimulus will do little to improve the economy’s medium-term outlook, which we believe hinges crucially on addressing the huge debt overhang. Until that has been accomplished, growth will remain well below expectations and a structural headwind for commodity prices.

EUR/USD is consolidating around 1.0820. The Eurozone July preliminary CPI print is up next (10:00am London). Headline CPI is expected to fall -0.1% m/m (versus +0.2% in June) and remain steady at 2.5% y/y in July. Core CPI inflation is projected to fall one tick to 2.8% y/y. Risks are balanced. The July EU harmonized CPI inflation for Germany unexpectedly quickened 0.1pts 2.6% y/y in July (consensus: 2.5%) while France’s undershot expectation rising 0.1pts to 2.6% y/y (consensus: 2.8%). Regardless, the Eurozone disinflationary process is well on track and supports the case for the ECB to cut rates again in September.

USD/CAD edged lower from a multi-month high on USD weakness and firmer crude oil prices. Canada’s May GDP report is the domestic data focus (1:30pm London). Canada’s economy is forecast to rise 0.1% m/m vs. 0.3% in April. The risks are skewed to the downside because retail sales volume plunged 0.7% m/m in May. Subdued Canadian economic activity and moderating inflation pressures suggest the bar for more Bank of Canada policy rate cuts is low which can further weigh on CAD. The swaps market is pricing 125bps of easing in the next 12 months.