Service Groove

June 05, 2024

Service Groove

  • The US May ISM services index will guide markets today.
  • Bank of Canada is expected to cut rates or deliver a dovish hold. National Bank of Poland is widely expected to keep rates at 5.75%.
  • Australia real GDP growth undershot expectations but RBA is more concerned with getting inflation down.

USD recovered some of yesterday’s losses versus JPY and CHF but pared-back gains against most other major currencies. Lower US Treasury yields, reflecting the recent batch of weak US economic data (ISM manufacturing and JOLTS job openings), is holding back USD.

USD and US interest rate expectations will take their cue today from the US May ISM services index (3:00pm London). Services activity is projected to improve to 51.0 from 49.4 in April. If so, US interest rate expectations can adjust higher in favour of a firmer USD. Otherwise, a weaker services ISM print could trigger a sharper correction in USD and Treasury yields. The regional Fed non-manufacturing business surveys suggest risks to the ISM services data are balanced. Of note the US S&P Global services PMI rose to a 12-month high at 54.8 in May. Ahead of the ISM services report, ADP releases its estimate of private sector jobs and is expected at 175k vs. 192k in April (1:15pm London).

USD/CAD is consolidating ahead of today’s Bank of Canada (BOC) policy rate decision (2:45pm London) and press conference (3:30pm London). Interest rate futures imply over 80% probability of a 25bps BOC rate cut to 4.75%. We think the BOC will deliver a cut which will weigh on CAD. And if they don’t, it will be a dovish hold which will also undermine CAD as interest futures move to fully price-in a July rate cut.

First, Canada Q1 real GDP growth fell short of the BOC’s projection by a wide margin (actual: 1.7% saar, BOC projection: 2.8% saar) and the previous quarter’s increase was slashed 0.9pts to just 0.1% saar. Second, inflation is slowing. The annualized growth on a three-month basis for CPI-trim and CPI-median tracked under 2% in March and April. Third, labour market conditions have eased. job creation has been slower than the increase in the working-age population.

GBP/USD is back under 1.2800 amid the lack of policy relevant UK economic data releases. The first televised head-to-head debate between Rishi Sunak and Keir Starmer took place last night. A poll by YouGov after the debate gave Sunak a narrow victory, 51% to 49%. Regardless, the Tories have consistently trailed in polls by around 20 points since Rishi Sunak took over as prime minister in October 2022. This suggests fatigue with the Conservatives after 14 years in power.

JPY is underperforming. The pick-up in Japan wages growth remains contained and signals the BOJ is unlikely to tighten more than is currently priced-in (25bps of hikes in 2024). Japan cash earnings rose more than expected in April to 2.1% y/y (consensus: 1.8%, prior: 1%) reflecting raises agreed during the Shunto spring wage negotiations. Meanwhile, the less volatile scheduled pay growth for full-time workers printed at 2.1% y/y for a second consecutive month and has been stuck around 2% since September 2023.

AUD/USD recovered some of yesterday’s losses supported in part by stronger services expansion in China. The Caixin May services PMI increased to a 10-month high at 54.0 (consensus: 52.5). This contrasts with the official non-manufacturing PMI, which dipped to a four-month low at 51.1 in May. Structurally, China’s economy remains constrained by a huge debt overhang and a property slump. This remains a drag on iron ore prices and AUD.

Australia real GDP growth undershot expectations. Real GDP grew 0.1% in Q1 (consensus: +0.2%) and the details were unimpressive. The drag from net trade (-0.8pts) was offset by an increase in inventories (+0.7pts) and household spending (+0.2pts). Nevertheless, the RBA will look through the soft Q1 GDP print because it’s more concerned with getting inflation down. RBA Governor Michele Bullock emphasised again overnight “that inflation needs to be coming back down and be sustainably back in the band on the board’s timetable because if it’s not, we can’t remove the restrictiveness of monetary policy”. Recall, the RBA May 6-7 meeting minutes showed policymakers considered raising the cash rate target.

NZD/USD is firmer. New Zealand’s terms of trade increased more than expected over Q1 (actual: 5.1% q/q, consensus: 3.2% q/q). A higher terms of trade has a positive net wealth effect on the economy and raises the fundamental value of NZD.

National Bank of Poland (NBP) is expected to keep rates at 5.75% today. The bank will likely reiterate that “the current level of the NBP interest rates is conducive to meeting the NBP inflation target in the medium term.” MPC members continue to stick to the message of no rate cuts before 2025. In our view, there is room for NBP to ease earlier. Poland annual headline CPI inflation hit the bank’s 2.5% target in May and economic activity in April was weak. The swaps market has fully priced-in a 25bps policy rate cut over the next six months. However, ongoing tension between the government and the central bank governor complicates the policy rate path projection. Governor Glapinski holds his post-decision press conference tomorrow.

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