The inflation narrative is still way more important than the employment story
Markets
Core bonds sold off yesterday with the belly of the curve slightly underperforming in the US while European curves showed more of a bear flattening. Daily changes on the US curve varied between +4.7 bps (2-yr) and +6.4 bps (7-yr). The US 30-yr yield is again within reach of the multi-annual high reached end July (5.25% vs 5.28%) which raises the stakes for the Treasury’s mid-month refinancing operation later this week (including 10-yr Notes & 30-yr Bonds). The 2-yr yield (4.25%) now fully reversed the initial decline on Friday’s disappointing US payrolls report (4.23% to 4.15%). Recall that the US economy lost 23k jobs in July according to BLS data with May and June numbers being downwardly revised by a cumulative 103k. They prompted a rethink of September Fed rate hike bets. However, following the Pavlov reaction markets soon recovered in a clear sign that the inflation narrative is still way more important than the employment story. Cleveland Fed Hammack, one of three dissenters in favour of a rate hike at the July FOMC meeting, repeated her call that now is the time to act. In this respect, focus turns to July US CPI (Wednesday) and PPI (Thursday) data while the US/Iran stalemate keeps oil prices (Brent $88/b from $82 close last Friday) elevated. Iran still refuses direct talks with the US, upping its conditions for talks as president Trump moves away from military action towards renewed economic pressure. Trump on his part made sweeping new demands including casualty compensation. The European reference gas contract (Dutch TTF) rose from €55/MWh to €62 with Ukraine hitting a major oil refinery deep inside Russia. The main move on FX markets occurred in JPY-crosses where the yen succumbs to new selling pressure following the intervention relief at the end of July. USD/JPY moved from 157.50 to >159 as markets seem to want to test Treasury Secretary Bessent’s pledge to do “whatever it takes” to support Japan in a way that helps the US economy, the US taxpayer and stabilizes the global economy. After the joint Japanese/US efforts, focus also turns to the Bank of Japan to give JPY more (interest rate) backing. BoJ governor Ueda last week accordingly explicitly stated that the policy rate would be raised soon after September while the pace of interest rate hikes could be accelerated if necessary. There was less action in other market pockets yesterday with EUR/USD holding a tight range near 1.1550 and main equity markets hovering sideways near recent (all-time) highs. Today’s eco calendar is empty apart from US NFIB small business optimism, suggesting that yesterday’s market themes will remain dominant.
News and views
The Reserve Bank of Australia kept its policy rate unchanged at 4.35% this morning. Australian inflation remains too high with both domestic capacity pressures and the disruption to global oil supply keeping prices elevated. There are also indications that higher fuel prices are being passed through to prices of other goods and services. Inflation is not expected to return to the midpoint of the 2%-3% inflation band until late 2027 with upside risks around this projection. If these materialize, the RBA will increase its policy rate further. The RBA nevertheless acknowledges for the first time that monetary policy is currently somewhat restrictive, while also signaling that consumer spending growth is slowing gradually in response to three rate hikes earlier this year. It suggests that the bar to implement another rate hike is somewhat higher, with a preference to keep a wait-and-see stance. Momentum in the housing market has also shifted, with housing prices falling in some capital cities and new housing loans declining noticeably. Apart from tighter policy, an overhaul of property taxation (May Budget) and macroprudential measures are having their effect. Labor market conditions have eased more than expected, though leading indicators only point to some limited additional easing. Growth in business debt and investment are strong. New RBA forecasts still show weaker growth ahead, but a slightly more resilient economy. The inflation path is slightly lower. The Aussie dollar lost marginally ground after the decision with AUD/USD dipping from 0.7060 to 0.7040. The market implied probability of a final RBA rate hike around the turn of the year remains broadly unchanged at 50%-60%.
Author
KBC Market Research Desk
KBC Bank
KBC's Market Research Desk publishes a number of short-term reports.
