Global bond yields are rising and the US dollar is trading on a firmer footing this morning after inflation surged unexpectedly in Canada and Australia, threatening to upend the rate cut consensus across developed markets and jeopardise growth outlooks.
Australian price growth accelerated to its fastest in six months in May, knocking markets off balance and raising the likelihood of another rate hike this year. According to the Australian Bureau of Statistics, consumer prices rose at an annual pace of 4.0 percent in May, climbing from 3.6 percent in April and topping market forecasts that had been set at 3.8 percent. The ‘trimmed mean’ measure of core inflation hit 4.4 percent, jumping from 4.1 percent, and underlining the relatively broad-based nature of the surprise increase. Cash futures suggest that the probability of a hike by the Reserve Bank of Australia’s September meeting has risen to nearly 60 percent from less than 15 percent a day earlier, and the Australian dollar is the best-performing major currency today on a narrowing in rate differentials relative to the US.
Australia’s data came after a similar shock in Canada, where inflation sped up on both the headline and core levels, surprising observers – including ourselves – who had expected a continued moderation. May’s acceleration was partly driven by a 4.6 percent year-over-year jump in travel costs, but shelter inflation remained incredibly hot, with rents climbing 9 percent and mortgage interest costs surging 23.3 percent. An average of the Bank of Canada’s preferred core inflation measures rose 2.9 percent, up from 2.7 percent in April, and our favourite benchmark – the old CPIX index – snapped its downward slide, rising 1.8 percent after slowing to 1.6 percent in the prior month.
We suspect the pace of inflation will shortly revert to trend, with June’s data cooling relative to May as weak domestic demand conditions take their toll on core price categories and the effects of currency depreciation wear off. A summer move can’t be ruled out, but the central bank’s confidence in the disinflation process has undoubtedly taken a knock, suggesting that September remains the most likely juncture at which rates could be eased again. Markets agree: odds on a move at the Bank of Canada’s July meeting are holding near 25 percent, down from 60 percent ahead of the release, and the number of rate cuts implied by year end is down to 1.75 from 2.15 earlier in the week.
The loonie might otherwise be expected to rally, but the trade-weighted dollar remains an unstoppable juggernaut as Fed officials make aggressive noises and conditions elsewhere continue to favour currency weakness.
The most hawkish member of the Federal Reserve’s rate-setting committee yesterday said holding policy rates unchanged “for some time” would make sense, warning that she remains willing to raise rates if price pressures fail to subside. In a London speech, Governor Michelle Bowman said “Inflation in the U.S. remains elevated, and I still see a number of upside inflation risks that affect my outlook,” before telling the audience “I have not written in further rate cuts in my statement of economic projections for the bulk of this year”.
The Japanese yen is trading below the 160 threshold against the greenback as traders bet authorities will remain sidelined for now. With rate hike prospects fading and interest differentials favouring further depreciation, the exchange rate has inched lower in recent weeks, but because trading ranges have remained narrow, realised volatility levels have subsided, and the traditional triggers for official intervention haven’t yet been activated. Markets are growing more confident in the currency moving into a lower trading band, with options markets increasingly assigning strong probabilities to a range between 160 and 170.
And the euro is failing to climb off the floor as French political turmoil intersects with dovish signals from policymakers at the European Central Bank. The jury is still out ahead of the first round of voting in the French snap election this weekend, but the spread between French and German yields remains elevated as markets brace for adverse fiscal outcomes under the most probable scenarios. Olli Rehn, member of the central bank’s Governing Council, seems unconcerned, telling Bloomberg this morning that he wasn’t seeing any “disorderly market dynamics at the moment,” while helping validate current market pricing for the euro area’s policy rate – which is pointing to two more cuts this year. “In case we see the disinflationary process continuing and moving toward our symmetric 2-percent target in the medium term, then it is reasonable to assume that we stay with this direction and continue rate cuts,” he said.
Today’s agenda looks quiet, but tomorrow’s US jobless claims number, Mexico’s central bank decision, and the US presidential debate could move markets in the run-up to Friday’s personal income and spending report. We expect a continued grind higher in applications for unemployment benefits as labour market slack increases. The Banxico is likely to stay on hold while expressing more hawkish sentiments than in prior meetings as officials seek to defend the currency against strengthening outflows. And – despite involving two candidates who have reached an age at which they might be better suited to eating jello than slinging mud – the US debate could see markets adjust the odds on a second Trump presidency, potentially impacting currencies exposed to a resumption of hostile trade actions. Markets remain relatively unconcerned, but Wall Street’s “fear gauge” – the VIX volatility index – is showing a clear peak in the contract month referencing the November election, suggesting that some participants are bracing for more turbulence than typically accompanies US elections.
