The Overnight Report: Post The RBA’s Dovish Cut

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US markets eased overnight after a six-day winning streak as investors rotated into the more defensive stocks. Asian and European markets moved higher yesterday and the ASX futures are pointing to another positive start, post the RBA’s rate cut.

Good Morning,

Concerns over debt, deficits and trouble in bond markets continued with Japan moving centre stage yesterday on a very poor JGB 20-year auction. Gold is finding attention after its -10% correction in May.

What happened overnight: Extract NAB Markets Today Research

A relatively quiet night for markets but with a slight whiff of a return to the ‘sell America’ theme, evident in weaker US stocks in contrast to decent gains in both the APAC and European region, modestly higher US Treasury yields and steeper curve, and a slightly softer US dollar but in which the AUD has not participated. AUD/USD is down half a percent on this time yesterday following yesterday’s RBA rate and accompanying evidence of a dovish tilt in the accompanying RBA narrative.

US equities finished in NY with the S&P500 and NASDAQ both down -0.4%, with defensives (health care, consumer staples and utilities) the only S&P sub-sectors finishing in the green.

Earlier, the Eurostoxx600 ended up 0.7%, the UK FTSE up 0.9% and in Asia the Hang Seng 1.5% higher.

Overnight, economic data has been confined to Canada April CPI. This showed headline inflation down to 1.7% from 2.3% in March, its lowest since last September, but due to the elimination of a consumer carbon tax and lower oil prices. 

Core measures in contrast accelerated, to an average of 3.2% up from 2.9%, against expectations of no change. As a result, expectations for another quarter point rate cut at the 4 June Bank of Canada meeting reduced to 44% from 68%, prior.

Fed speakers included St. Louis Fed President Alberto Musalem who said tariffs will likely weigh on the US economy and weaken the labor market. “Even after the de-escalation of May 12, they seem likely to have a significant impact on the near-term economic outlook.On balance, tariffs are likely to dampen economic activity and lead to some further softening of the labor market.”

But Musalem warned against looking through tariff related inflation, saying a look-through policy has risks and costs. “Committing now to ignoring higher inflation from tariffs, or to easing policy, runs the risk of underestimating the level and persistence of inflation”, he said.

Meanwhile, Atlanta Fed President Bostic has been back on the wires, saying that the (Moody’s) US debt downgrade and the proposed government tax bill could add to overall uncertainty which could extend the timeline for any policy move (Bostic earlier this week reiterated his forecast for one Fed rate cut this year).

We’ve had a couple of ECB speakers, both indicating sympathy for a June rate cut, Governing Council (GC) member Pierre Wunsch saying the Eurozone economy may need “mildly supportive” interest rates to ensure inflation doesn’t fall below target and that two more quarter point decreases to 1.75% would achieve.

Fellow GC member Klaas Knot meanwhile said another rate cut is possible next month but that it’s “too early” to make decisions without seeing fresh quarterly forecasts.

In bond markets, yesterday’s awful 20-year JGB auction drew international attention and comes in front of a similar 20-year US treasury bond sale tonight.

The bid-cover ratio of 2.5 was the lowest since 2012 and saw the 30-year bond yield jump to 3.1%, the highest since the introduction of this tenor in 1999.

Overnight, 10-year Treasury yields rose to a high of 4.52% at the start of the New York day before easing to 4.48% by Tuesday’s close. 2-years saw a high of 3.99% before easing to 3.97%. Earlier European bond yields were lower everywhere at 10-years, Gilts ending down -4bps and Bunds -2bps.

RBA Meeting Review: Extract from Chris Weston, Pepperstone

The big consensus position going into the RBA meeting was for a -25bps cut, and the implied pricing expressed into Aussie interest rate swaps had the RBA outcome well and truly nailed to the post.

Like many, I had seen the risk of a ‘hawkish cut’ with the statement expected to lack the urgency to cut again and subsequently meet the additional -50bps of implied cuts priced by December. 

The RBA’s statement offered limited push back on market expectations for further RBA easing, and swaps traders saw the statement and the new set of economic projections as possibly even opening the door to a third -25bps this year. The Q2 CPI print on 30 July, as well as developments in the labour market and global trade, are set to guide market expectations for future RBA easing.  

While market positioning is always a factor that impacts the extent of movement in a market when we marry the facts (from a major market event) to prior pricing/expectations, the initial reaction in Aussie markets is clear cut, and while not overly prolific, we can certainly say the response has been taken as a ‘dovish cut’.  

We’ve seen solid buyers of shorter-dated Aussie govt bonds, with Aus 3yr govt bond yields trading lower by a punchy -17bp (3.62% to 3.45%), in turn, this has resulted in a solid bull steepening of the 3s v 10s yield curve.

Australian Interest rate swaps now price -67bps of cuts by December (from -55bps) this essentially implies two -25bps cuts by year-end and a 68% chance of a third. 

The -50bps of additional implied cuts by December feels a fair call, judging by the tone of the statement and the economic projections. 

We can see that the market pricing has the RBA taking the cash rate to a trough rate of 3.10% by March 2026, which falls in line with the RBA’s own forecasts for a low/trough cash rate of 3.2%

Naturally, if the labour market was to deteriorate at a faster clip and the unemployment rate was on a trajectory to push towards 4.5% by December, then market pricing would likely imply a ‘terminal’ RBA cash rate below 3%, and a greater discount to the RBA’s own terminal forecast; the greater the discount to 3.2%, the higher the perceived recession odds.

With the government not holding back on its fiscal plans, and with household real income also rising and consumption holding in, it seems unlikely that we will see a material deterioration in the labour market, but it’s not out of the question. 

Risk On & Off Here & There: Ed Yardeni extract

As the world turns, so do risk-on and risk-off trades around the world. Some are for the short term and based on technical factors. Others are for the long term and based on fundamentals.

Let’s take a quick tour of latest events:

Japan. While pessimists have been predicting an imminent sovereign debt crisis in the US, it seems to be unfolding in Japan currently.

Amid a shrinking economy and growing mountain of debt, Prime Minister Shigeru Ishiba issued a harsh warning this week, “Our country’s fiscal situation is undoubtedly extremely poor,” adding, “worse than Greece’s.”

Japan’s GDP shrank in Q1; and on Monday, the cost of borrowing increased after yields on its 40-year government bond reached highs last seen about 20 years ago.

The slump in Japanese bonds worsened today after the weakest demand at a government debt auction in more than a decade. The bid-to-cover ratio at Tuesday’s 20-year bond sale fell to the lowest since August 2012.

The Bank of Japan has stopped increasing its holdings of Japanese government bonds over the past two years.

China. On Monday, official data showed that China’s industrial output in April grew 6.1% y/y, while inflation-adjusted retail sales increased 5.4%.

The data followed firmer-than-expected exports last month. In other words, China continues to export its excess production, which is exacerbating global trade frictions and deflation around the world. China cut its key lending rates by -10 basis points on Tuesday.

Gold. The price of an ounce of gold has corrected by about -10% so far in May, especially following the May 12 postponement of most of the reciprocal tariffs imposed on China during “Liberation Day” on April 2.

Turmoil in the Japanese bond market seems to be giving the price of gold a boost today.

Corporate news in Australia 

-Tabcorp Holdings ((TAH)) is assessing the sale of Max Gaming to Intralot which is worth around $610m as part of a strategic review.

-MA Financial Group ((MAF)) is nearing completion on the acquisition of IP Generation, a $2bn property investor.

-Westpac ((WBC)) is expected to announce the cut of -1500 employees, the biggest redundancy in around ten years.

-Rest Super risks losing exposure to Melbourne Airport if Dexus ((DXS)) is forced to sell its holding which it manages on behalf of clients like rest.

On the calendar today:

-NZ April Trade Bal

-JP April Trade Bal

-UK April CPI, PPI

-AMCOR PLC ((AMC)) ex-div 19.97c

-CATAPULT GROUP INTERNATIONAL LIMITED ((CAT)) earnings report

-JAMES HARDIE INDUSTRIES PLC ((JHX)) earnings report

-NUFARM LIMITED ((NUF)) earnings report

-SEEK LIMITED ((SEK)) investor briefing

-SGH LIMITED ((SGH)) investor briefing

-WEBJET GROUP LIMITED ((WJL)) earnings report

FNArena’s four-weekly calendar: https://fnarena.com/index.php/financial-news/calendar/

The Australian share market over the past thirty days

For more detail go to FNArena’s Australian Broker Call Report, which is updated each morning, Mon-Fri.

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