Australia’s June quarter consumer price inflation (CPI) is almost upon us.
It’s arguably the most important data release for the Australian economy, and the outlook for domestic interest rates.
It can and does surprise, often lead to pockets of market volatility before and after it’s released, especially in Australian rates and stocks, along with the Aussie dollar.
Given it’s influence, and the fact that it’s only released once a quarter (once a month would be nicer. Hint, hint ABS), traders naturally have an interest in the release. Today will be no exception.
Heading into the event, almost all economists believe that the core inflation reading will be low enough to validate another rate cut from the RBA, most likely when the bank next meets on August 2.
Financial markets are less certain, attaching around a two-in-three chance that a 25 basis point rate cut will be delivered in just six days time. Beyond the August meeting, traders are actually speculating that the RBA will cut rates twice, not once, before the year is out.
Given those expectations, it appears that the risks for markets today are for the core inflation reading coming in hotter-than-expected, scuppering the view that another rate cut, let alone two, will be delivered.
It’ll either validate easing expectations, or create a massive rethink across the markets.
So, how will the markets react when the data is released? Core inflation is tipped to rise 0.4% for the quarter, leaving the year-on-year rate at a fresh record-low of 1.4%.
Annette Beacher, TD Securities chief Asia-Pacific macro strategist, believes she has the answer.
She’s put together an excellent synopsis on how rates and currency markets will likely react to a “hawkish”, “neutral” or “dovish” core inflation print, attaching a probability of each individual scenario occurring.
Here’s what she expects.
- NEUTRAL (35%): A “consensus” quarterly rise of +0.4%/qtr and 1.43%/yr may briefly be interpreted “as expected”, but 1.4% does not actually provide a clear trigger for a rate cut next month. The RBA expects underlying inflation to remain at 1.5%/yr, and if this was a trigger for easing it would have been expressed as a clear easing bias by now, but it hasn’t. When this realisation is digested by the market, we expect OIS to shave back pricing for an August cut to closer to 33% and the AUD is short-squeezed back towards $US0.7550 on a not-weak outcome.
- DOVISH (60%): A print closer to our +0.2%/qtr is the bottom of the market range, and at 1.25%/yr all-but cements the case for a rate cut in August. On these headlines expect the curve to bull-steepen as 2-3yr bond yields sink below 1.5%, and the AUD slumps straight through $US0.74 on the way to $US0.7322, the 200dma.
- HAWKISH (5%): An average quarterly print of +0.5%/qtr exactly meets the RBA projection of 1.5%/yr (if 1.5% is taken literally). We see a hawkish outcome closer to +0.65+%/qtr slashing OIS pricing of a rate cut by year-end to a 50/50 risk (currently 140%) as the 2% lower bound is reached six months earlier than the RBA anticipates. On this scenario, 3yr bond yields jump back towards 1.65%, and the AUD could retest the recent $US0.78 cyclical high. However, with very low wages growth and spare capacity in the economy, we only attach a 5% probability to this scenario.
While Beacher believes that another incredibly weak core inflation reading is the most likely scenario, perhaps the most interesting point she raises is the likely market reaction, in her opinion, should the core CPI reading meet expectations.
Most are of the view that a 0.4% quarterly core CPI will push the RBA over the line when it comes to a further rate cut. However, as Beacher points out, the RBA has not explicitly stated that another rate cut is coming, despite being given ample opportunity to do so.
Given markets are almost unilateral in their thinking that rates will be heading lower, it does raise the prospect of a “buy the rumour, sell the fact” outcome occurring for rates, or in the case of the Aussie a “sell the rumour, buy the fact” scenario, should the core reading print in line with expectations.
The answer to that question will be known soon enough. The report will arrive at 11.30am AEST.
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