Ella 
In its latest daily market commentary, the KBC Bank Market Research Desk points to the non-manufacturing ISM shock and the RBA decision – what lies ahead? Here are the key takeaways from the report.
Market
Disappointing US non-manufacturing ISM data was yesterday’s defining moment in financial and FX trading. Momentum after the jobs data still pushed U.S. rates and the dollar slightly higher ahead of the data. After that, the fortunes of the plate changed, and the first Pavlovian reaction didn’t really get attention after that. Looking at the data first, the ISM index fell to 50.3 from 51.9, just above the 50 boom/bust index. With the exception of December 2022, this was the lowest reading since May 2020 and was also lower than the consensus estimate (recovering at 52.4). The deterioration in confidence in the services sector will be closely watched as the sector has kept the global economy booming over the past few months. The details didn’t offer much hope, with the inventory build index (58.3 from 47.2) and the inventory confidence index (61 from 48.9) the only factors keeping manufacturing from slipping into contraction territory. Overall business activity fell to 51.5 from 52 and new orders fell to 52.9 from 56.1. The backlog of orders fell to 40.9 from 49.7. The employment rate fell to 49.2 from 50.8. Prices paid continued a disinflationary trend, rising to 56.2 from 59.6. The market reaction has been generally orderly. U.S. Treasury yields ended up down 0.2 basis points (30-year) to 3.3 basis points (2-year), masking an intraday single-digit drop. Bunds lagged significantly, with yields rising 5.5 basis points (30-year) to 7.9 basis points (2-year). Those indexes were back from last week’s close in U.S. stocks, which opened higher on higher energy prices and were little affected by the non-manufacturing ISM data. The dollar trade-weighted exchange rate opened at 104.04, reached an intraday high of 104.40, and finally settled at 104. EUR/USD followed a similar intraday move and ended up barely changing at 1.0713, off the daily bottom of 1.0675.
This morning’s RBA decision (see below) is the main course of the day and a reminder to central banks and global markets that the battle against inflation is hard won. That set the tone for another start to weaker trading in core bonds. Risk sentiment in Asia was mixed, unable to provide further guidance. The euro is getting some interest rate support, after not having it for most of May. EUR/USD trades at 1.0729, with May lows – 1-day support (1.0635) starting to look firmer. Today’s economic calendar contains no events/data worth mentioning.
News and Views
The Reserve Bank of Australia raised its policy rate by a further 25 basis points to 4.1%. Most analysts expect the RBA to keep its decision on hold after it restarted raising rates last month. The RBA believes inflation has passed its peak, but 7% is still too high. Recent data also suggest that upside risks to the inflation outlook have increased. Today’s rate hike should increase confidence that inflation will return to target within a reasonable time frame. Australia’s economic growth has slowed and labor market conditions have eased, but remain very tight. Wage growth also accelerated due to a tight labor market and high inflation. In this regard, the RBA board remains vigilant about the risk that persistently high inflation expectations will lead to sharp price and wage increases, particularly given the limited spare capacity in the economy and the still-low unemployment rate. The Committee concluded that further tightening of monetary policy may be required. The 2-year Australian government bond yield jumped 9 basis points to hit a new cycle high around 3.85%. After the decision was announced, the Australian dollar rose about 1 basis point, with AUD/USD trading around 0.6675.
Japanese wages rose less than expected in April. Labor cash earnings rose 1 percent from a year earlier, down from 1.3 percent in March. The April data is the first wage data series after the spring labor market talks (Shunto). However, it may be a while before the full impact of wage negotiations is seen in the coming months. Actual cash earnings were even down 3% from a year earlier. Consumer spending data also disappointed in April, falling 4.4% from a year earlier. Today’s weak wage data may not prompt the Bank of Japan to change its easing policy anytime soon. The 10-year JGB yield was little changed around 0.43%. USD/JPY is falling, but that may mostly reflect dollar weakness.
