A$ has been resilient in the face of deepening trade tensions but faces major challenges in the week ahead from a likely RBA rate cut and dovish statement plus Australia’s Q1 GDP report.
Trade wars have dominated global financial markets in May and bond markets are clearly warning of weaker global growth ahead as tariff hikes start to bite.
Global markets have had a lot to worry about over recent weeks. We’ve had Trump announce that tariffs on $200bn of goods imports from China would increase from 10% to 25% and that work on next round of tariffs on the final $300bn of imports had started too.
We had Huawei put on a ‘blacklist’ and the Commerce Department announce they were looking at a rule change that could place countervailing duties on imports from countries that act to undervalue their currency.
We’ve also seen a step up in retaliation from China too. Chinese tariffs on $60bn of imports from the US increase tomorrow and the People’s Daily suggested this week that China is “seriously” considering restricting rare earth exports to the U.S.
Rare earth elements such as lanthanum and neodymium are used in a host of complex electronic goods such as smartphones, night vision goggles and guidance systems and China has become the dominant supplier of these rare elements to the rest of the world.
As we move into June, with a G20 meeting at the end of the month which is supposed to see Trump and Xi sit down to talk trade, these increased signs of aggression from both leaders have left equity markets unsettled.
The S&P 500 is set to finish the month down circa 5% and China’s Shanghai index down close to 7%. Concerns about global growth have driven US 10yr yields down to the lowest level seen since September 2017 and copper back to the lows for the year.
If Fed vice chair Clarida is a fair reflection of views within the FOMC, then it appears the board is watching trade developments closely. In Q&A after a speech to market participants in NY Thursday, he commented that “If the incoming data were to indicate that global economic and financial developments present a material downside risk … then these are developments that the committee would take into account in assessing the appropriate stance for monetary policy”.
While there are a number of ‘ifs’ in that comment, it’s one of the clearest statements yet that the Fed is watching trade wars closely. Markets brought pricing of a rate cut in the US forward to September.
Despite this, a widely watched measure of the US dollar is at 2yr highs and that’s despite Trump facing more political pressure at home after Special Counsel Mueller’s statement earlier in the week.
Trump will also likely face criticism for the emergency measures announced to address the Mexican border crisis which will see a 5% tariff on all goods imported from Mexico starting June 10 rising to 10% July 1 and so on until 25% on October 1 unless “Mexico substantially stops the illegal inflow of aliens coming” into the US.
Back in Australia, the RBA outlook remains the key talking point. Westpac was the first major bank to forecast a cash rate below 1%. On 24 May, Chief Economist Bill Evans wrote that “Westpac is now forecasting three cuts in 2019 in June; August and November to push the cash rate from 1.5% to 0.75% and to hold at that level through 2020.” We are therefore confidently forecasting a rate cut next week.
An important area of support for the A$ has continued this week, with iron ore touching the highest level back to April 2014, and in A$ terms it hit the highest seen since August 2013. It was probably this factor alone that helped the A$ trade in a quiet range just above 69 cents to the US$ this week.
Clearly the RBA will dominate a very busy week for financial markets. All forecasters expect a 25bps cut Tuesday, so the guidance from the RBA on the prospects for more cuts will be key to price action in domestic money markets. We also have retail sales and the current account deficit on Tuesday, Q1 GDP on Wednesday and the April trade balance. Westpac is forecasting 0.6% real GDP growth in the first quarter, but with downside risks, adding to the possibility that the A$ drops below 0.69 next week.
Event risk: Aust Q1 company profits & inventories, US President Trump state visit to UK begins, US May manufacturing ISM (Mon), Aust Apr retail sales, Aust Q1 balance of payments & public demand, RBA policy decision (Tue), Aust Q1 GDP, US May non-manufacturing ISM (Wed), Aust Apr trade balance, ECB policy decision, Reserve Bank of India policy decision (Thu), Aust Apr home loan approvals, US May employment (Fri)
