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Richard Franulovich, Research Analyst at Westpac, explains that Eurozone political risk has of course erupted in recent days, the prospect of fresh elections in Italy – effectively a referendum on the euro – is the latest shoe to drop.

Key Quotes

“The impressive lift the regional US PMI’s for May masked some weaker detail, notably on CAPEX intentions. Forward CAPEX plans in the Philly, Richmond, Dallas and Kansas Fed surveys all moderated, albeit from multi year highs. A strong tax driven uplift in US business investment is among several factors underpinning hopes for US growth in the high 2s this year.”

“The neutral Fed Funds rate is under even more scrutiny than usual as the tightening cycle matures. In last week’s Fed minutes a few members noted that it would be soon appropriate to revise forward guidance given, “”¦the federal funds rate could be at or above their estimates of its longer-run normal level before too long”. Neutral is not directly observable but the most closely followed measure, from Laubach & Williams, puts real neutral at around 0.0%. With the core and headline PCE deflators at 1.9% and 2.0% respectively a +25bp hike at the Fed’s June 12/13 meeting to 1.75%-2.00% would put real Fed Funds effectively at neutral. Absent a meaningful lift in r-star, another +100bp in Fed Fund hikes beyond that through to end-2019, as implied by the Fed median dot, would put Fed Funds well into contractionary territory in 2019.”