USD broadly weaker overnight, seeing NZD push up towards 70 USc. Curve flattening continues in the NZ rates market

There has been some consolidation in US bond yields and equities overnight, after their recent surge higher.  In Europe, German inflation hit its highest level since at least the early 1990s, sending the German 2-year rate back into positive territory for the first time in almost eight years.  The USD is broadly weaker over the past 24 hours, with the NZD pushing up to just below 0.70. Domestic rates were volatile again yesterday with curve flattening the key trend.

In the context of recent extreme volatility, market changes over the past 24 hours have been reasonably subdued.  The S&P500 and NASDAQ are down around 0.5% and 0.7% respectively overnight, although this follows gains of 11% and 17% in little more than two weeks.  European equities were a bit weaker, with the German DAX down 1.5% after some less positive comments on peace talks (see below) and as markets worry about the economic impact of the energy crisis.

Overnight, a Russian spokesperson pushed back against optimism for a peace deal, saying “we can’t point to anything particularly promising” in the talks.  Optimism had been growing after Russia said it would scale back its military activities around Kyiv as a goodwill gesture, but overnight there have been reports of renewed Russian shelling in areas surrounding Kyiv.

Germany and Austria have taken the first steps in contingency plans for rationing gas, in the event Russia cuts of supplies if the two countries refuse to pay in rubles.  The German plan would involve first cutting off gas supplies to non-essential industry while prioritising households.  Any major disruption to European energy supplies would significantly increase recession risk while exacerbating inflation pressures.  Russia said it wouldn’t immediately demand payment in rubles and it would take time to switch to a ruble-based payment method.   Meanwhile, a Russian politician floated the suggestion that Russia could demand payment in rubles for other commodities, including wheat and metals.

German annual inflation surged to 7.6% y/y in March, its highest level since at least the early 1990s and much stronger than market expectations of 6.8%.  In Spain, annual inflation hit a 40-year high of 9.8% (8.4% expected).  These preliminary inflation releases do not have the full breakdown of drivers, although higher energy costs are sure to have played a significant role.

In a fresh milestone for the German bond market, the 2-year bond rate is back in positive territory for the first time since mid-2014.  The 2-year rate jumped as much as 12bps at one point after the upside surprise to German and Spanish inflation before ending the day 6bps higher, just above 0%.  The market now prices just over 60bps of ECB rate hikes by the end of the year. European 10-year bond rates were 2-4bps higher on the session, despite a pullback in US bond rates.

The US 10-year rate is trading around 2.36%, a few basis points below yesterday morning’s close and well down on the 2.55% level seen a few days ago.  The US 10-year rate is still more than 60bps higher than it was earlier in the month so some consolidation in rates isn’t a huge surprise.  A day after briefly inverting, the US 2s10s yield curve has steepened up a touch, to 3bps.  The market prices the 2s10s curve to fall as low as -45bps in a year’s time, a reading which historically would been associated with a subsequent recession.  Writing in a Bloomberg opinion piece, former NY Fed President Bill Dudley said the Fed was well behind the curve, making a hard landing “virtually inevitable.” 

Also helping to provide some stability to the bond market, the Bank of Japan announced an upsized bond buying operation yesterday.  The BoJ has conducted multiple interventions in the bond market this week, previously offering to buying unlimited amounts of bonds at a fixed rate of 0.25% to enforce its 10-year yield target.  The 10-year Japan bond rate edged down to 0.23%, now a few basis points below the BoJ’s tolerance threshold of 0.25%.

The USD is broadly weaker over the past 24 hours, extending its losses from the previous session.  The pullback in US bond yields has seen USD/JPY fall back to below 122, from above 125 a few days ago.  The EUR has appreciated to 1.1155, its highest level in almost a month, on the back of the repricing in ECB rate hike expectations.  Against a weaker USD backdrop, the NZD has pushed up to around 0.6980 this morning, having almost touched 0.70 overnight.  The NZD/AUD cross has also rebounded back to near the 0.93 mark.

In US economic data, the US ADP employment survey showed a 455k increase in jobs in March, close to market expectations.  ADP has had an unreliable track record as a predictor of payrolls over the past few years and there was no market reaction.  The consensus is for a nonfarm payrolls gain of 490k, although Pantheon Macroeconomics warn that Homebase data points to a much weaker result, at face value closer to zero.

Going against the grain of recent Fed commentary, Atlanta Fed President Bostic offered some more cautious remarks yesterday, saying if Fed moved too aggressively it could hurt the economy (evidently Bostic is not an advocate for 50-point moves).  Bostic, who is not a voter on the FOMC this year, added the Russia-Ukraine war had increased uncertainty to the outlook for both demand and inflation.  Despite Bostic’s comments, we would view the lack of pushback amongst core FOMC members (including Powell and Williams) on a 50bps move as an implicit endorsement of market pricing.

Yesterday was another wild day in the domestic rates market, with big swings in both directions.  Early in the session, NZ rates ignored the overnight moves in global bonds, with the 2-year swap rate pushing as much as 6bps higher – to a new cycle high of 3.34%.  But as Australian and US rates fell further through the trading session, momentum shifted, and NZ rates were pulled lower into the market close.  On the day, the 2-year swap rate ended 1bps higher and the 10-year rate 6bps lower, with the global flattening trend spilling over to New Zealand.  Market expectations of RBNZ tightening remain elevated, with 44bps of hikes priced into the April meeting (i.e. a ~75% chance of a 50bps hike) and 46bps for the May meeting.  The terminal rate for this cycle is priced by the market around 3.70%.

Yesterday’s March ANZ business survey was less downbeat than February’s edition, with a welcome, albeit modest, lift in the Own Activity indicator and a rebound in employment intentions.  At face value, the increase in employment intentions is consistent with further falls in the unemployment rate.  There was no let-up in inflationary pressures either with pricing intentions hitting a new record high – a staggering (net) 80.5% of businesses intend to raise prices.  Our current forecast for the OCR is for a long series of consecutive 25 basis point moves through to a peak of 2.75% by February 2023 although we recognise that, with inflation so elevated and the unemployment rate so low, the decision on whether to hike by 25bps or 50bps in the near term is a finely balanced one.  As noted above, the market already ascribes a high chance to back-to-back 50bps hikes.

The Chinese PMIs are released this afternoon and are expected to weaken a little, in part due to the lockdowns in Shenzhen and Jilin which impacted more than 45m people.  The US core PCE deflator, the Fed’s preferred inflation measure, is released tonight and is expected to hit an annual rate of 5.5%, which would be its highest since the early 1980s.  New York Fed President John Williams is also on the speaking circuit tonight.