A robust US nonfarm payrolls report and further steps by China to loosen Covid-19 restrictions have pushed global rates higher, with the US 10-year rate breaking back above 3% overnight. The higher rates backdrop has hit US equity markets, with the S&P500 around 1.5% lower than Friday morning’s close. The USD is broadly stronger, sending the NZD back below 0.65 and USD/JPY up to a fresh 20-year high, just below 132. It’s a big week ahead. The RBA is expected to raise rates today, with the market roughly split between a 25bps hike and a 40bps move, and US CPI data and the ECB policy meeting later in the week.
Starting with the nonfarm payrolls data from Friday night, the monthly report showed still solid job growth, an ongoing recovery in labour force participation and, encouragingly, no further acceleration in wages growth. Non-farm payroll growth of 390k was stronger than the 318k consensus, but a little lower than the 428k gain in April. The pace of employment growth has moderated this year, albeit to a still healthy pace, with the three-month moving average of payrolls gains now its lowest since early 2021. The unemployment rate was steady at 3.6% as jobs growth was counterbalanced an increase in the labour force participation rate. Importantly, average earnings per hour grew 0.3% m/m against expectations for a 0.4% rise, continuing the trend of moderation in this measure of wage growth over the past six months. The verdict is still out as to why the monthly pace of average hourly earnings growth has eased this year even though the labour market is even tighter than it was six months’ ago, but, on the face of it, it does add some weight to the argument that core inflation pressures might start to ease going forward. The all-important US CPI release comes out later this week.
The market saw the payrolls report as confirming that the Fed will need to keep up its aggressive pace of rate hikes in the coming months, a view reinforced by hawkish subsequent comments from Cleveland Fed’s Mester. Mester reiterated her support for 50bp moves at the next two meetings while implying the September meeting was a choice between hiking 25bps or 50bps, not pausing as her colleague Bostic had recently suggested, saying “if I don’t see compelling evidence, then I could easily be a 50 basis-point in that meeting as well.”
US rates increased modestly post-payrolls and they have extended those moves overnight, with the US 10-year rate breaking above 3% for the first time in three weeks. It is currently trading at 3.03%, around 12bps higher than the NZ market close on Friday afternoon. The market is pricing 144bps into the Fed’s next three meetings, indicating a high chance of 50bps hikes at each, while the US 2-year rate is around 8bps higher than Friday morning’s close, at 2.73%. Ahead of the ECB’s policy update this week, at which the Bank is almost certain to announce the end to net asset purchases and set the stage for a rate hike in July, the German 10-year bund yield has pushed up to a fresh eight-year high, at 1.32%. Bank of America is now calling for two 50bps ECB hikes by the end of the year.
US equity markets were down heavily on Friday after payrolls (S&P500 -1.6%, NASDAQ -2.5%) amidst firming Fed rate hike expectations. The ‘good news is bad news’ mindset still appears at play with the equity market, whereby stronger economic data is seen as increasing the chances of more aggressive tightening, in turn increasing medium-term recession risks. Meanwhile, not helping the mood, Tesla slumped 9% on reports Elon Musk was planned to cut 10% of its workforce, the latest in a string of tech firms to announce hiring freezes or layoff plans, with Musk citing a “super bad feeling” about the economy.
There has been some stabilisation in risk sentiment overnight, with US equities recovering some of those losses from Friday (S&P500 +0.4%), even as rates have pushed even higher.
Helping the stabilisation in sentiment, the WSJ reported that Chinese regulators were planning to lift restrictions on ride-hailing app Didi, seemingly confirming the shift away from the regulatory crackdown on tech firms as the Chinese authorities pivot towards supporting the economy. Separately, China announced a further easing in Covid restrictions, with public transport to resume in most of Beijing, which will allow most workers to return to the office, while restaurants and cinemas in the city will be allowed to reopen. Copper prices are 2.5% higher overnight and nickel 5% while the CSI300 equity index was almost 2% higher, symptomatic of less pessimism around the Chinese growth outlook. It remains to be seen whether China can keep Omicron out, with Shanghai reporting three new cases out of quarantine on Sunday.
The USD is broadly stronger since Friday against a backdrop of higher Fed rate expectations and still cautious risk sentiment. The BBDXY index is around 0.6% higher than it was on Friday morning, with the USD gaining against all the G10 currencies.
JPY has been a notable underperformer amidst the surge in US Treasury yields, with USD/JPY blasting up to almost 132, a fresh 20-year high. BoJ Governor Kuroda reiterated that “monetary tightening is not at all a suitable measure” for Japan at this point, signalling that the BoJ has no intention of folding into line with other central banks’ tightening plans. The GBP hasn’t been too ruffled by the confidence vote in UK PM Johnson, which he is expected to win (results expected shortly), outperforming the other majors overnight. Despite generally stronger commodity prices, the AUD and NZD are both around 1% lower than Friday, with the latter falling back below the 0.65 mark.
In other economic data, the US Services ISM (released Friday night) was a touch softer than expected at 55.9 (from 57.1), continuing its recent downtrend. That was its lowest reading since February 2021 but the 24th consecutive month in growth territory. In China, the Caixin Services PMI rebounded only modestly, to a still contractionary 41.4, although there was no market impact with investors looking ahead to easier Covid restrictions in the country.
In other news, Bloomberg reported that the semiconductor shortage, which has played a part in recent supply chain disruptions, may be starting to ease. Mercedes, Daimler, and BMW were all receiving enough semiconductors to produce at full capacity, a welcome change for an industry which has been crippled by shortages. New and used car prices have been a major contributor to higher US core inflation over the past two years, albeit far from the only factor. But this inflationary impulse has recently started to ease, a trend likely to continue if supply chain issues with semiconductors are indeed moderating.
It was a quieter end to the week for domestic rates market on Friday with swap rates little changed around the curve but a slight steepening bias evident. The short end of the curve appears to have some stability with terminal cash rate pricing at around 4%. Government bonds were 1-3bps higher across most of the curve, unwinding some of their recent significant outperformance against swaps.
Today sees the RBA meeting where economists are divided between whether it will raise its cash rate by 25bps or 40bps (with a few even calling for a 50bps hike). The rationale for a 40bps hike, not a standard increment for central banks, would be to return the cash rate to a ‘round’ 0.75%, still extremely low in the context of a super-tight labour market and well above-target inflation. The market is pricing 33bps for the meeting, indicating a roughly even chance of a 25bps hike and a 40bps move.
As for the rest of the week, the key focus offshore is the US CPI release and the ECB meeting. For CPI, the consensus is looking for a 0.7% monthly increase in headline inflation, which would see the annual rate steady at 8.3%, and a still-too-high 0.5% increase in core inflation (5.9% y/y expected). The ECB’s meeting on Thursday night should see the announcement of a well telegraphed end of asset purchases and set the stage for the first interest rate rise at the following July meeting, with market attention likely to be focused on how open Lagarde is to a potential 50bps move. While the ECB is all but certain to announce the end to bond purchases by early next month, the FT reports that most committee members are in favour of setting up a new backstop bond buying facility for weaker sovereigns, such as Italy, which could be deployed if these bond markets come under significant stress, with details on the scheme possible this week. Locally there are more ‘partial’ indicators of GDP, which will help firm up estimates for GDP, released next week. As things stand, we anticipate a flat result on Q1 GDP, well below the RBNZ’s 0.7% MPS forecast.
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