Market sentiment improves - equities, commodities, global rates all higher. US 10-year rate recovers back to 3%. GBP outperforms after Johnson announces resignation. EUR under pressure with fresh 20-year lows overnight

Having been gripped by recession fears over recent weeks, markets are trading with a more upbeat tone overnight.  US equities and commodity prices are higher, the US 10-year rate is back to 3%, while global growth-sensitive currencies, including the NZD, are stronger.  The EUR remains under pressure though, falling to 1.0150 and bringing parity into closer view.  The nonfarm payrolls release is the key market focus in the session ahead.

Market sentiment has improved over the past 24 hours, with recession concerns appearing to ease a little.  The improvement in sentiment has been attributed, at least in part, to a Bloomberg report that China is considering letting local governments sell an additional $220 billion (~1%/GDP) of special bonds in the second half of the year, to fund infrastructure investment, as policymakers try to shore up an economy which has been battered by Covid restrictions.  Copper prices, which have slumped over the past few months, have rebounded 4% overnight while most other industrial commodities are also higher, consistent with investors taking a less negative view of global growth.  Likewise, equity markets are higher across the board with the S&P500 up 1.5%, the NASDAQ up 2.3% while the EuroStoxxx 600 index was almost 2% higher for the second day in a row.  The rebound in risk assets may also simply reflect a recovery from oversold levels.

While Chinese policymakers are reportedly considering boosting stimulus, the threat of renewed Covid restrictions remains live.  Shanghai reported another two Covid cases outside of quarantine yesterday and the (very infectious) BA.5.2 Omicron subvariant has been detected in Beijing.

Global rates have pushed higher for the second day running.  The US 10-year rate, which hit an intraday low of 2.75% the previous night, has rebounded back to 3%, while the German 10-year rate has jumped 11bps, to 1.31%.  Higher oil prices (Brent crude +4%) have supported the move higher in rates via higher inflation expectations (US 10-year breakeven inflation +4bps).  Yield curves have steepened although, notably, the 2y10y US curve remains inverted, which has historically been a warning signal of future recession.  We think global rates are likely to remain in a choppy range for now with high inflation and hawkish central bank messaging impediments to a significant fall in rates while lingering recession concerns are likely to cap the upside.

There has been no let-up in the hawkish rhetoric coming from Fed officials, despite recent weaker activity data.  Overnight, Fed Governor Waller reiterated the message from the FOMC minutes, saying “we need to move to a much more restrictive setting“, adding he wanted to do so “as quickly as possible.” Like most of his colleagues, Waller favours a 75bps hike later this month, while he said he was “probably ” inclined to hike by 50bps at the subsequent meeting in September, although there is a lot of water to go under the bridge between now and then.  Separately, St Louis Fed President Bullard reiterated his support for a 75bps hike later this month, something the market sees as highly likely (85% priced in).  Both officials were optimistic the US could avoid a proper (as opposed to ‘technical’) recession.

Commodity currencies have rebounded overnight amidst the recovery in risk sentiment and commodity prices.   The AUD has led the charge, up around 0.8% over the past 24 hours to back above the 0.68 mark.  The AUD may also have benefited from news that the Australian and Chinese foreign ministers plan to meet on the sidelines of the upcoming G20 meeting, offering a chance to improve relations which have been strained over recent years.  The CAD and NZD are both around 0.5% higher, with the NZD trading this morning around 0.6180.

The GBP has been the other key outperformer overnight, with the market seemingly taking Boris Johnson’s inevitable resignation as a positive for the currency.  Press reports suggest Johnson wants to stay as caretaker prime minister until October, with the timing of the leadership contest set to be announced next week, although MPs are pressing for him to step down sooner.  The GBP is 0.8% higher over the past 24 hours and has recovered to back above 1.20.

In contrast, the EUR remains under pressure, falling to a fresh 20-year low below 1.0150 and bringing parity into closer view.  The EUR is down almost 2.5% this week alone against a backdrop of continued concerns around an energy crisis in the region.  There has been no let-up with gas prices in Europe, with natural gas futures rising another 6% overnight to €183, their highest level since March.

Economic data has been second tier and not market moving.  Initial jobless claims nudged up to 235k, continuing their gentle trend higher over the past three months, with the four-week moving average reaching its highest level since last December.  The US trade deficit was slightly smaller than expected, seeing a modest upward revision to the Atlanta Fed’s GDPNow estimate for Q2 growth from -2.1% to -1.9% (q/q, ann’lsd).  The market is much more focused on the nonfarm payrolls report due tonight, with consensus looking for a healthy 265k monthly jobs gain and for the unemployment rate to hold steady at an ultra-low 3.6%.

NZ rates were higher yesterday, taking their direction from global moves the previous night.  The 2-year swap rate rebounded 4bps, to 3.80%, while the 10-year rate was only 1bps higher.  The interest rate spread between NZ 10-year swaps and those of the US and Australia reached their lowest levels of the year yesterday as market expectations for the RBNZ converge towards Fed and RBA expectations.