Risk-on mood continues post the FOMC meeting. Wall Street up strongly, capping off best month since 2020. Equity markets supported by lower bond rates

Equity markets extended their post-FOMC rallies on Friday, capping off a very strong month (S&P500 +9.1%, NASDAQ +12.4%).  US and European economic data were stronger than expected, but there was little response from the bond market, with 10-year rates continuing to push lower.  NZ rates had a massive fall last week (more than 30bps across the swap curve) in response to the moves offshore.  The JPY continued its recent resurgence against a backdrop of lower US Treasury rates while the NZD closed the week just below 0.63.  It’s another big week ahead, with the ISM Manufacturing survey out tonight, nonfarm payrolls on Friday and the RBA and Bank of England both expected to raise rates by 50bps.  Domestically, the HLFS labour market due on Wednesday is likely to show a further fall in the NZ unemployment rate to a fresh low.

The US Employment Cost Index (ECI), the most comprehensive measure of US wage growth, was stronger than expected, with private sector wages and salaries increasing by a sizeable 1.6% over the quarter, taking its annual rate of wage inflation to 5.7%.  Average hourly earnings data from the nonfarm payrolls report had been suggesting some moderation in wage pressure, but the ECI tells a different story, with wage inflation still running much too high for comfort for the Fed.  Separately, the Fed’s preferred inflation measure, the core PCE deflator, increased to 4.8% y/y, slightly higher than expected, and still way above the Fed’s 2% target.  The market is priced for a rapid normalisation in US inflation over the coming 12 to 18 months, with CPI inflation expected to fall from its current 9.1% to just 2.75% by the end of next year. The greater risk would appear to be that US inflation falls more slowly than what is priced.  Elsewhere, the Chicago PMI was disappointing, falling to its lowest level since mid-2020, at 52, and pointing to downside risks to tonight’s national ISM manufacturing survey.

Atlanta Fed President Bostic was the first of the Fed speakers to comment since last week’s FOMC meeting, although there was nothing contentious in what was said.  Bostic pushed back against the idea the economy was in a real (rather than ‘technical’) recession and said the Fed would likely “have to do more” tightening, although how much would depend on the data.  There was no major pushback against the fall in Fed rate expectations since the meeting, consistent with the Fed’s desire to provide less forward guidance to the market and let the data do the talking.  Like Bostic, Minneapolis Fed President Kashkari sounded hawkish on inflation but didn’t provide any policy guidance.

US short-end rates saw a modest rebound on Friday after their post-FOMC and GDP falls, the US 2-year rate increasing 2bps to 2.88%.  But the 10-year continued to push lower, down 3bps to 2.65%, as investors unwound short positions in bonds.  Month-end related bond demand may also have been a factor in pushing down longer-term rates.

Equity markets capped off a good week with another strong performance on Friday, the S&P500 increasing 1.4%, the NASDAQ up almost 2% and the EuroStoxx 600 index was up by more than 1% for the second day running.  Over the month, the NASDAQ was up more than 12% and the S&P500 more than 9%, their best monthly performance since 2020.  Of course, the rebound in equities needs to be seen in the context of the substantial falls earlier in the year that saw both indices enter ‘bear markets.’  The rebound in July owed much to the repricing of bond rates (US 10-year real yield -56bps on the month) and somewhat less pessimism around the economic outlook. Speculative investors bailing out of short positions in equities was probably also a factor.  The question is whether this is marks a sustainable turnaround or simply a correction within a broader downtrend.

Also helping market sentiment on Friday were strong earnings reports from tech heavyweights Apple and Amazon.  Amazon’s share price rocketed more than 10% higher after beating expectations for revenue and earnings and reporting progress in its cost cutting measures while Apple was up a more subdued 3.3%.  Given their sizeable weights in the broader equity indices (more than 10% combined in the S&P500), this flowed through to broader equity market performance on Friday.

In Europe, Eurozone GDP growth for Q2 was much stronger than expected at 0.7% (0.2% expected), largely due to strong growth in France, Spain and Italy (helped by a rebound in tourism), partially counterbalanced by flat quarterly growth in Germany.  While this implies a stronger starting point for the Eurozone economy, the market is much more focused on the collapse in leading indicators of activity, which point to negative growth ahead. Meanwhile, Eurozone inflation hit a fresh record high of 8.9% y/y, as foreshadowed by the strong German inflation data the day before.  Energy and food prices remain significant contributors to Eurozone inflation (+39.7% y/y and +9.8% y/y respectively) but they are far from the only story, with core (ex food and energy) inflation hitting 4%, a fresh high for this series.  The market is still pricing a high chance of a 50bps hike from the ECB at the upcoming meeting in September but only around 50bps of additional rate hikes beyond that point.  The EUR was modestly higher on Friday, to back above 1.02, little changed on the week.

Elsewhere in currency markets, the JPY continued its recent resurgence, strengthening 0.8% on Friday against a backdrop of lower US Treasury rates, bringing its gains on the week to over 2%.  USD/JPY closed at its lowest level in over month, just above 133.  The USD was broadly weaker last week amidst the recovery in equity markets, broader improvement in risk sentiment, and paring back of Fed rate expectations.  The BBDXY index is now around 2.5% off its recent multi-year high.  The NZD was only slightly higher last week, ending the week just below the 0.63 mark.

The Official Chinese PMIs were released over the weekend, with the Manufacturing PMI falling back into contractionary territory, at 49, while the non-manufacturing index slipped to 53.8.  The ever-present risk of new Covid restrictions in China and the slowdown in the property sector continue to weigh on activity.

In more positive news for Europe, Bloomberg reported the leader of the right-wing Brothers of Italy party, which is currently leading in the polls, plans to abide by EU fiscal rules and stick with previously agreed economic reforms if it comes to power after the upcoming election.  This is critical for Italy as it would allow it to continue receiving funds from the EU recovery fund and enable the ECB to purchase Italian bonds under its recently announced “Transmission Protection Instrument.”   The Italy-Germany 10-year bond spread fell 14bps on Friday, to 220bps, in response to the news, although the spread remains significantly higher than it was earlier this year.

NZ consumer confidence remained severely depressed in July, with the ANZ survey still sitting below the levels reached during the GFC and the early stages of the Covid outbreak in 2020.  The highlight domestically this week is the HLFS labour market report on Wednesday.  We’ve pencilled in the unemployment rate falling to a fresh low of 3.1%, although leading indicators point to the risk of an even stronger result, including a chance the unemployment rate could fall below 3%.

Domestic rates saw further big falls on Friday in response to the moves in offshore markets.  The 2-year swap rate was down 13bps, to 3.74%, as the market continued to pare back RBNZ rate hike expectations.  The market now prices the peak in the cash rate at around 3.8% and expects rate cuts from the RBNZ starting in 2023.  The 10-year rate was down 8bps, to 3.58%, leaving it at its lowest level in almost four months.  Swap rates across the curve were more than 30bps lower last week, a huge weekly move in normal times but in keeping with recent extremely elevated volatility.  Global drivers, rather than domestic developments, remain the key influence on NZ rates at present.

The ISM survey is the key data release tonight, with the market looking for a modest fall in manufacturing activity.   The nonfarm payrolls report takes centre stage later in the week, with the market looking for another robust month of job gains (250k expected).  The RBA is widely expected to raise rates by 50bps at the meeting tomorrow, which would take the cash rate to 1.85%, and majority of economists expect the same from the BoE later in the week.  The BoE is also due to formally announce its plans for ‘quantitative tightening’, with the market focused on how it plans to go about selling down its large bond holdings.