Despite data that should support sentiment, markets adopt a softer more cautious tone, with added concerns out of Europe

By Jason Wong

In a reversal of recent trends a mild risk-off sentiment has developed, with lower equities and lower bond yields.  The risk off tone sees JPY at the top of the leaderboard, the commodity currencies near the bottom, and the USD facing some downward pressure.

There was enough good US economic news to drive markets further along the reflation trade path, but a sense of exhaustion seems to have appeared and resistance to push along further has been met.  After a rare 7-day winning streak for the S&P500, the equity market has a softer tone. 

Economic releases showed strong US housing starts and permits, a Philly Fed business confidence survey that rocketed to its highest level since 1984 (businesses love Trump), smoothed jobless claims remained near record lows after adjusting for population growth, and a Bloomberg consumer comfort index climbed to a 10-year high (despite media perception, consumer confidence has also rocketed ahead after the US election).

Under normal circumstances, this news would have sent US Treasury yields and the USD higher.  A sense of market exhaustion was already evident yesterday, when yields rose only modestly after the much stronger than expected CPI inflation data.  The market has been short US Treasuries for some time and it is going to take a more significant shock to break the 10-year rate out of the well-established 2.30-2.60% trading range.  Rates are 3-4bps down across the curve, with the 10-year rate at 2.45%, in the middle of the range.

The recent stronger activity and inflation figures and Yellen keeping her options open, haven’t seen the market move to expecting a March tightening.  Near-term rates have peeled off a little and Bloomberg’s calculation shows a 45% probability of a March rate hike priced into the OIS curve, while Fed Funds futures put the probability at more like 38%. CME Group’s calculation puts the probability at closer to 22%. In a Bloomberg TV interview the Fed’s Fischer echoed Yellen’s comments, putting the Fed on a path “that we more or less expected” to raise interest rates.

Another factor for lower US yields overnight might have been the downward pressure seen in European rates.  ECB minutes showed that the central bank might have to bend its own rules with regards to its bond buying programme due to supply constraints, deviating weightings away from its capital key – that might mean more purchases of peripheral bonds.  That triggered a narrowing of peripheral 10-year yields to Germany, with Italy, Spain and Portugal 10-year yields down 9-10bps compared to Germany’s 2bps fall.

Global forces have been the dominant driver of kiwi rates this week and that saw yields higher across the curve yesterday and a slight steepening.  The 2-year swap rate closed up 1.5 bps to 2.385% and the 10-year rate rose by 3 bps to 3.57%.  The government’s tender of 2025 bonds saw solid support in the context of upward pressure on yields.  Longer dated bond yields ended the day up 5-6 bps, with today’s bias likely to be one of lower yields.

Jason Wong is on the BNZ Research team. All its research is available here.