US growth and inflation data sees markets accept higher change of Fed rate hikes. Local wholesale rates hit fresh lows

By Jason Wong

Strong US activity and inflation data got the market re-thinking about the outlook for US monetary policy.

The market has spent most of this year gradually pricing out the chance of any further Fed tightening in 2016, but the Fed’s preferred inflation measure – at 1.7% for the core PCE deflator – is now already above its year-end projection of 1.6%.

A number of Fed officials have noted the global financial market turbulence and strong USD as providing good reason to be cautious about the path of further tightening from here.  But at the end of the day, the US unemployment rate has already fallen to its natural rate and we are now seeing the anticipated effect on wage and price inflation.

The probability of the Fed tightening by December rose from 38% to 53% in the course of the day. More inflation data like that, and one or two tightenings could easily be re-priced back into the curve for this year.

The US 2-year rate rose by 7 bps to 0.79%, its highest level since 1 February, while the 10-year rate rose by 5 bps to 1.76%.

The local rates market on Friday was fairly quiet.  Fresh lows were set in short and long term rates, following the lead of offshore trading in the previous session. The 2-year swap rate closed down 0.5 bps to 2.42% while the 10-year swap rate fell by 2bps to 3.07%. NZ’s 10-year government bond rate (2027) fell by 1.5 bps to 2.965% a record low for the country. With the moves in the US market on Friday, expect rates to be higher today.

Coming Up

The ANZ business outlook will be closely watched for any signs of weaker business confidence at the beginning of the year, while the RBNZ is closely monitoring inflation expectations data.  Year-ahead inflation expectations have been flat at around 1.6-1.7% since May 2015.  A lurch down would add to market expectations of further policy easing.