Federal Reserve seen hiking 25 basis points next week after 'stagflation-like' GDP release

By Jason Wong*

Following a stagflation-like US GDP print, the market focused on the higher inflation component, driving US Treasury yields higher. A stronger USD after the release wasn’t sustained and it is flat on the day, with commodity currencies modestly outperforming, seeing the NZD just under 0.6150. Higher rates have done no harm to US equities, which have bounced back, supported by stronger earnings from big tech.

US first quarter (Q1 GDP) data conveyed a picture of stagflation, with weak growth, softer than expected, and strong inflation, higher than expected – annualised growth of 1.1% and a core PCE (personal consumption expenditure) deflator of 4.9%, the latter implying a stronger monthly read of 0.5% month-on-month (m/m) for March (in data to be released tonight) unless the earlier months for the quarter are revised up. Weak growth was driven by a 2.3% contraction in inventories, falling residential investment, and sluggish business investment, offset by strong growth in government spending and a 3.7% surge in consumption – the latter reflecting the 8.7% cost-of-living boost to social security payments and the warmer winter. Neither of these forces will help current quarter estimates, where some project an outright contraction in growth signalling the beginning of economic recession.

In separate reports, initial jobless claims unexpectedly fell last week to 230k, against the prevailing trend, which probably just represents noise in the data. And pending home sales fell 5.2% m/m, the largest drop since September, against expectations for a 0.8% rise.

The market focused more on the inflation than growth message from the GDP print, driving rates higher, with the 2-year Treasury yield currently up 14 basis points (bps) for the day to 4.10% and the 10-year rate up 8bps to 3.53%. The data cemented in expectations for a 25bps Federal Reserve hike next week (23bps priced), while paring the scale of easing priced for the second half. Tonight’s employment cost index is arguably more important than the GDP release – if wage inflation shows further signs of slowing or stabilisation then that will support the view that next week’s hike will be the last, while an upside surprise would be unhelpful for that view.

US equities have bounced back from weakness earlier this week, with the S&P500 up nearly 2%, encouraged by the strong earnings reports from big tech so far this season, with Meta’s share price up 15%, and less worry about the banking sector, the KBW banking index performing in line with the market.

In a reversal of the previous day, commodity currencies have modestly outperformed, while the euro is on the weaker side of the ledger against a backdrop of a flat USD – the initial boost to the USD in response to higher inflation and rates not sustained. The NZD trades just under 0.6150 and the AUD at 0.6630, with the cross steady at 0.9270, after a failed attempt to sustain a break above 0.93. Other NZD crosses are modestly stronger. NZD/EUR has pushed up to 0.5575.

Yesterday, the ANZ NZ business outlook survey painted a picture of ongoing weakness in activity indicators and moderating pricing indicators, albeit the latter still remaining well above historical averages and too high for comfort.

PM Chris Hipkins delivered a pre-Budget speech where the emphasis was on a “no-frills” Budget, viz “the government is committed to reducing our proportion of spending to dampen demand in the economy”. He ruled out new taxes or a levy to pay for recovery from Auckland floods and Cyclone Gabrielle, with the rebuild to be covered from the annual operating and capital allowances, savings and reprioritisations and “some debt”.

Global forces sent domestic rates higher, with NZ swap rates up 5-6bps across the curve, seeing the 2-year rate close at 4.97% and the 10-year rate at 4.15%. Ahead of month-end, NZ government bonds outperformed, with rates up just 1- 3bps across the curve, following another successful bond tender with solid demand – bid/cover ratios around 3x-4x, and pricing just under prevailing mids.

The calendar for the day ahead is action packed. Another rock-bottom NZ consumer confidence reading wouldn’t surprise but during NZ trading hours the Bank of Japan policy update will be of some interest, the first led by new Governor Ueda. Given his comments to Parliament earlier this week, where he defended the Bank’s current ultra-easy policy stance, a continuation of that policy is widely expected, with only some tail-risk of a surprise announcement, that would trigger higher rates and a stronger yen.

European and Canadian GDP figures are released tonight, as well as German CPI data. But as previously noted, the US employment cost index is the key release, with the market expecting 1.1% in Q1 after 1.0% in Q4, which would see annual wage inflation fall further, as a 1.4% figure drops out from last year. The prior consensus estimate of 0.3% m/m for the core PCE deflator now looks too light, given the stronger quarterly figures released overnight, so any updated figure is probably closer to 0.5%. The release should also see real personal spending down in March.

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*Jason Wong is BNZ's Senior Markets Strategist. David Chaston is away this week.