Global equities have made small gains overnight and the US 10-year rate has pushed a few basis points higher, following stronger than expected employment and ISM services data. Currency moves have been small overnight, but the NZD has given up some of yesterday’s post-employment report gains, which drove a further sharp increase in rates.
US equities have spent much of the overnight session in positive territory, with the S&P500 currently up 0.2%, helped by a 7+% gain in Alphabet, after its strong result after the bell yesterday. Amazon also recorded a strong result but the stock is trading flat. The results highlighted how well big tech is doing in the pandemic environment. Energy names are outperforming as oil prices continue to rise. WTI crude is up 2½%, breaking USD56, its highest level in a year, consistent with the reflation theme which is boosting commodity prices. The US 10-year rate is up 3bps to 1.13%, with 2bps of that increase reflected in a higher break-even inflation rate.
The US ISM services index for January came in stronger than expected, driven by a rise in new orders and the employment index returned to an expansionary reading. Separately the ADP employment increase was also stronger than expected, setting the scene for some positive non-farm payrolls growth when released at the end of the week. The data reinforced the idea that the third wave of COVID19 hasn’t done as much economic damage as expected and the US economy is on a better footing, at least for the short term, than the euro area economy. A better vaccine rollout in the US compared to Europe and a big fiscal stimulus also weigh in favour of the US.
That narrative is keeping the EUR under pressure, which is on the soft side staying just above the 1.20 mark. The announcement that well-respected ex ECB President Mario Draghi (and ex Super-hero from a markets perspective for his ability to navigate through the European debt crisis) accepted a mandate to form the next Italian government supported Italian bonds (its 10-year spread to Bunds falling 9bps), but the euro was unmoved. It remains to be seen whether Draghi can secure sufficient backing to get a workable coalition.
Core CPI inflation in the euro area jumped higher to 1.4% y/y in January, but much of this reflecting expiring temporary tax reductions in Germany, something the consensus didn’t capture in its estimate, even though German CPI data released last week showed the same pattern.
The NZD is the best performer of the major currencies relative to this time yesterday, up 0.7% to 0.7200. It got off to a good start for the day after Fonterra upgraded its FY21 forecast farmgate milk price by 20 cents to a range of $6.90-$7.50 per kgMS. The NZD was further boosted by the surprisingly strong employment report, however, it has lost some ground overnight after peaking at 0.7225 yesterday afternoon.
The Household Labour Force Survey showed strong employment growth driving a fall in the unemployment rate to 4.9% – a remarkable result when nine months ago we were staring in the face of the possibility of a double-digit unemployment rate. Wage data showed the private sector LCI up 0.5% (or 2% annualised), consistent with the midpoint of the RBNZ’s 1-3% CPI inflation target range. The data added fuel for expectations of policy tightening next year, driving NZ rates and the NZD higher.
By the close, some 4bps of tightening was priced for February 2022, one year from now, while a full 25bps tightening is priced towards the end of 2022. BNZ’s economics team pencilled in a first rate hike for the cycle for May 2022. NZGB and swap rates closed at 9-10 month highs, with the 2-year swap rate up 4bps to 0.36% and the 10-year rate up 9bps to 1.37%. The Treasury launched the new May 2026 bond with price guidance of 14-18bps over the April 2025 bond. The higher rates backdrop – with the launch coming after the employment figures were released – saw good demand, well covered at the maximum issue size of $4b.
It is fair to say that a lot has changed since the RBNZ’s November MPS. The Bank will need to factor in the recent run of much stronger CPI and labour market data (the Bank meeting, or close to meeting, both its inflation and employment mandates), the global rollout of vaccines that brightens the global economic outlook and the booming housing market for which we saw one agent quoted as saying it was a “feeding frenzy”. Someone awakening from a coma might wonder why the RBNZ would be trying to suppress interest rates at this point. The scene has been set for an interesting policy update on the 24th, with the RBNZ having to tiptoe between a surprisingly better economic backdrop and reluctance to stand out from the crowd of dovish developed country central banks.
On that note RBA Governor Lowe expanded on the RBA’s (dovish) policy outlook in an afternoon speech. He noted that the RBA might need to consider shifting the yield curve control target from April 2024 to November 2024, consistent with his view that the cash rate is likely to remain unchanged for at least the next three year. But what caught our eye was Governor Lowe admitting that part of the reason for extending QE earlier in the week was because of “the decisions of other central banks”, highlighting that the RBA’s reaction function is overly sensitive to the AUD outlook. Governor Orr might well adopt a similar strategy.
This probably held back the performance of the NZD, with the currency in the middle of its recent 0.71-0.73 range despite the new information on the labour market. NZD/AUD rose to a high of 0.9487, but has since retreated to 0.9440, only 20 pips higher from the pre-employment data level. NZD crosses are modestly higher form this time yesterday, but all lower from the NZ close.
Today, the ANZ releases its preliminary business outlook survey, and we’ll be interested to see whether activity and inflation indicators remain on an upward path. The first Bank of England monetary policy update after the EU-UK trade agreement isn’t expected to cause any fireworks, with no change to rates or QE programme, with plenty of headroom still available in the latter. More interest will lie in its study of the feasibility of negative rates.