Reflationary expectations in the market continue to build. The market brushed off a weaker-than-expected US nonfarm payrolls release on Friday, instead focusing on the prospect of another huge US fiscal stimulus and Covid vaccine rollout. Equities and commodities have continued to push higher while the US 10-year rate hit its highest level since March, before retracing over the past few hours. US market-based inflation expectations have reached their highest level since 2014. The USD is on the back foot again, seeing the NZD push back above 0.72.
For the record, the nonfarm payrolls report from Friday night was disappointing, with employment rising just 49k in January while the December print was revised down from -140k to -227k. The unemployment rate unexpectedly fell to 6.3% from 6.7%, although mainly due to a decline in the participation rate (not normally a good sign).
Reacting to the Labour market report, Biden noted the report confirmed the government needed to do more. On that front, both chambers of US Congress on Friday passed a budget resolution, setting the wheels in motion for the Democrats to get their fiscal stimulus plan (currently set at $1.9 trillion, ~10%/GDP) approved without Republican support. House speaker Pelosi said her chamber would begin work on stimulus bills and “hopefully” send them to Senate in two weeks.
The market looked right through the weakness in payrolls report, presumably on the basis that the economy – including the broader labour market – will improve significantly when Covid-related restrictions are rolled back later in the year and the fiscal stimulus will give the economy a powerful boost. The S&P500 is up around 0.8% since the Thursday night close and the NASDAQ is 1.2% higher, with both indices reaching fresh all-time highs. Yesterday. the Nikkei rose 2% to its highest level since 1990.
Likewise, in the bond market, US Treasury yields dipped only briefly after the payrolls report, before heading higher again. The US 10-year yield reached an 11-month high of 1.2% overnight and the US 10-year yield 2%, although rates have, for no obvious reason, turned lower in the last few hours. The US 10-year rate is trading about 1.16% this morning, reversing most of its gains from Friday’s session.
As for currencies, the USD is on the back foot again, following its recent mini resurgence over the past few weeks. The BBDXY USD index is down about 0.7% since Friday afternoon, with the downside surprise to nonfarm payrolls contributing to its weakness. Other factors weighing on the USD include the risk-positive backdrop, ultra-low US real interest rates (US 10-year real yield still below -1%) and longer-term concerns about the US twin deficits, which the Biden stimulus plan will only exacerbate.
Against a backdrop of a weaker USD, the EUR is back above 1.20 while the NZD is trading around 0.7220, almost a cent higher than it was on Friday afternoon. The EUR has been supported by news that former ECB President Draghi was close to forming a technocratic government in Italy after the Five Star Movement and League parties signalled their support. Commodity currencies have led gains, with the NOK and AUD up around 1.5% since Friday afternoon while the NZD is about 1.2% higher. The CAD has underperformed the rest of the commodity currency bloc (+0.6% since Friday afternoon) after its own disappointing labour market report.
The market has started to price-in greater inflation risk than it has for some time. The US 10-year ‘breakeven inflation rate’, derived from the difference between conventional and inflation-indexed government bond yields, has reached its highest level since 2014, at 2.2%. The 5-year, 5-year forward US inflation swap is almost 2.5%. Rising commodity prices, with Brent crude oil breaching $60 for the first time in over a year, have added to the reflationary tailwinds.
The increase in inflation expectations in the market comes as investors debate whether the Biden stimulus plan could trigger an unexpected increase in inflation. Over the weekend, renowned economist Larry Summers – a Democrat supporter – published an op-ed in the Washington Post warning that a WWII-scale stimulus might “set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability. ” Those worried about inflation argue there will be huge pent-up demand when economies reopen, given household savings are extremely high, and this could trigger a boom in consumer spending. Treasury Secretary Yellen sought to play down the concerns, saying the greater risk was that of doing too little rather than too much, and the central bank and government had the tools to stamp down on inflation were it to become a problem.
In credit markets, US high yield (ie. ‘junk’) bond yields reached a record low on Friday, at 4.03% on an index basis. The increase in Treasury yields has been more than offset by tighter credit spreads. Similarly, the yield on the US investment-grade corporate bond index was just 17bps off its all-time low, a sign that financial conditions remain exceptionally easy, despite the increase in government bond yields.
In other news, South Africa has suspended roll-out of the AstraZeneca/Oxford University vaccine after preliminary data showed that it has little effect in preventing mild cases of the South African Covid variant. The findings were based on a small sample of 2000 people and didn’t test whether the vaccine reduced the risk of severe illness, including hospitalisation and death. Clearly, virus mutation and vaccine resistance would be an obvious risk to the market’s expectation that economies will reopen this year.
The NZ rates market was closed yesterday but the 5bp increase in yield on the Australian 10-year bond future since Friday afternoon implies NZ rates will open higher and steeper again this morning. The NZ 10-year swap closed last week at 1.43%, 25bps higher on the week. The RBNZ kept its government bond buying at $570m for this week, after slightly tapering last week.
In the session ahead, Finance Minister Robertson will outline the size and priorities of the 2021 Budget in a speech this morning. The speech will accompany the release of the 2021 Budget Policy Statement, which is usually released alongside the Half-Year Economic and Fiscal Update (HYEFU) in December but was delayed. The RBNZ’s inflation expectations survey should show further recovery in respondents’ inflation expectations. There is only second-tier data in the US tonight.