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Higher inflation expectations drive US 10-year rate above 1.20%. Equity market unperturbed, with S&P500 posting fresh high. Yellen tells G7 Finance Ministers to "go big" on fiscal policy. NZD/AUD drifts down further to 0.93

Higher inflation expectations drive US 10-year rate above 1.20%. Equity market unperturbed, with S&P500 posting fresh high. Yellen tells G7 Finance Ministers to "go big" on fiscal policy. NZD/AUD drifts down further to 0.93

Ahead of the long weekend in the US, the S&P500 rose 0.5% to close at a record high while the US 10-year rate closed above 1.20% for the first time in almost a year. Currency markets were dull by comparison, with the NZD flat at 0.7220 and losing further ground to the AUD, with NZD/AUD down close to 0.9300.

Last week was one of the dullest in a while but global equities still squeezed out some modest gains to post fresh record highs, both the S&P500 and the MSCI World Index achieving that milestone. The S&P500 rose by 0.5% to end the week 1.2% higher. The gains have been attributed to further momentum towards sealing the forthcoming massive fiscal stimulus package, strong corporate earnings and the US striking a deal for another 200m vaccine doses for COVID19. The US has now ordered 600m vaccines from Pfizer and Moderna, enough to cover 300m citizens by the end of July. Daily new infection rates in the US continue to steadily decline and are now down to levels last seen in October.

The equity market ignored the drop in consumer sentiment to a six month low against expectations for a small rise. The market was also unperturbed by higher US bond yields. The 10-year Treasury yield moved higher through the session and punched up through the 1.20% mark after data showed 1-year inflation expectations rising to a 6½-year high of 3.3%, while 5-year ahead expectations held at its top-of-the-range level of 2.7%. Higher inflation expectations being the cause of the fresh high in the 10 year rate is reflected in the fact that the implied break-even inflation rate from inflation-indexed bonds is at a 6½-year high of 2.23% while the real 10-year rate continues to hover around the minus 1% mark.

The 1-year inflation expectations figure was likely linked to higher gasoline prices, but in a market nervous about the potential for inflation to take off, due to too much stimulus, the data were noticed. The 1.21% close was the high for the day and the highest close in almost a year. Looking at the charts, there doesn’t look to be much resistance ahead of the 1.50% mark now.

Treasury Secretary Yellen told G7 Finance Ministers the importance of providing further fiscal support and emphasised that “the time to go big is now”, highlighting her dovish credentials and adding to concern that the government is at risk of over-stimulating the US economy and driving inflation higher. The proposed $1.9t fiscal relief package is some 9% of GDP on top of the 4% of GDP fiscal support package currently in train that was agreed just before Christmas.

Currency movements overall were modest again. GBP was one of the better performers. UK GDP for Q4 rose by double market expectations at 1.0% q/q, albeit capping off a poor year overall. While that had little impact on the market, sentiment might have been supported by a report showing the latest COVID19 reproduction factor or “R0” value dropped to 0.7-0.9, the lowest since July, giving confidence that the UK is getting on top of the infection rate.

The NZD remained range-bound all week and was flat for the day around 0.7220. The AUD slightly outperformed again, closing the week around 0.7760 and dragging NZD/AUD down below 0.93 and closing the week around that level. In Europe, Draghi officially became Italy’s latest Prime Minister with a big majority, after winning the backing of almost every large political party and giving the country hope for the future. EUR was tightly range-bound and finished the week at 1.2120.

In the domestic rates market, NZGB’s outperformed swaps, with steady government rates against steeper curve pressure in swaps, with the 10-year swap rate up 4bps to 1.42%. For the third week in a row, the RBNZ will keep its LSAP schedule for the week ahead unchanged, seeking to buy $570m of NZGBs. The market will be interested in the 24 February MPS for an update on guidance for the programme. On recent macro trends the need for the RBNZ to maintain such a high purchase rate is fading, so some tapering seems likely over coming months.

NZ moves to a higher alert level for three days after the discovery of three new cases of COVID19 in the community in South Auckland. This will affect activity more in Auckland than the rest of the country but will barely cause a ripple unless the restrictions are extended. However, it is a reminder of how we are still living amidst a global pandemic, adding to the uncertainty overhanging the outlook, a factor which the RBNZ will be taking into account in its policy deliberations.

The week will be off to a quiet start with the US public holiday Monday. In the week ahead, key data releases include global PMIs at the end of the week. Ahead of those, are US retail sales and Australian employment data. Only second-tier releases are scheduled for NZ.

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