US equities have pulled back overnight after long-term US Treasury yields extended their upward trend in the afterglow of the uber-dovish FOMC statement some 24 hours ago. The USD has recovered some of its post-FOMC losses. The NZD has been one of the weakest performers overnight, settling back below 0.72.
As we noted yesterday, the FOMC update was a market mover, seeing US equities recover and the USD slump after the Fed published some upbeat economic and above-2% inflation projections, but remained unmoved on projecting any rate hike until at least 2024. Moves in US Treasuries after the announcement were surprisingly minimal, even as currency and equity markets reacted, but in a delayed response, long-term yields surged ahead with much of the move coming from around the European open.
The 10-year rate broke up through 1.75% for the first time since early 2000 and has settled around the 1.72-1.75% mark since late last night. Decomposing the move, about two-thirds reflects higher real rates and one-third reflects a higher break-even inflation rate, the latter reaching a fresh eight-year high of 2.34%.
After yesterday’s Markets Today went to press, Powell said that the Fed won’t act on forecasts, but will wait for actual data to confirm that the economy is on track to achieve its goals before tightening policy. This was confirmation that the Fed will be “behind the curve” because in normal times monetary policy should be forward, not backward, looking given the inherent long lags between policy decisions and outcomes. It’s a recipe for higher than otherwise inflation, steeper yield curves, and ultimately a weaker USD, with the market “doing the job” that the Fed should be doing.
Powell also noted that a decision on the Supplementary Leverage Ratio would be made “in coming days”. Leniency on the SLR since COVID hit – which reduces the need for trading banks to set aside more capital when they hold more US Treasuries and deposits on account at the Fed – is due to expire at the end of the month. While this was widely anticipated to be extended, the Fed increased the counterparty limit on the overnight reverse repo facility from $30b to $80b which could signal that an extension of relief on SLR will not be made.
Higher bond rates and steeper curves have driven further sector rotation in equity markets, with Europe’s bank-heavy Stoxx 600 index showing further gains, while US equities are weighed down by underperforming big tech stocks – the S&P500 index is currently down around ½% while the Nasdaq index is down around 1½.
On the economic front, US initial jobless claims unexpectedly rose last week to 770k, breaking what looked like a slightly declining trendline over recent weeks, highlighting how weak and patchy the US labour market remained. Breaking this week’s run of weaker than expected data, the Philly Fed business outlook survey surged to its highest level since 1973, alongside a four-decade high in the prices paid index. The data was consistent with the view that the manufacturing sector is recovering nicely, while the backdrop of higher commodity prices has intensified near-term inflationary pressure. It remains to be seen how sustainable the lift in inflation will endure for.
The Bank of England’s latest policy update came and went with little market reaction, with the message as expected. The Bank upgraded the outlook for the UK economy but is not looking to tighten policy until “significant progress” is made in eliminating spare capacity and achieving the 2% inflation target sustainably – joining the chorus of other major developed central banks singing the same tune, basing policy on the rear vision mirror rather than projections.
The European Medicines Agency said that there was a “clear scientific conclusion” that the Oxford/AstraZeneca vaccine was “safe and effective” and that the vaccine was “not associated” with an increased risk of blood clots, adding that the benefits of the vaccine outweighed any possible risks. The announcement will pave the way for EU countries to reinstate the use of the vaccine and get the programme back on track. In the last hour, Italy said that it would restart the AstraZeneca vaccination programme on Friday.
Oil prices are under pressure on near-term supply/demand considerations in a market where traders have been long the commodity. Both Brent and WTI crude fell by more than 5%, exaggerated by some closing of long positions, the former now below USD64.50, after trading above USD71 earlier this month.
In currency markets, the USD has reversed about half of its post-FOMC losses, with the BBDXY index up 0.3% for the day. Since the NZ close, GBP and JPY have largely held their ground against the USD. Despite the high global rates backdrop, which would normally be negative for JPY, the currency has seen some support since the Nikkei reported that today the BoJ will amend the 10-year JGB target band to plus or minus 0.25% and scrap the ¥6b annual buying target of ETFs. USD/JPY currently trades around 109.
The NZD has been the worst of the majors, falling 0.7% overnight 0.7190 while the AUD is down only 0.4% to 0.7790.
NZ Q4 GDP came in much weaker than expected at minus 1.0% q/q, but this came on the back of the surge in activity in Q3 (revised down a touch to 13.9% q/q). The data are so dated and volatile of late, there was only a small market reaction, with the rates market slightly reducing the chance of a rate hike from early next year. The story remains one of the NZ economy struggling to gain further traction after the strong post-lockdown bounce-back, given the hit to global tourism during the summer peak, while Q1 will be affected by the couple of temporary lockdowns. Confidence and tourism will lift in Q2 if the borders reopen as soon as next month, which has been hinted by government officials.
The Australian labour market report was another blockbuster, with strong employment driving the unemployment rate down 0.5 percentage points to 5.8%, much lower than expected. The fall in the unemployment rate is now running a full year ahead of the RBA’s upside scenario, suggesting that the RBA can be more confident in the economic outlook, reducing the chance of the Bank extending the 3-year yield-curve-control target from the April 2024 bond to the November 2024 bond.
The combination of soft NZ GDP and strong Australian labour market data was likely behind some trading in the cross, with NZD/AUD down to 0.9225, near the bottom of its range this year.
In the domestic rates market, the soft NZ GDP report and backdrop of higher global rates had the effect of steepening the yield curve, with short-dated NZGBs and swaps showing small declines in yield while rates at the longer end pushed higher. The 2-year swap rate fell 2bps to 0.52% while the 10-year rate rose 3bps to 1.96%.
In the day ahead, the key event on the calendar is the BoJ’s policy announcement. After a major review of monetary policy, we expect the BoJ to tweak its policy stance, along the lines mentioned in the Nikkei report, with the Bank aiming to make stimulus more sustainable for a longer period. Governor Kuroda will be sensitive to any unwarranted tightening in financial conditions so will likely stress the Bank’s willingness to ease further, if required.