Even with a run of softer than expected US economic data, risk appetite ended last week on a positive note, with a second day of solid gains after the losses seen earlier in the week. The S&P500 rose 1.5%, the USD showed broadly-based losses and the NZD gained some 1% in Friday night trading to close the week near 0.7250. The US 10-year rate drifted lower, falling 3bps on the day to 1.63%.
Last week proved to be a rollercoaster ride for financial markets, with risk appetite falling ahead of the US CPI release mid-week, lurching lower after that shockingly strong release and then recovering nicely into the back end. Clearly, inflation pressures have been rising but we are none the wiser as to whether or not it will be transitory, a key question for investors with a medium term focus. Market reaction has been contained to the extent that the US Fed is not blinking at this juncture, remaining consistent in its message that it will be slow to remove policy stimulus, preferring to watch the economic recovery take shape before responding.
All three key US economic releases on Friday night undershot market expectations, lending some support to the prevailing “take it easy” Fed stance. Retail sales were flat in April compared to expectations of a 1% increase, but March was revised stronger so the level of sales remained extraordinarily high. The outcome was much harder to predict, given the massive impact of recent stimulus handouts, so the market brushed off the announcement.
Weak auto production, due to well-known semi-conductor shortages, were a drag on manufacturing production, but auto sales were strong in the month – thus there is no shortage of demand, just an unusual supply shock. Inventories are being run down and when constraints normalise, future production will bounce back strongly. Consumer sentiment weakened, with higher gasoline prices a likely factor. Of note, both short-term and long-term inflation expectations shot up, the latter rising to 3.1%, its highest level in a decade. The question becomes at what point does the Fed think that inflation expectations have become unanchored from the 2% mark.
In a Bloomberg TV interview the Fed’s Mester kept to the script, arguing that Fed policy was in a good place right now, and that volatility month-to-month is something we should expect, adding “this is not the time to be adjusting anything on policy…it really is a time for watchful waiting, seeing how the recovery evolves”.
After the initial inflation shock mid-week, some calm has returned to markets and the “buy the dip” mentality resumed. The S&P500 showed a strong gain of 1.5%, following the previous day’s 1.2% recovery. The index still ended down 1.4% for the week, not fully making up the early-week losses.
US Treasuries were already well supported prior to those US data releases and tracked sideways after they printed, the 10-year rate closing the day down 3bps at 1.63%. That the rate only ended up 5bps for the week, one in which we got one of the biggest inflation shocks in decades, is notable – perhaps a reflection that many investors do believe that inflation pressures will eventually normalise and the curve is steep enough for now.
The stronger risk backdrop saw the USD give up more of its post-CPI shock gains and it was lower on Friday against all the key majors, with the BDXY index falling 0.4%. The NZD was one of the best performers, gaining 1% on Friday night and closing the week around 0.7250, moderating its weekly loss to 0.4%.
The AUD pushed higher as well, but gains were likely held back by further weakness in iron ore prices. Prices weakened further, with some nerves setting in following China’s multi-pronged response to try to control the skyrocketing prices with Premier Li Keqiang getting involved earlier in the week. Iron ore prices on the Singapore exchange closed the week at $198, well down from the mid-week peak above $230.
So the NZD/AUD cross rate rose to as much as 0.9325, but the air has been thin above that level over the past few months. NZD crosses were all higher. Stronger risk appetite meant that JPY was on the softer side of the ledger, seeing it up near resistance around 79.3.
NZ bonds traded heavy on Friday, slightly underperforming on spread to offshore and against swap, with the LSAP being well offered. The RBNZ kept the bond buying for this week at $350m, as expected ahead of its May Monetary Policy Statement next week. The 10-year NZGB rose by 2bps to 1.90% against a 1bp fall in 10-year swap to 2.01%. The manufacturing PMI, which fell by over 5 points to 58.4 wasn’t a market mover, as it was coming off an extraordinary high base.
After NZ’s PSI release this morning, key monthly China activity data for April are released this afternoon, still expected to show strong growth off a low base, albeit to a lesser extent compared to March. Fed vice chair Clarida talks tonight, with the market looking for any changes in tone after his digesting of last week’s shockingly high CPI data.
The economic highlights for the rest of the week will include Australian labour market data and the flash PMIs for May at the end of the week. The NZ Budget on Thursday should show a better set of fiscal accounts than the December update and a lowering of the required bond programme for the next few years.