Market moves were subdued to end last week, with little change in bond yields and US equities. The EUR fell after some dovish comments by ECB President Lagarde, with the market looking through a generally upbeat set of European PMIs. The NZD was dragged down with the EUR, ending the week around 0.7170. The RBNZ MPS is the highlight of the week ahead for the domestic market.
Economic data remains positive, and consistent with market expectations for a rapid recovery in the global economy this year, but bond yields remain confined within tight trading ranges, for now. The ‘flash’ European PMIs showed manufacturing activity remained at historically high levels while services activity has started to rebound sharply. The European Services PMI increased to 55.1 in May, above market expectations and its highest level since mid-2018. With the European vaccination rollout finally into its stride, we should expect further improvement in the services sector as Covid-related restrictions are removed. Separately, European consumer confidence rose to its highest level since late-2018.
In the US, both the manufacturing and services PMIs reached their highest levels on record. IHS Markit, which publishes the indexes, said activity would have been even stronger had firms not been constrained by supply shortages, including difficulty finding labour. The impressive PMI results bode well for the more widely followed ISM surveys, which are released at the start of June.
Philadelphia Fed President Harker came out in support of a tapering discussion “sooner rather than later”, joining Dallas Fed President Kaplan (who made his views known last month). This remains the minority view on the committee, for now, although if the economy continues to recover rapidly, and inflation remains elevated, it’s only a matter of time before it becomes mainstream.
The US 10-year rate barely moved on Friday, ending the week at 1.62%. It remains well contained within its existing 1.50%-1.70% range. It was a mixed session for equities on Friday. The S&P500 was broadly flat on Friday (-0.4% on the week), the NASDAQ fell 0.5%, while the Eurostoxx 600 index was 0.6% higher.
The USD indexes rebounded 0.2% on Friday, although that still left them 0.3%-0.4% lower on the week. The USD strength on Friday was as much a reflection of weakness in the EUR, which responded to a dovish set of comments from ECB President Lagarde. Responding to a question of whether the ECB might taper its bond buying in response to the improved economic outlook, Lagarde replied that “it’s far too early and it’s actually unnecessary to debate longer-term issues”. The market seemed to interpret the comments as suggesting the ECB may not taper its bond buying at its upcoming June meeting. The EUR dropped from around 1.2220 to 1.2180 immediately after Lagarde’s comments, ending the week around that level.
The NZD and AUD fell around 0.5% on Friday, in sympathy with the weakness in the EUR. The NZD fell 1.1% last week, ending the week at around 0.7170, the second worst-performing of the G10 currencies (after the oil-sensitive NOK), while the AUD was down 0.5% on the week. The pullback in commodity prices explains the underperformance in the commodity currencies last week, even as the USD itself was generally weaker (Bloomberg DXY -0.3% last week). The NZD remains stuck within a 0.7100 – 0.7300 range at present.
On fiscal stimulus, the Biden administration reduced the size of their proposed infrastructure bill, from $2.3b to $1.7b, in a show of compromise in negotiations with Republicans. But Republicans continue to push back against the overall size and scope of the package as well as the proposal to increase corporate tax rates to fund it. The Democrats can still push through the infrastructure proposal without bipartisan support, although they will need to keep all their senators in-line (Virginia Democrat senator Manchin, for one, baulked at the initial proposal to increase the corporate tax rate to 28%).
In domestic developments, swap and bond rates moved lower on Friday, following global moves and a well-supported tender of government bonds. The 2-year swap rate was down 2bps and the 10-year rate 4bps, although both remain within vicinity of 12-month highs.
The focus this week is the RBNZ MPS on Wednesday. The most likely scenario is that the RBNZ acknowledges the recent strength in economic data, including an unemployment rate which is tracking well below its previous forecast, but retains its cautious messaging around the policy outlook. We think the risk is the RBNZ tones down its dovish rhetoric at the MPS.
Offshore, there is mainly second-tier data released, with the highlight probably being the personal spending and deflator report on Wednesday night. The market expects the core PCE deflator, the Fed’s preferred inflation measure, to jump from 1.8% to 2.9% y/y, although this reflects, in part, base effects from the low levels last April.