US Treasury yields and the USD have rebounded overnight on the back of stronger-than-expected US economic data (ISM Services index and ADP employment). Equities are lower, with interest rate-sensitive tech stocks underperforming, although they recovered some of their earlier losses on reports that Biden might choose not to raise the headline corporate tax rate, in a concession to Republicans. The NZD and AUD have underperformed against a backdrop of a higher USD and weaker risk assets, with the NZD trading around 0.7130 this morning. All eyes are on the US nonfarm payrolls report tonight, with the market believing this will have an important bearing on whether the Fed will soon begin a tapering discussion.
Economic data remains very strong and consistent with a rapid global recovery. Overnight, the US ISM Services index hit an all-time (since 1997) high of 64 in May, above the market consensus. Consistent with other business surveys and yesterday’s Fed Beige Book, pricing pressures remained intense, with the ‘Prices Paid’ component hitting its second highest level on record. Ahead of the nonfarm payrolls report tonight, the employment component slipped from 58.8 to 55.3, although this is a level still consistent with brisk job growth. The accompanying ISM statement observed “the rate of expansion is very strong” in the services sector, as the economy reopens, while highlighting capacity constraints and supply shortages. The ISM Manufacturing survey, which has a longer history, is near its highest level since the mid-1980s.
Likewise, the ADP employment report was very strong, showing 978k new jobs created in May, well above the 650k market consensus. At face value, the ADP report bodes well for a big job gain in the payrolls report tonight (+672k expected), although it has had an unreliable relationship with the official statistics since the crisis (overstating job growth by around 500k in April). Separately, US jobless claims continue to trend down, falling below 400k for the first time since before the crisis. The main constraint to higher job growth at present appears to be a lack of available workers, with the WSJ running a story overnight on how this was hampering new restaurant and supermarket openings.
The immediate market reaction to the US data was higher rates and a stronger USD. The read across from stronger data, especially if it is corroborated by bumper employment gains in the payrolls report tonight, is that the Fed is likely to soon start discussing a plan for tapering its bond buying. The US 10-year rate has rebounded from 1.59% to 1.62%, although it remains locked in its well established 1.5% - 1.7% range for now. The 5-year point on the US curve led the move higher (+5bps to 0.84%), a sign that the market interprets a possible tapering discussion as a precursor to earlier rate hikes.
The USD has had a big move higher overnight. The Bloomberg USD index (BBDXY), which is up 0.7% over the past 24 hours, is currently on track for its biggest one-day gain since September. The USD appreciation started after the ADP employment report, gathering momentum after the ISM Services index was released an hour and a half later. Notwithstanding its rebound overnight, the BBDXY remains close to a three-year low.
The NZD and AUD have both fallen sharply against a backdrop of a higher USD and more cautious risk appetite. Alongside the NOK, another commodity currency, both the NZD and AUD are down over 1% since 5pm yesterday. The NZD trades this morning around 0.7130, close to the bottom of the recent 0.7100-0.7315 range that has held for the past two months. We still think the NZD will ultimately move higher this year, on positive macro forces and renewed weakness in the USD.
In other currencies, the GBP has outperformed overnight (falling 0.5% to around 1.41), underpinned by expectations for a sharp recovery in the UK activity as the economy reopens. The final release of the UK services PMI overnight was slightly higher than the ‘flash’ estimate, showing services sector activity at its highest level since 1997. The JPY and EUR fell 0.5-0.6% overnight, with USD/JPY breaking above the 110 mark amidst higher US Treasury yields. The EUR is trading at a three-week low around 1.2125.
Equity markets were already on the back foot before the US data releases, with the market seemingly growing somewhat more wary about the prospect of a Fed tapering discussion commencing soon. Shortly after the cash market open, the S&P500 and NASDAQ were trading down 1% and 1.5% respectively. However, reports that Biden was considering dumping his proposal to raise the corporate tax rate from 21% to 28% (see below) lifted sentiment. The S&P500 has rebounded to be only 0.3% lower on the day now while the NASDAQ, which is typically more sensitive to higher interest rates, is now down 0.9%.
The Washington Post reported that Biden has made further concessions in the infrastructure bill negotiations. Having already lowered the proposed size of the bill from $2.2t to $1.7t, the Post reported that he offered a $1t sized bill to Republican negotiators and was willing to give up his initial plan to raise the corporate tax rate from 21% to 28% (a ‘red line’ for Republicans). Instead, Biden proposed a new, minimum corporate tax of 15 percent. It remains to be seen whether the compromises will be enough to get a bipartisan deal over the line (the Democrats have the option of pushing the bill through without Republican support, if they can keep all their senators in line). Republican senate leader McConnell said he was hopeful for a bipartisan deal and “maybe” the $1t size could be reached, although there remain differences between the two sides that need to be ironed out.
Yesterday our NAB colleagues updated their RBA expectations ahead of the crucial policy meeting next month. They see the RBA extending QE (to what would be QE3), but reducing the quantity purchased from the current $100b to $75b over six months (a moderate taper). They continue to expect the RBA will refrain from rolling its Yield Curve Control bond forward to the November-2024, instead keeping it at the April-2024 bond.
In the domestic rates market, there was little movement in both bonds and swaps yesterday. The swap curve moved slightly lower and flatter (10-year swap rate -1.5bps to 1.98%) while the government bond curve was slightly steeper after New Zealand Debt Management announced its intention to syndicate a new May-2032 government bond next week. The syndication is expected to be at least $2b in size, with the deal capped at $3b. The 10-year government bond yield was 1.5bps higher on the day, closing at 1.79%.
The US nonfarm payrolls report is the focus tonight, with the market looking for a 672k increase in jobs in May and a fall in the unemployment rate to 5.9%.