Last week ended with a rebound in the USD, seeing the NZD and AUD close the week on a soft note at 0.7130 and just over 0.77 respectively. US equities showed small gains, hovering near record highs. The US 10-year rate drifted higher but still ended down 10bp for the week in which annual CPI inflation cracked 5%, with inflation expectations lower.
The key price action on Friday night was a broadly based rebound in the USD, with the BBDXY index up by 0.5%. Traders put this down to some short covering ahead of the key FOMC policy update this week. The NZD underperformed, falling 0.9% on Friday night to close the week about 0.7130, its lowest close in two months and getting close to the key 0.7100 support level. The AUD fell 0.6% to close the week just over 0.77, after another probe sub 0.77, with NZD/AUD down to 0.9250. EUR and GBP probed sub 1.21 and 1.41 levels respectively and finished near those levels, while the yen was one of the better performers, with USD/JPY drifting up to only 109.65.
The dollar repositioning shows some nerves heading into the FOMC policy update early Thursday morning NZ time about what might be said at the press conference on tapering. Over the past month there appears to have been a growing chorus that the time to talk about tapering bond purchases had been reached, including Fed Governors Clarida and Quarles, alongside regional Presidents Kaplan and Harker.
The key economic release Friday night was the University of Michigan survey, showing consumer sentiment up by slightly more than expected, driven by the expectations component. The report noted that stronger economic growth was expected and that a record number of consumers expected a net decline in unemployment. Perhaps of more interest to the market was that both 1-year and 5-year inflation expectations fell in early June, the former down from 4.6% to 4.0% and the latter down from 3.0% to 2.8%.
Interestingly, market-implied break-even 10-year inflation expectations have been drifting lower over the past month, from an 8-year high of 2.59% to 2.34%. Furthermore, this has occurred against the backdrop of higher oil prices, breaking the usual positive correlation between these two series. The logical conclusion then is that after being spooked by the prospect of higher inflation over recent months, investors have gradually bought into the Fed’s view that higher inflation will only be transitory.
The nominal US 10-year rate rose 2bps on Friday to 1.45%, after recording a fresh 3-month low of 1.4266% but the yield still ended the week down 10bps (a week in which annual core CPI inflation printed at a stronger than expected 29-year high of 3.8%) as lower inflation expectations were the key driver of lower yields last week.
In other economic news, Germany’s Bundesbank upgraded its economic projections, seeing GDP growth of 3.7% this year (previously 3.0%) and 5.2% next year (previously 4.5%). Inflation projections were also upgraded, with a transitory increase to 2.6% this year, falling to 1.8% next year.
UK economic activity data were on the softer side of expectations, but GDP still rose by a strong 2.3% m/m in April, putting the economy on track to show a strong Q2 result as lockdown restrictions have eased. Industrial production was dragged down by plant closures and lower mining activity.
The S&P500 showed a small gain of 0.2% on Friday, hovering near its record high. Early in the day the WSJ reported that House lawmakers were preparing to propose bipartisan legislation that could require Amazon and other technology giants (including Apple, Facebook and Alphabet) to effectively split into two companies or shed their private-label products. The Democrats released five antitrust bills later in the day but this news didn’t seem to have much impact on the market.
The domestic rates market showed further falls across the swaps and bond curves, driven by a combination of global forces and some outperformance of the NZ rates market. The 10-year NZGB yield fell by 5bps to 1.64%, taking its fall for the week to over 20bps. Liquidity in the market has been poor, reflected in wider bid-ask spreads. The RBNZ’s LSAPs haven’t helped and the Bank has probably taken this into consideration, with another tapering of its bond purchases for the week ahead, down to $220m from $250m last week and $350m the previous week.
The economic calendar is light for the day ahead, with the Services PMI for NZ and industrial production for the Euro area. The calendar for the week ahead has a number of key releases, but markets could well tread water ahead of the latest FOMC policy announcement on Thursday morning NZ time. Key economic releases include US retail sales, China monthly activity indicators and Australia’s monthly employment report. Domestically, Q1 GDP will be released on Thursday, with market expectations ratcheting up recently to about 0.5-0.8% q/q, well ahead of the RBNZ’s now-dated pick of a minus 0.6% contraction.