US 10-year rate up nearly 5bps, reversing half of last week's fall, ahead of key FOMC policy update later this week. Oil prices hit a 2 year high; bets increase of an eventual move to $100 a barrel

The new week has begun on a quiet note, with little news to drive markets and some prevailing nerves ahead of the FOMC policy update later in the week. Currency movements have been small apart from a weaker yen, as US Treasury rates reverse some of last week’s downward move. Oil prices hit a 2-year high. The S&P500 is currently down 0.3%, falling from the record high set towards the end of last week.

After last week’s 10bps fall for the US 10-year Treasury yield despite CPI inflation cracking 5%, some reversal of sorts is taking place, with the yield up nearly 5bps overnight to 1.50%, having troughed to a low of just under 1.43% intraday on Friday. The focus remains on the FOMC meeting on Thursday morning NZ time, where talk of “tapering” of bond purchases should get an airing. Even if a date to begin winding down bond purchases won’t be given, it wouldn’t be credible for Chair Powell to say that tapering wasn’t discussed at the meeting when at least four FOMC members have said that it would be appropriate to begin discussing the topic.

The recent surge in inflation and how transitory it might be will form part of the debate, as well as whether or not inflation expectations are still well anchored. On that note, overnight a NY Fed survey of three-years ahead inflation expectations rose to an eight-year high in May to 3.6% (previously 3.1%), while the year-ahead version rose to a record high to 4.0% (previously 3.4%). This survey follows a fall in expectations measured by the University of Michigan survey that was released Friday, and the fall over the past month on implied break-even inflation rates from traded nominal and real Treasury yields.

In other news, as widely anticipated, UK PM Johnson announced a delay of at least four weeks to 19 July for the full easing of COVID-related restrictions. COVID19 cases have been rising rapidly, due to the highly contagious India variant, and the delay will allow more time for people to get vaccinated. The latest research on vaccine effectiveness by UK researchers released overnight said that the Pfizer shot was 96% effective against hospitalisation for the Indian variant while the AstraZeneca shot was 92% effective.

Oil prices hit a fresh 2-year high as investors continue to bet of impending tighter supply/demand conditions due to a low level of investment in the sector as nations attempt to turn “greener”. Prices peaked overnight at $71.78 for WTI and $73.64 for Brent crude. Data from the NY Mercantile Exchange shows rising interest in $100 call options for WTI oil delivered in December 2022 and they are now the most widely owned WTI call contracts.

In currency markets, movements have been small, with the key majors we follow all within 0.1% of last week’s close. The higher global rates backdrop sees the yen underperforming, with USD/JPY up 0.4% to return to a 110 handle. The NZD is fairly flat at 0.7140, while the AUD has been hovering just above the 0.77 mark.

Yesterday, in our weekly currency update we noted that it was difficult to point to fundamental drivers for recent NZD weakness. Our risk appetite index rose to 72% on Friday, its highest level since pre-COVID, with the VIX index continuing to trend lower and high yield credit spreads continuing to grind lower. Meanwhile commodity prices continue to trend higher, reflecting the positive global economic outlook and inflationary backdrop. Domestic economic data point to stronger growth than expected and the RBNZ recently signaled tighter policy from mid next year.  All these forces ought to be NZD-positive. Our short-term fair value model estimate for the NZD has pushed up to 0.7420, the highest level since 2014!

The domestic rates market was quiet yesterday with much of Australia on holiday. NZGB yields were up 1bp across most of the curve while swap rates were marked flat-to- 1bp higher. NZ’s performance of services index (or PMI for services) fell by over 5 points in May but from a very high level. Combining the series with the PMI for manufacturing to create a composite growth indicator implies GDP running about 4%. It is debateable whether the economy can grow that fast with widespread capacity constraints, so naturally the release valve is higher inflationary pressure.

In the day ahead, the RBA’s minutes of the June policy meeting should pass without much interest, given the July is the key meeting for any tweaks in policy settings. The key release tonight will be US retail sales, with the market expecting a soft result as the level of sales comes back down to earth after the sharp stimulus-fuelled surge in spending earlier this year.