Markets trade cautiously ahead of key FOMC meeting tomorrow morning. Equities slightly lower, USD higher, most commodities (ex oil) softer. US 10-year rate continues to trade around 1.50% ahead of the Fed

The market has traded with a slightly cautious tone overnight as investors wait for the key FOMC meeting tomorrow morning.  US equity markets have eased back from the record highs set yesterday, the USD is stronger and most commodity prices (except oil) are lower.  The US 10-year rate continues to hover around 1.50% ahead of the Fed update.  The NZD has drifted down towards 0.71 amidst USD strength and softness in commodity prices.

There have been plenty of data releases overnight, with US retail sales the highlight, but without much market impact as investors await the FOMC meeting tomorrow morning.  Core retail sales in the US fell 0.8% in May (0% expected), as the effect of the government’s stimulus cheques start to fade, although the April result was revised up by a similar amount (+0.1% vs. -0.8% previously).  Elsewhere, the Empire manufacturing survey, based on firms in the New York region, fell by more than expected, providing tentative evidence that the manufacturing sector is moving past peak growth, even if activity remains very strong in an absolute sense.  The US NAHB housing index fell to 81 in June, its lowest level in 10 months but still extremely high on a historical basis.

Investors are keenly waiting on the FOMC meeting tomorrow, with the key areas of focus being the Fed’s interest rate projections and whether the Fed discusses a tapering of its bond buying.  Some market participants expect the so-called ‘dot plot’ to indicate an interest rate increase in 2023 (at the March meeting, the median Fed official saw no hike in 2023).  On tapering, the best the market can probably hope for is some slightly more detailed guidance on the conditions that need to be met before the Fed will consider tapering.

The US 10-year rate has fluctuated around the 1.50% mark overnight, little changed from yesterday’s close.  The first 25bp Fed hike is fully priced for Q2 2023.  US equity markets have reversed yesterday’s gains, with the S&P500 falling 0.2% and the NASDAQ 0.7%.  Both benchmarks hit all-time highs yesterday, on a closing basis.

Copper prices fell a chunky 4% overnight, to around $9,550/ton, while other industrial metals such as nickel (-4.4%) and aluminium were also lower.  The move in copper prices follows speculation that China might release some of its stockpiles in the next few months, as part of its broader efforts to contain commodity prices.  Copper prices are now some 11% off the all-time high reached in May.  In contrast, oil prices have continued to push higher, with Brent crude oil rising 1% to $73.60, its highest level in over two years.  The FT reports that some of the largest players in the commodity market think $100 oil prices are a real possibility given the confluence of strong demand and constrained supply.

The USD has strengthened slightly overnight, in index terms, amidst the more cautious risk backdrop.  The traditional safe haven currencies – the JPY and CHF – have outperformed (+0.2% and 0% respectively overnight) while the EUR is also marginally higher.  Commodity currencies have been the laggards.  The AUD has fallen back below 0.77 (-0.4% on the day) while the NZD has drifted towards the low end of its recent 0.7100 – 0.7315 range.  The NZD trades this morning around 0.7120 (-0.3% on the day), having briefly reached a two-month low overnight.

There was little new information in yesterday’s release of the RBA minutes, with the July meeting having already been earmarked as the time when the Board will make its decision on QE and the yield curve target.  Our NAB colleagues think the RBA will refrain from rolling the yield curve target bond from the April 2024 to the November 2024 and expect a moderate tapering of QE, from the current $100b size to $75b over a six-month period.

Last night’s GlobalDairyTrade auction showed a fall in both the overall index (-1.3%) and whole milk powder prices (-1.8%).  Still, whole milk powder prices are some 25% higher this year.

Yesterday, we formally revised our NZ CPI forecasts higher.  Our Q2 2021 CPI estimate is unchanged (at 0.4% q/q and 2.7% y/y) but we now see headline inflation breaching the top of the RBNZ’s 1-3% target range later in the year, peaking at 3.4% in Q4.  The big question, both here and offshore, is where inflation settles after the low base effect washes out.  But we think the risk of inflation settling higher is rising, with measures of inflation expectations already pushing higher.

There were limited moves in the domestic rates market yesterday with swap rates broadly flat out to 5-years and 1bp higher at the 10-year point.  2 to 5-year swap rates have now completely reversed their post-RBNZ move higher, while the 10-year rate is almost 10bps lower than before the MPS.

The other notable feature in the domestic rates market has been the continued outperformance of short-to-mid curve government bonds against swaps.  The 5-year swap spread (i.e. the difference between the 5-year swap rate and 5-year government bond yield) has reached its widest level in over two years.  This reflects, at least in part, the RBNZ’s ongoing bond buying operations in this sector.

Markets are likely to tread water ahead of the FOMC statement at 6am tomorrow and Powell’s press conference, which starts at 6:30.  Chinese activity data is released this afternoon while the UK and Canada report CPI.