Bond yields have moved sharply higher overnight, with equities falling, after the FOMC ‘dot plot’ indicated two rate hikes in 2023, compared to none at its meeting in March. The initial market reaction has also seen the USD strengthen with risk-sensitive currencies, including the NZD and AUD, underperforming. The NZD is currently trading around 0.7060. Markets are still in flux, with Powell still midway through his press conference.
The FOMC statement was released about an hour ago. As expected, there was no change to the Fed’s key policy rate or its $120b/month bond buying pace (although there was a technical adjustment to the Fed’s Interest on Excess Reserves rate, from 0.10% to 0.15%). The key market-moving feature was the so-called ‘dot plot’, which showed the median Fed official saw two rate hikes in 2023, compared to the March projection which indicated rates would be on hold in 2023. The market had been looking for a one hike baseline for 2023 so the dot plot constituted a hawkish surprise. Furthermore, seven of the eighteen Fed officials indicated a rate hike in 2022, up from four in March.
There wasn’t much change to the Fed’s economic projections, except for a substantial upward revision to core PCE inflation this year (from 2.2% y/y to 3%). The Fed’s medium-term projections are consistent with the current inflation pressures proving temporary, as core inflation is projected to fall back to 2.1% in 2022 and 2023. The unemployment rate forecasts are almost identical to March (4.5% at end-2021, 3.8% at end-2022) even as growth for this year was revised up by 0.5% to 7%.
Powell started his press conference around 30 minutes ago, although he hasn’t tried to water down the message from the ‘dot plot’ yet (besides saying they should be taken with “a grain of salt”). On QE, Powell reiterated the line from the statement that “substantial further progress” would be required before its bond buying would be tapered, something he thought was “still a ways off”. Powell did say the Fed would say more about the likely timing of tapering as it sees more data.
The market is still digesting the implications and market prices are still in flux. The immediate market reaction has unsurprisingly seen bond yields spike higher, led by the 5-year point (+10bps), with the curve flattening thereafter. The 10-year Treasury yield is currently +7bps on the day as we write this, at 1.57%, while the 30-year yield is only 2bps higher. Market-based inflation expectations have corrected lower with the 10-year breakeven inflation rate falling 5bps, to 2.33%.
The broader market reaction is probably best characterised as ‘risk off’ at this early stage. US equity markets are lower, by around 0.8%, although they remain close to their recently set all-time highs. The USD has strengthened across the board, with the BBDXY rising 0.7% to a six-week high. The BBDXY is set for its biggest one-day rise since September last year amidst the sharp rise in US real yields (US 10-year real yield +13bps, to -0.78%).
The EUR has fallen 0.8%, to around 1.2020, a six-week low. JPY has outperformed against the risk-off backdrop, although USD/JPY has still managed to push up to around 110.50, its highest level since the start of April.
Since the statement, the NZD and AUD, as risk-sensitive currencies, have underperformed. The NZD, which was trading around 0.7135 beforehand, has broken below 0.71 and is currently trading around 0.7060 (-0.9% on the day). The NZD is trading at a two-month low, while there has been little movement in the NZD/AUD cross, which is still hovering around 0.9270.
Turning to other developments over the past 24 hours, UK CPI was higher than expected, coming in at 2.1% y/y, with core inflation hitting the BoE’s 2% target for the first time since 2018. Inflation was boosted by pressures related to the reopening of the economy, with restaurant meals, clothing and recreational goods amongst the categories adding to inflation pressure last month. The GBP received a short-lived boost from the UK CPI data although there was little reaction in bonds. Canada CPI was also higher than expected, with the average of Bank of Canada’s three core inflation measures rising to 2.3%, above the 2.1% market consensus. Yesterday, Chinese activity numbers were weaker than expected.
As foreshadowed by media reports, yesterday China announced it would release copper from its strategic reserves, alongside aluminium and zinc. This is the first time China has publicly released copper stockpiles from its strategic reserves since 2005 and forms part of its broader efforts to cool commodity prices. Relatedly, Bloomberg reported that Chinese regulators had ordered state-owned enterprises to limit their exposure to overseas commodities markets. Copper prices, which fell 4% yesterday on these media reports, initially dipped before turning around and closing 1% higher, at $9,667/ton (the London market closed before the FOMC statement).
In the domestic market, swap rates and government bond yields edged higher, by 2-3bps at the 10-year point. The market was relatively quiet ahead of the FOMC meeting and NZ GDP this morning. We should expect rates to open higher this morning in NZ following the US Treasury market reaction to the FOMC statement.
Yesterday, the RBNZ announced that Debt-To-Income (DTI) lending restrictions had been added to its macroprudential policy toolkit. The details have not been worked out yet and it will take some time to do so, so the announcement will have little immediate effect.
It’s a busy day ahead for markets. Locally, NZ Q1 GDP is released this morning, with Bloomberg reporting the median estimate among economists at 0.5% q/q (the RBNZ MPS forecast minus 0.6%). BNZ economics have pencilled in a 0.8% quarterly increase, albeit subject to greater than usual bounds of uncertainty. This afternoon RBA Governor Lowe speaks ahead of the monthly labour market report. Our NAB colleagues expect an above-consensus 60k increase in jobs and a fall in the unemployment rate from 5.5% to 5.3%.
Finally, yesterday’s report mentioned that we had formally revised up our CPI forecasts. Some of the numbers quoted were incorrect so, for completeness, here are the correct numbers. Our Q2 2021 CPI estimate is unchanged (at 0.7% q/q and 2.7% y/y) and we now see headline inflation breaching the top of the RBNZ’s 1-3% target range later in the year, peaking at 3.3% in Q4.