The fallout from the more hawkish Fed update has continued into a second day, with some notable positioning shakeouts in currencies, commodities and the Treasuries curve. The NZD has fallen over 1% overnight and taken a peek below 0.70 while AUD has traded below 0.7550. The US Treasuries curve has flattened significantly, while some significant sector rotation is evident in US equities.
The Fed has really shaken up financial markets with its more hawkish than expected policy announcement yesterday. Investors seemingly have less concern that the Fed is behind the curve, upending the global reflation trade – somewhat amusing in our view, given that any rate hike might still be two years away and the Fed will probably still be buying $120b of bonds per month for another six months.
We’d argue that by keeping its foot on the accelerator for a long time yet, the Fed will be fuelling more global inflationary pressure and nothing much has really changed. Still, while the Fed’s change in tone doesn’t really represent one giant leap, it’s been enough of a small step to cause a positioning shakeout. This is most evident in the commodities market, with Bloomberg’s commodity index down a chunky 3.7%, including a 5% fall in copper prices, silver down 7% and gold down 4%.
NZ doesn’t export any of these apart from a little bit of gold, but that hasn’t prevented the NZD from being one of the worst performers overnight, down over 1%. It hit a low of 0.6992 and has since settled just above 0.70. The 200-day moving average of 0.7041 was broken and the chartists will be eyeing up the March low of 0.6943. The 200-day moving average has also been broken for EUR and AUD, the former trading sub-1.19 and the AUD trading to a low of 0.7540.
The USD remains in charge, with the BBDXY index up for the fifth day running, having recovered in that time more than 50% of the fall since late-March. Against a backdrop of lower long term rates (see below), JPY is the only major rising against the USD, with USD/JPY down to 110.2.
While we understand NZD and commodity price weakness go hand-in-hand it is hard to argue that relative monetary policy considerations deserve to be a factor in driving the NZD lower. While Fed rate hike expectations have been brought forward a little, so too have RBNZ expectations.
Yesterday, NZ Q1 GDP was a stonker, with the combination of strong quarterly growth of 1.6% and upward revisions taking annual growth to 2.4%, some 1½% higher than market expectations. Relative to the RBNZ’s estimate, which didn’t have the benefit of the run of recent partial indicators, the level of real GDP was a massive 2.6% higher than expected, meaning that economy is now likely travelling well ahead of potential meaning a positive output gap – consistent with the plethora of anecdotes from businesses and the rampant inflationary pressure we keep hearing about.
As if the recently reported near-30% rise in annual house prices wasn’t enough, the GDP data will give plenty of food for thought for the RBNZ as to what an appropriate policy setting is at the moment. It certainly doesn’t feel like emergency policy settings are required. For someone awakening from an 18-month long coma, an immediate end to QE and lift in the cash rate wouldn’t seem out of place. The data adds to the weight of evidence that the RBNZ will be well ahead of the US Fed in any policy normalisation. While the Fed is talking-about-talking about tapering bond purchases, the RBNZ has been on a tapering path for several months already.
For Australia, the market is also bringing forward its policy normalisation view for the RBA. Employment growth surprised to the upside for the umpteenth time, dragging down the unemployment rate to 5.1%, back to pre-COVID19 levels. The RBA has been running a line that conditions for a rate hike are unlikely to be met until 2024, but that view is looking more obsolete by the day.
Yesterday’s data gave the market another nudge towards pricing in tighter financial conditions, with NZ rates up strongly across the board. NZGB rates were up 11-13bps across the board, while swap rates were up 10-12bps. The OIS market prices in a small chance of the RBNZ beginning the rate hike cycle as soon as November (6bps priced), while a February hike is priced at a 50% chance. The 2-year swap rate closed at a post-COVID high of 0.64%.
While the immediate reaction to the Fed statement was a sharp lift in the US 10-year rate, that move has completely reversed overnight, seeing the rate down 8bps from the NZ close to 1.50%. The Treasuries curve shows a notable flattening, with the 2-year rate flat to slightly higher, while the 30-year rate is down 13bps. Steepeners were a popular part of the global reflation trade on the idea that the Fed was complacent about inflation so price action overnight represents a swift closing of those trades. The implied yield on Australian 10-year bond futures is down 5bps overnight, so NZ rates are looking to open the day with lower yields.
In overnight economic news US jobless claims unexpectedly rose last week for the first time since April, at 412k versus 360k. It would be too early to jump to the conclusion that the downward trend has been broken, and the figure might just represent noise. The Philly Fed manufacturing index was in line, suggesting robust activity levels while the mix showed a notable fall in new orders and a rise in employment. The prices paid index rose to a fresh multi-decade high of 80.7.
US equities show some significant sector rotation. The hit to commodity prices and flatter yield curve see Energy, Materials, Industrials and Financials down 2-3%. Big tech and growth stocks are higher. The net result is the S&P500 flat for the day while the Nasdaq index is currently up 1%.
In the day ahead the BoJ meets and no change in policy is expected. Ahead of that Japan CPI data should show that despite the BoJ’s best efforts, no progress towards meeting the 2% inflation target has been made, with annual core CPI inflation still likely negative.