Overnight market moves have been reasonably subdued, with investors waiting on the key nonfarm payrolls report tonight. US equities are slightly higher, with some rotation back into ‘reflation trade’ favourites, while the US 10-year rate is hovering just under 1.50%. The USD has strengthened and is trading back near its recent highs. This has seen the NZD fall back to 0.6965, although it is up on most of the key crosses overnight.
Economic data overnight has been robust although market attention is still focused on the nonfarm payrolls release tonight. The ISM manufacturing survey was close to expectations, with the index remaining at very high levels on a historical basis, at 60.6, indicating very strong growth in the manufacturing sector. The survey highlighted intense inflation pressures, with the prices paid component rising to its highest level since 1979, at 92.1. But there were also tentative signs of supply-related disruptions starting to ease, with the supplier deliveries and order backlog indexes slipping on the month. Meanwhile, initial jobless claims fell to a new post-Covid low of 364k. In Japan, the Tankan survey of large manufacturers rose to its highest level since 2019, albeit by slightly less than expected.
The USD strengthened and US rates picked up after the ISM survey release. The US 10-year rate is back at 1.48%, reversing yesterday’s month-end related fall. The Bloomberg USD index (BBDXY) is up 0.3% for the second day running and it is now trading back near its post-Fed meeting highs of a fortnight ago. The market showed little reaction to comments from Philadelphia Fed President Harker who argued the tapering process should start this year, with purchases potentially reduced by $10b a month over 12 months to get down to zero.
The grinding rally in US equities has continued overnight, with the S&P500 adding 0.5%, its sixth consecutive daily increase, to a fresh record high. Under the surface, there has been some rotation back into the cyclical sectors, with energy stocks leading gains and tech stocks underperforming. Subdued market volatility has seen the VIX fall to a post-Covid low of 15.5.
The EUR is down only slightly overnight (-0.1%) but has still managed to post a three-month low, around 1.1840. USD/JPY has continued to push higher, to around 111.60, its highest level since last March. Alongside the GBP (-0.6%), which has underperformed on some dovish comments from BoE Governor Bailey, the JPY (-0.5%) has been one of the laggards overnight.
In his annual Mansion House address, Bank of England Governor Bailey reiterated the message from the most recent monetary policy report, saying the Bank’s job was to ensure it didn’t undermine the recovery by tightening prematurely. The headlines caused an immediate dip in the GBP although there was little impact on UK interest rates. Bailey adheres to the conventional central banking view that current inflation pressures will prove temporary, citing base effects, the eventual easing of supply-related disruptions and a post-reopening switch to spending on services, a part of the economy with greater spare capacity. The message contrasts with that of departing Chief Economist Andy Haldane who, in his last speech for the Bank earlier this week (well worth reading), warned of a significant and persistent rise in inflation that could affect monetary policy credibility.
USD strength has seen the NZD fall back to around 0.6960, approaching the seven-month lows set in mid-June. In a change from June, the NZD has held up better on the crosses. Except for NZD/EUR, all the key NZD crosses we follow are modestly higher overnight, with the NZD/AUD pushing up to 0.9330. We still see the NZD as undervalued compared to its historical drivers of commodity prices, risk appetite and relative interest rate differentials.
Oil prices are up around 1% overnight, after reports that OPEC+ would increase supply by less than expected. An internal committee of the cartel proposed that supply be increased each month between August and December by 400,000 barrels/day, less than the previously reported 500,000 figure. The meeting was postponed to tomorrow after a late objection from the UAE, but oil prices have still retained most of their overnight gains, with Brent crude oil trading just over $76.
Domestic rates were relatively settled yesterday, with the market finally starting to consolidate after what has been a big repricing of the RBNZ OCR outlook over the past fortnight. The 2-year swap rate was 1.5bps higher yesterday, at 0.80%, as it hovers near its recent 15-month highs, with the 10-year swap rate up a similar amount, at 1.90%. Market pricing for the November 2021 meeting is back to 50/50 with a 25bp hike fully priced for February.
Yesterday saw the first government bond tender of the new fiscal year, with nominal bond supply increasing to $500m, from $300m in June. As a reminder, the RBNZ decided to keep its bond buying volume unchanged this week, at $200m, leaving the market to absorb more supply. The tender attracted a bid-to-cover ratio above 2 with the bonds issued at yields at, or slightly under, prevailing secondary market levels, a tentatively encouraging early sign that the market might digest the increased bond supply (and, eventually, the absence of RBNZ bond buying support) without major price adjustments.
Sticking with fiscal policy and bond supply, yesterday saw the release of the government’s fiscal accounts for May, with the budget deficit coming in a whopping $5.8b lower than forecast only two months ago. If sustained, the fiscal deficit for the year to June 2021 will fall to just 2.8%/GDP rather than Treasury’s 4.5%/GDP estimate. So, while the RBNZ’s bond buying programme won’t be around forever, if the government’s fiscal accounts keeping exceeding expectations, it’s likely to allow bond issuance to be reduced in the future (unless the government decides to “recycle” the windfall into new spending).
Markets are likely to tread water ahead of the monthly nonfarm payrolls report tonight. The median estimate on Bloomberg is for a 720k jobs gain in June and a 0.2% fall in the unemployment rate, to 5.6%. The market will also be watching wage growth, which has surprised to the upside two months running amidst anecdotes of firms having to ‘pay up’ to get workers on board. ECB President Lagarde is also speaking tonight.