NZ QSBO and RBA update drive NZD and AUD higher as market brings forward start date of expected policy tightening. But moves reverse course overnight as risk sentiment sours. US 10-year rate falls to lowest level in more than four months 

It has been an eventful 24 hours in markets, with big turnarounds in the NZD and AUD currencies after their gains post QSBO and RBA policy updates, following a fall in risk sentiment. US Treasury yields have fallen to their lowest level in over four months. There are a few catalysts but individually they don’t look particularly significant. It’s just been one of those days.

US investors have returned from their Independence Day holiday in a much more cautious mood. Certainly, there has been much to digest and it isn’t obvious which factors are in the driving seat – whether it be concerns about the valuation of the equity market after a blistering run, China’s latest crackdown on public-traded companies, soft data out of the US, or turmoil in oil markets.

Certainly, a risk-off tone currently overhangs the market, with the S&P500 down 0.9% at one stage but crawling back losses as the session progresses, now down 0.4%. Falls would have been even greater, if not for a notable rally in the bond market, with the US 10-year rate falling to as low as 1.35%, a level not seen since February. The rate is currently down 7bps from the NZ close at 1.37%.

For the NZD the fall in risk appetite has trumped the bringing forward of rate hike expectations, seeing the currency trade a wide range of 0.6990-0.7104 overnight. The same can be said for the AUD, with a high of nearly 0.76 last night giving way to an overnight low just above 0.7480. Reflecting their safe-haven status both the USD and JPY have outperformed overnight. EUR is down to 1.1825 and GBP went sub 1.38.

On to developments, China’s State Council released a statement yesterday signalling a clampdown on company data and offshore listings. China will apparently step up its regulatory oversight of companies trading in offshore markets and publicly-traded firms will be held accountable for keeping their data secure. The move followed the listing of Didi in the US (China’s version of Uber), seeing its share price slump over 25% in the past couple of days. Investors will increasingly take a more cautious view when investing in Chinese companies.

The US ISM Services index fell by more than expected in June to 60.1 from a record high level of 64.0 the previous month. The survey commentary said that “challenges with materials shortages, inflation, logistics and employment resources continue to be an impediment to business conditions”.  Notably, the employment index slumped to below the 50 mark, as did the manufacturing sector version of the survey released last week, but in the current environment this appears to be indicating difficulty in finding labour than a lack of demand. Oddly, the market has taken the view that this takes the heat off the Fed in normalising its monetary policy stance. The 2-year Treasury rate has fallen alongside longer term rates, the former down nearly 2bps at one stage.

Germany’s factory orders unexpectedly slumped 3.7% m/m in May, driven by a 6.7% drop in foreign orders, with domestic orders up 0.9%. Disruptions in the auto sector from chip shortages look to have played a role in the data.

Oil prices have reversed course. After touching a multi-year high on concerns that production won’t automatically be raised by OPEC+ next month, Brent crude has slumped from nearly USD78 a barrel to about USD74.50 – the market now seemingly taking the view that a breakdown in talks, with UAE and the rest of the group at loggerheads, might ultimately lead to even higher supply. Prices could remain volatile until the dispute within OPEC+ is resolved.

In the latest GDT dairy auction the price index fell by 3.6%, the seventh fall out of the past eight auctions, off a very high base. Price falls were widespread, with whole milk power down 3%, skim milk powder down 7%, butter down over 3% and cheddar down over 9%. While dairy prices have been falling recently, other key NZ commodity prices have been rising enough to drive the ASB NZ export commodity price index to a record high when measured in both SDR and NZD terms.

Turning to yesterday’s news, NZ’s QSBO highlighted how overheated the local economy was, with record shortages in finding labour and massive jumps in cost and inflation indicators. A net 50% of retailers said that they had increased prices in Q2 and a net 64% expect to raise prices further. Along with the wealth of other economic data along similar lines, we brought forward our expectations for the first rate hike this cycle to November this year.

The OIS market saw the same risks, pricing in an extra 8bps of tightening for the November meeting taking it to 22bps of tightening, equivalent to an 88% chance. An appropriate question to ask is that if it’s so damn obvious that the current emergency policy settings are no longer appropriate then why will the RBNZ wait for the fourth meeting away to take action? Next week’s policy review will be revealing. Yield curves showed a flattening bias, with 2-year swap up 8bps to a fresh pandemic high of 0.89% while the 10-year rate rose by 5bps to 1.84%. The pressure on the market open will be for lower rates reflecting the overnight move in Treasuries.

The takeout from the RBA policy statement and commentary from Governor Lowe was that the Bank was policy was edging towards a less dovish direction. The Bank didn’t extend yield curve control beyond the April 2024 bond and signalled a tapering of QE to $4b per week from $5b per week and more flexibility in that policy with another review in November. Forward guidance on future rate hikes was tweaked, with the Bank opening the door for upside scenarios to bring forward expected rate hikes earlier than 2024.

Furthermore, Governor Lowe downplayed wages as a factor that might drive policy decisions, highlighting that CPI inflation was more important. The market read the commentary on the hawkish side. With the real economy in no obvious need of emergency policy settings, a rogue CPI print or two could easily bring into view a policy tightening as soon as next year. Australian 3-year bond futures moved as much as 5bps after the announcement (implied yields higher), but that move has reversed overnight. The 10 year bond future is down about 6bps in yield terms from the NZ close, reflecting the move in Treasuries.

On the economic calendar, there will be some interest in the minutes of the June FOMC meeting, with particular focus on the discussion around the possible tapering of asset purchases.