Limited moves overnight as markets await key event risks later in the week. US equities and USD slightly higher, US 10-year consolidates. US CPI release the highlight tonight, with core inflation expected to hit 4% y/y

Market moves have been limited overnight as investors wait on the US CPI release tonight and Fed Chair Powell’s testimony later in the week.  The S&P500 and USD have edged higher while the US 10-year rate has consolidated after Friday’s sharp increase.  The NZD has eased back to around 0.6775.

There has been little news overnight to move markets ahead of several key events later this week, such as the US CPI release tonight, Fed Chair Powell’s testimony to the Senate and House and Chinese economic activity data, including Q2 GDP.  Equity markets in Asia were higher yesterday, following on from the PBOC’s cut to the reserve requirement post the market close on Friday, with China’s CSI300 index rising 1.3% and the Nikkei 2.3%.  The positive tone continued into Europe, where equity markets were up 0.5%-1%, and the US, where the S&P500 (+0.3%) has eked out a fresh record high.  There will also be focus on US earnings season, which kicks off this week with the big US banks reporting.  Analysts expect earnings for the S&P500 to be 64% above the year-ago levels, although the annual increase is flattered by the comparison to the Covid-depressed levels of Q2 last year.

After rebounding sharply on Friday, the US 10-year rate has consolidated overnight, around 1.36%.  In Europe, 10-year yields were slightly lower (Italy -3bps, Germany -0.5bps) after some dovish comments from ECB President Lagarde in a Bloomberg TV interview.

Lagarde put the market on notice that there would be “some interesting variations and changes” at the central bank’s meeting next week.  Her comments follow the conclusion of the ECB’s strategy review, at which it agreed to change its inflation target from “close to, but below, 2%” to a symmetrical 2% target.  Lagarde said she expected the ECB’s pandemic bond-buying programme would run “at least” until its scheduled end date in March next year, with a “transition into a new format” to follow.  The comments suggest Lagarde wants to distance herself from any notion that the ECB could follow the likes of the Fed down the tapering path any time soon, presumably to add credibility to the new policy framework.  For the ECB, getting core inflation up to 2% in the first place (a feat it has managed just once in the past eighteen years) is a challenge in and of itself, especially when it has effectively exhausted its current range of policy instruments.

In the currency market, the USD is broadly stronger but moves have been limited.  There is a slight flavour of commodity currency underperformance, with the NZD and NOK down 0.3% so far this week and the AUD off 0.2%.  All the other G10 currencies are 0.1%-0.2% lower.  The NZD trades this morning around 0.6975 while the NZD/AUD cross has drifted down to 0.9330.

Concerns around the Covid-19 delta variant continue to get a lot of airplay in the financial media.  The UK confirmed it would remove remaining restrictions on 19 July, as planned, but PM Johnson warned the public to “proceed with caution” amidst rising infections.  The market will be closely watching the UK experience, particularly the rate of hospitalisations and severe health outcomes, as a test case for how other countries might fare once a significant portion of the population is vaccinated.

In Australia, NSW reported 112 new cases yesterday, a new high for the current outbreak and making it almost certain the lockdown in Sydney will need to be extended beyond Friday.  The Australian interest rate market appeared to take notice, with the 3-year bond rate falling 4bps, as RBA rate hike pricing was pushed out, while the 10-year rate was down 4bps despite the Friday night sell-off in US Treasury bonds.  There has been a less observable impact on the AUD.

The Covid situation in Sydney has also seen the market temper its RBNZ rate hike expectations slightly.  Market pricing indicates a 70% chance of a hike at the November meeting, having been as high as 90% in the wake of last week’s very strong QSBO business survey.  The 2-year swap rate fell 1.5bps, to 0.84%, while the 10-year rate edged 2bps higher, to 1.77%.

NZ government bonds continued to outperform swaps, with another poorly offered RBNZ bond buying operation yesterday highlighting the lack of selling interest in bonds at present.  The 5-year swap spread, which is the difference between the 5-year swap rate and government bond yield of the same maturity, is at its widest level since the start of 2019.

The only economic data of note over the past 24 hours has been NZ electronic card transactions, which were again strong.  Total transactions lifted 1.6% in the month of June’s, followed gains of 2.0% in May, 4.6% in April and 2.0% in March.  The recent strong run in electronic card transactions increases the chances of seeing another strong gain in retail trade in Q2 and bodes well for Q2 GDP.

The US CPI release is the highlight tonight.  The market is looking for the core measure to hit 4.0% y/y, which would be its highest level since the early 1990s.  But it’s still too early to judge whether the recent ramp up in inflation is transitory or not, with that debate likely to continue to rage in the coming months.