Risk appetite was a little weaker at the end of last week, with equity markets notching falls and the US 10-year rate closing below 1.3%. Currency movements were modest, with notable NZD outperformance following a much stronger than expected CPI print that cemented expectations for a series of rate hikes beginning next month.
Friday night’s trading session was fairly downbeat following some mixed US economic data. US retail sales were stronger than expected in June, with ex auto and gas sales up 1.1% m/m, although May sales were revised lower. Consumers remain cashed-up, with sales from the government handouts earlier in the year.
The market seemed to take more notice of the University of Michigan index of consumer sentiment which unexpectedly fell to a five-month low in July. The survey commentary noted that higher inflation had put added pressure on living standards, with “consumers’ complaints about rising prices on homes, vehicles, and household durables” reaching an all-time record. Year-ahead expected inflation rose to a 13-year high of 4.8%. The longer term 5-10 year measure, which Fed policy is more sensitive to, rose to 2.9%, at the higher end of the 2.2-3.0% range of the past decade.
The weak confidence survey saw US equities and US Treasury yields track lower. The S&P500 fell 0.75%, driving a 1% fall for the week overall, following three straight weekly gains that had taken the index to a record high. The 10-year rate drifted lower, closing 3bps down from the NZ close at 1.29%, its lowest close since February.
The spread of the delta variant of COVID19 across the world remains a key focus for the market. The US CDC reported that new case numbers had risen in 49 States. New cases were surging in the UK, with the daily rate surpassing 50,000 – the highest in six months – and ahead of the lifting of final restrictions from today, so-called Freedom Day. Rising case numbers are also evident across Europe. The spread of the virus, even across well-vaccinated countries, is likely to see delayed recovery paths as consumers behave more cautiously.
In currency markets, movements were modest but the weaker risk backdrop Friday night supported a stronger USD, although EUR and JPY largely maintained their poise. Commodity currencies and GBP underperformed, the latter possibly reflecting some concern that COVID19 restrictions of some form might be restored.
The AUD remained under pressure, taking a peek below 0.74, a fresh low for the year before closing the week around 0.74. The NZD escaped the same fate, supported earlier on Friday by a stonking CPI report (see below) that cemented in expectations that the official cash rate would need to head higher from next month. On the day, the currency met some resistance just under the 0.7030 mark before closing the week around 0.70. For the week, the currency was little changed, a relatively good performance against a backdrop of further USD strength that saw fellow commodity currencies, namely the AUD and CAD, down 1.2-1.3%.
NZ’s Q2 CPI rose by 1.3% q/q and 3.3% y/y, with an unusually large positive forecast error relative to market expectations of 2.7% y/y. Unlike recent US CPI figures, which have been exaggerated by the “reopening” of the economy, NZ’s inflation pick-up has been more broadly based, indicative of an over-heated, over-stimulated economy. Anecdotes and business survey pricing indicators have suggested this for some time, with the latter signalling that there is plenty more upside to be measured. Statistics NZ’s measures of the core CPI showed annual inflation surging to just over 3%, while the RBNZ’s sectoral factor model estimate – which historically has been smoother and slower moving – printed at 2.2% y/y, a 12-year high.
The OIS market moved to price in a much greater chance of a higher OCR over the three meetings left for the year, with a 25bps hike next month almost fully priced and just over two hikes priced for the year. Now that higher rates seem unquestionable, the debate is now likely to shift to how quickly the RBNZ might raise rates and ultimately how high the OCR ultimately needs to go to get headline inflation (and most of the core CPI measures) back comfortably within the 1-3% target range, as required by law.
NZGB and swap curves flattened after the announcement, with the 2-year swap rate closing 5bps higher at 1.09% and the 10-year rate flat at 1.86%, with NZGB rates showing similar moves. For the week, the combination of the more hawkish RBNZ Statement earlier in the week and stronger CPI data saw the 2-year swap rate up a hefty 23bps, while the 10-year rate was 10bps higher.
For households, the tightening cycle has already begun, ahead of official cash rate increases, with the major trading banks passing on some of the Risk higher wholesale rates seen over the past month into mortgage rates. BNZ’s carded fixed mortgage rates rose between 26-44bps on Friday.
Over the weekend, OPEC+ retook control of the oil market as it finally agreed to a supply deal that will see an increase in production of 400,000 barrels per day from next month and thereafter gradually increase production, committing to fully restore all of the cuts made at the start of the pandemic. Helping to reach agreement, some countries including UAE will be allowed higher production baselines. Monthly meetings will be held to review market conditions. Brent crude was relatively flat on Friday near USD73.50 and the supply deal should ensure that the market will remain tight over the short term.
The economic calendar in the week ahead is fairly sparse both domestically and globally, the highlight being the ECB policy update and global PMIs towards the end of the week.