Trading for the new week has begun with mixed performance for equity markets, global rates nudging higher, volatile energy markets and only modest currency movements. There has been more action in the NZ market, with rates surging after a whopper CPI print, but resulting in only a modest gain for the NZD.
There hasn’t been a great deal of news overnight but traders have been closely watching energy markets, given their recent inflationary impulse and price action for gas and oil has been volatile. European gas prices had another rollercoaster ride, surging another 15% before falling back. There was little sign that Russia was helping to support the market, with no sign that Gazprom was looking to book additional gas-transit capacity via Ukraine or Poland and its gas export data showed a decline as domestic demand in Russia surged.
Oil prices reached fresh multi-year highs, with Brent crude hitting US86 per barrel and WTI almost at USD84, before peeling off to be slightly lower for the day, both off a couple of dollars from their highs. Bloomberg reported that the global oil supply deficit was exacerbated after OPEC+ cut its production 15% deeper than planned in September, following a 16% shortfall in August, according to delegates with knowledge of the matter. This reflected the inability of some members to raise output to agreed volumes due to a lack of investment, exploration and other issues.
US economic data were mixed, with industrial production unexpectedly falling by 1.3% m/m in September, attributed to the impact of Hurricane Ida while supply shortages hit the auto sector. Meanwhile confidence among US homebuilders unexpectedly rose in October, despite rising material prices and supply shortages.
Reported yesterday, China economic activity data for September and Q3 were mostly on the weaker side of expectations, with GDP growth of 4.9% y/y. The economy is struggling against a number of headwinds, including lockdown restrictions alongside its zero-tolerance for COVID19 outbreaks, a weaker property sector and the energy crunch which has seen widespread power cuts and factory closures.
US equity futures were weaker during the Asian trading session and the S&P500 opened some 0.5% weaker before recovering into positive territory, now up 0.2%. Earlier, the Euro Stoxx 600 index closed down 0.5%.
Global rates continue to push higher as traders look towards monetary policy tightening ahead. US rates are higher across the curve, led by the belly. The 10-year rate rose to a high of 1.62%, before peeling off, now back down to 1.58%, up 1bps for the day and down slightly from the NZ close.
A number of global investment banks brought forward their call for UK rate hikes, now seeing a hike as soon as next month after BoE Governor Bailey said over the weekend that the central bank “will have to act” to prevent higher inflation expectations becoming more entrenched. The market is pricing over 100bps of hikes through the next year and the implied tightening is even greater allowing for the fact that the BoE has said that it would stop reinvesting bonds held under its QE programme once Bank Rate reaches 0.5%.
Higher UK rates, with the 2-year bond up some 13bps, have done little to support GBP, as traders worry that the BoE might be over-reacting to a supply-driven inflation surge against a backdrop of some key headwinds for the UK economy. GBP is down slightly to 1.3740. Most major currencies show little movement against the USD, contained within plus or minus 0.15%. The NZD has been the best performer, up 0.3% to around 0.7090, a modest but explainable performance in the face of surging interest rates, as we note below. NZD crosses are all slightly higher for the day, although relative strength in the euro means that NZD/EUR is fairly flat around 0.61.
Yesterday, NZ recorded another monster CPI print, with annual headline inflation of 4.9% and an average of Statistics NZ core measures at 4.1%. The RBNZ’s sectoral factor model estimate of core inflation, which is slow-moving, exhibits low volatility and is very slow to pick up on new trends, showed a record-equalling lift of 0.3% in the annual increase to 2.7% alongside upward revisions to recent data.
The inflation data far exceeded market expectations even though most of us were poised for a big outturn. Inflationary pressure was widespread, and included a 4.5% lift in non-tradeables inflation, heavily tied to the excesses in the domestic housing market, a market normally viewed as being under the control of monetary policy. The data provided further confirmation that monetary policy was excessively easy and the market rightly built in more rate hikes into the curve.
The OIS market moved to price in a near-even chance of a 50bps increase in the OCR next month and built in about an extra 25bps hike by early next year. An OCR of over 2% is now priced for the end of next year. This all fed into higher swap rates and a steeper curve, with the 2-year rate up a massive 28bps to 1.93% and the 10-year rate up 15bps to 2.49%. The NZGB curve showed a similar flattening bias.
The NZD showed a muted reaction to the data, not surprising given that high inflation is a double-edged sword. In fact, our short-term fair value NZD estimate fell a little, with higher rates not keeping up with higher inflation (real rates matter more than nominal rates). The theory of purchasing power parity also means that higher inflation means a lower long-term fair value estimate.
The data was a wake-up call for RBA watchers, with a significant move higher in rates across the Australian curve, with the market now seeing a 25bps rate hike by August 2022 and two hikes by the end of next year. The market will be closely watching the RBA’s operations this week, after the Apr-24 bond moved further away from the 0.1% policy target. The market rightly sees policy tightening well ahead of RBA rhetoric, which has consistently been that the Bank doesn’t see conditions for a rate hike before 2024. This guidance looks more ludicrous by the day as other central banks tilt in a more hawkish direction.
Finally, PM Ardern announced that Auckland will stay in alert level 3 lockdown for at least two more weeks and at the end of the week some vaccination targets will be provided that will offer a conditional path towards an easing of restrictions. The current lockdown, which is strict by global standards, is looking to endure for much longer than initially expected and this will lead to widespread downgrades for Q4 GDP estimates.