Market sentiment remains broadly positive despite a long list of potential risks. The S&P500 has pushed ahead to a new all-time high ahead of a deluge of corporate earnings reports over the next two weeks. Bond yields have come off their recent highs, despite rising inflation expectations. Following its recent strong run, the NZD has been consolidated around the 0.7150 mark over the past few sessions.
One of the notable features of market moves since Friday has been the continued trend higher in market-based inflation expectations. Partly, this reflects ongoing strength in energy prices, with WTI oil futures hitting $85 per barrel overnight for the first time since 2014 (now back under $84) and US natural gas futures jumping 10% on forecasts of colder weather in the US in November. The shortage of natural gas is adding to already strong oil demand while supply remains constrained, with OPEC+ only gradually increasing supply.
The UK 10-year breakeven inflation rate has reached its highest level in 25 years, at 4.20% (note that UK inflation-linked bonds are indexed to the retail price index which has historically had higher inflation than CPI). The European 5-year 5-year forward inflation swap, a key measure of medium-term inflation expectations favoured by former ECB President Draghi, has broken above the ECB’s 2% target for the first time since 2014. The US 5-year breakeven inflation rate hit 3% for the first time on record on Friday, before reversing lower to 2.95%. In New Zealand, breakeven inflation rates stretching from 5 years to 20 years are all above the RBNZ’s 2% target midpoint. The fact longer-term inflation expectations have made new highs suggests there is likely more to the moves than just higher energy prices, with the market likely factoring in rising underlying inflation and wage pressures.
Despite the increase in inflation expectations, global bond yields have fallen back over the past two sessions. The US 10-year rate is trading this morning around 1.63%, down from its recent 4½-month high of 1.70% which was reached on Friday morning. The pullback in rates has also occurred despite Fed Chair Powell, in comments on Friday, all but confirmed an imminent start to tapering. The market expects the tapering process to begin in mid-November and new purchases to stop by June next year. Fed rate hike expectations have been relatively stable, with the market pricing around a two-thirds chance of a Fed rate hike by June next year and two 25bps rate hikes by the end of 2022.
The S&P500 is up 0.5% overnight, to a new all-time high, while the NASDAQ is up 0.9%. The Energy and Materials sectors have been amongst the biggest gainers in the S&P, reflecting the higher commodity prices overnight (e.g. copper +1.5%). The US corporate earnings season gets into its stride this week, with 316 companies in the S&P500 reporting over the coming fortnight, including Facebook, which reports after the bell tonight (followed by the other big tech firms later in the week).
For now, equity markets remain resilient to a long list of investor concerns, including the potential for earlier monetary policy tightening and demand-destructive increases in energy prices. We can add to that list an outbreak of Delta variant cases in China, with cases now reported in 11 provinces and 38 new cases reported yesterday. With China still pursuing its elimination strategy, the authorities have locked down a small county in Inner Mongolia.
More encouragingly, there seems to have been some progress on US fiscal stimulus negotiations. Senator Manchin, one of two centrist Democrats opposed to the huge price tag on Biden’s social spending bill, said he expects to agree a framework on the package this week. That may also pave the way for a vote in Congress on the $550m infrastructure package. Manchin continues to insist the larger social spending bill shouldn’t exceed $1.5tn.
Currency moves have been limited over the past two sessions, with overnight moves contained to within +/-0.3% against the USD. After its recent strong run, the NZD has been consolidated since Friday, within a 0.7130 – 0.7190 range. The NZD trades this morning around 0.7165. Commodity currencies, including the NZD, are hovering near multi-month highs amidst robust risk appetite and generally firm commodity prices.
In economic data, the German IFO expectations index, taken from a survey of businesses, fell for the fourth month in a row, to a six-month low. It won’t surprise anyone to hear that supply problems continue to hamper activity. Friday’s European PMIs highlighted similar themes, although the Eurozone manufacturing index remains relatively elevated on a historical basis, at 58.5.
Evergrande appears to have staved off default, at least for a couple of days, after it reportedly made the overdue coupon payments on dollar bonds on Friday just ahead of the expiration of the 30-day grace period that commenced Sep 23. The distressed real estate developer will need to make several more coupon payments in the coming weeks, the next being Friday, to avoid default.
The RBA finally stepped into the market on Friday, offering to buy $1b of the April 2024 bond, which had traded persistently above its 0.1% target all week. The bond’s yield dropped from 0.18% to 0.12%, now within the RBA’s assumed tolerance threshold. Despite the RBA enforcing its yield target, it’s clear the market thinks the RBA will be raising rates well before 2024, with the first hike priced in by September next year.
Friday was quieter in the domestic rates market, after the enormous moves earlier in the week. The yield curve continued to flatten, with the 2-year swap rate moving up 3bps on Friday, to 1.99%, while the 10-year rate was 1bps lower, at 2.59%. NZ rates were 24-34bps higher last week, reflecting the huge upside surprise to CPI and the ensuing recalibration of RBNZ rate hike expectations in illiquid market conditions.
It should be a quiet session ahead, the only data of note being the Conference Board consumer confidence index. Wednesday sees the all-important Australian CPI release, with the potential for volatility in Australian interest rates (and likely spill overs to New Zealand).