Bond markets remain volatile amidst high inflation and growing expectations that central banks will bring forward interest rate hikes. Friday saw the highest quarterly wage growth in the US in almost 40 years and European core inflation above the ECB’s 2% target for the first time since 2002. The US 10-year rate fell slightly on Friday but there were big movements in Australia after the RBA decided against enforcing its Yield Curve target once again, signalling that it will ditch the policy and its 2024 rate guidance at its meeting tomorrow. NZ rates had some respite on Friday, falling back after their big moves higher earlier in the week. The USD was stronger on Friday, with the EUR giving back its post-ECB gains and the NZD falling back below 0.72. Equities continue to edge higher.
Inflation concerns remain front and centre for market participants. In the US, the Employment Cost Index (ECI) recorded a 1.3% quarterly increase in Q3, much higher than expected, with wages and salaries 1.5% higher over the quarter, the largest such increase since 1982. The very high rate of wage growth in the US confirms the US labour market is extremely tight. Fed officials expect that more workers will return to the labour force in the coming months following the end of generous unemployment benefits, the return of schools and the decline in Covid-19 cases in the country, in turn moderating wage pressure. But, if wage growth remains elevated, it will likely sustain higher inflation, in turn requiring a more aggressive Fed monetary policy response.
The Fed meets on Thursday morning, with the market expecting it to formally announce tapering, likely to commence mid-November and finish by mid-2022. The market prices an almost 80% chance of a Fed rate hike by June next year. Economists are finally starting to catch up to the market, with Goldman Sachs changing its Fed rate call on Friday, now expecting the first hike in July 2022.
In Europe, CPI inflation was much higher than expected, as foreshadowed by the Spanish and German inflation numbers the previous night. Headline inflation matched its highest since the formation of the euro, at 4.1%, while core inflation rose to 2.1% y/y, the first time it has been above the ECB’s 2% target since 2002. The market continues to bring forward the expected timing of ECB rate hikes following President Lagarde’s ‘half hearted’ pushback against market pricing on Thursday night, with now 20bps of hikes priced in by the end of 2022 and 60bps by the end of 2023. The German 5-year rate was 5bps higher on Friday, hitting its highest level in 2½-years, at -0.39%, while Italy’s 10-year yield pushed another 12bps higher, with the market anticipating less ECB bond buying support ahead.
US Treasury yields bucked the global trend on Friday, despite the extremely strong wage data, with the 10-year rate falling 3bps, to 1.55%. The yield curve remains under flattening pressure amidst expectations that the Fed will raise rates by the middle of next year, in turn leading to a growth slowdown down the line. Month-end related demand may also have supported bonds on the session.
Equities remain oblivious to the increase in central bank rate hike expectations, with the S&P500 grinding out a 0.2% gain on Friday, taking it to a fresh record high. Earnings reports from tech heavyweights Amazon and Apple disappointed market expectations, but the corporate earnings season has been positive overall, with more than 80% of S&P500 companies having beaten earnings expectations so far. The S&P500 was up 6.9% in October, and the NASDAQ 7.3%.
The USD appreciated sharply on Friday, rising by 0.7-0.8% in index terms. The EUR gave back all its post-ECB gains, and some, falling over 1% to 1.1560, near its year-to-date low. The NZD was down 0.4%, falling to around 0.7170. Currencies and equities haven’t been overly affected by the recent volatility in interest rate markets and risk appetite remains generally positive, a key factor behind the almost 4% appreciation in the NZD over the month.
European natural gas futures fell another 13% on Friday continuing the trend lower after Russian President Putin signalled that Gazprom would start filling European storage facilities from early November. Gas futures are now some 60% off the panic levels reached in early October but, to put the moves in context, they are still more than 2.5 times higher than at the end of last year. 10-year breakeven inflation expectations in Europe and the UK fell almost 10bps on Friday on the back of the moves in gas prices, albeit they remain near multi-year highs.
In Australia, the RBA again decided against enforcing its Yield Curve Control policy on Friday, even with the April 2024 bond trading well above the 0.1% target. The bond’s yield jumped another 24bps, to 0.78%, following on from Thursday’s 33bps rise, as the market took the RBA’s inaction as confirmation that it will change its forward guidance at tomorrow’s meeting and will drop the policy altogether. The reason the RBA had previously been buying the April 2024 bond if it was trading above 0.1% was because it tied in with its central view that rate hikes were unlikely until 2024. But with core inflation now within the 2-3% target range, that forward guidance will be dropped tomorrow, and more realistic, outcomes-based guidance is likely to be adopted. The market prices an almost 40% chance of an RBA rate hike at the February 2022 meeting. The volatility wasn’t confined to the Australian short end, with the 10-year rate increasing a massive 24bps, to a 2½-year high of 2.09%, before reversing that move during Friday night futures trading.
New Zealand rates finally found some relief on Friday, even with Australian rates pushing sharply higher. The 2-year swap rate dropped 9bps, to 2.26%, still some 83bps higher during the month of October. And the yield curve reversed some of its recent flattening trend, the 10-year swap rate unchanged on the day, at 2.74%. Volatility remains very high and liquidity is thin, exaggerating market movements.
In other news, overleveraged Chinese real estate developer Evergrande has seemingly staved off default for another few weeks after reportedly making USD bond interest payments to investors on Thursday, just ahead of the end of its 30-day grace period. The next coupons come due on the 11th of November and media have reported that Chinese authorities have pressured the company’s founder to commit his own personal capital to help the company survive.
Finally, in data released over the weekend, the official Chinese manufacturing PMI fell to 49.2, its lowest level since the nationwide lockdown last year, amidst electricity shortages in the country. The non-manufacturing index was also softer than expected, albeit it remains in expansionary territory.
The highlight in the session ahead is the ISM Manufacturing survey but focus really lies on the upcoming central banks decisions this week, starting with the RBA tomorrow, and followed by the Fed and Bank of England later in the week. In New Zealand, we’re looking for the unemployment rate to fall to 3.7%, which would be its lowest level since 2008.
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