US Fed's Williams finally acknowledges growing underlying inflation pressures in the US. RBNZ 2-year inflation expectations hit a 10-year high driving NZD outperformance and another surge in the NZ 2-year swap rate

Offshore markets have been relatively quiet overnight.  There have been small gains in US equities while bond yields and the USD are slightly lower.  The NZD and NZ rates were higher yesterday after a jump in the RBNZ’s inflation expectations survey.  The NZ 2-year swap rate hit its highest level since early 2017 with nerves running high ahead of the RBNZ’s MPS next week.

There haven’t been many major developments to report on overnight.  Economic data have been generally positive but not market moving.  US weekly jobless claims fell marginally, to a new post-Covid low, while the Philadelphia Fed’s business index showed a sharp bounce in November, with new orders surging to their highest level since 1973.

New York Fed President Williams, considered one of the ‘core’ members of the FOMC, acknowledged that underlying US inflation had picked up and become broader based in recent months.  Williams also observed that long-run inflation expectations had “moved up quite a bit”, adding that he wouldn’t want to see these long-run inflation expectations move significantly higher from here.  US 10-year breakeven inflation hit its highest level since 2005 earlier in the week while surveyed inflation expectations have also been trending higher.  Williams’ comments didn’t move the market although they suggest that centrist Fed officials are gradually moving in a hawkish direction.  The market awaits Biden’s decision on who he will nominate as Fed Chair, which should be due any day.

Global bond yields are slightly lower over the past 24 hours, with the US 10-year rate slipping 1bp, to 1.58%, and 10-year rates in Germany and UK down 3-4bps.  The market has pushed back its expected timing of the first 10bps ECB rate hike to early 2023 following recent dovish comments from ECB officials and the surge in Covid cases in the region, which has led several countries to implement renewed lockdown restrictions.

After its recent strong run, the USD is weaker overnight. The BBDXY and DXY indices, which reached 12-month highs on Wednesday night, are down by 0.1-0.3%.  The EUR has recovered some lost ground, up 0.4% overnight to 1.1387.  The NZD has outperformed over the past 24 hours after the RBNZ’s 2-year ahead inflation expectations series hit a 10-year high (see more below).  The NZD is up 0.5% from this time yesterday, at 0.7030, while the NZD/AUD cross has pushed up to 0.9665, on track for its highest close in almost two months.

Turkey’s central bank cut its cash rate 100bps overnight, with the Turkish lira plunging almost 4% to a new record low.  President Erdogan has replaced senior central bank officials over the past year with officials sympathetic to his unconventional view that higher interest rates are a cause of higher inflation.  The policy experiment is going to be put to the test with Turkish CPI already running at around 20% y/y and the fall in the lira only likely to exacerbate inflationary pressures.

US equities are slightly higher, with the S&P500 and NASDAQ hovering just below their recent all-time highs.  Strong earnings remain a supportive driver for equities, alongside ultra-low real interest rates, with chipmaker Nvidia and retailers Macy’s and Kohl’s all beating analysts’ earnings expectations over the past 24 hours.  In an encouraging sign for US consumer spending, Macy’s and Kohl’s both increased their full-year earnings guidance.

In Japan, the Nikkei reported that the government was planning a ¥55.7tn (~10%/GDP) fiscal stimulus, larger than previously reported, with details due to be announced today.  The size of the stimulus reportedly includes loans and previously unused funds, so the net ‘new’ stimulus will be lower than the headline implies.

Turning to domestic developments, the RBNZ’s Survey of Expectations showed 2-year ahead inflation expectations at 2.96%, much higher than the 2.27% reported last quarter.  The 2-year ahead inflation expectations series tends to be contemporaneous with headline inflation, and the spike higher is to be expected given CPI printed 4.9% in Q3.  5-year and 10-year inflation expectations remain close to the 2% target midpoint, at 2.17% and 1.97% respectively, suggesting the RBNZ’s inflation-fighting credibility remains intact, despite the current inflation overshoot.

NZ swap rates were already higher heading into the inflation expectations release and jumped higher in illiquid conditions into the market close, with the price action suggesting some market participants have been caught offside.  Nerves are clearly elevated ahead of the RBNZ’s MPS next week.   The market is pricing just over a 40% chance of a 50bps hike next week and 72bps in total over the next two meetings (i.e. a high chance of a 50bps move at one of the November or February meetings).  The 2-year swap rate closed 8bps higher on the day, at 2.43%, a striking move given that US and Australian rates were lower yesterday.  The 2-year rate is trading at its highest level since 2017.  Meanwhile, the yield curve continues to relentlessly flatten with the 10-year swap rate up ‘just’ 3bps yesterday, at 2.75%.

It was a completely different story in the NZGB market, with a very strong government bond tender setting the stage for sizeable falls in long-term bond yields and a big widening in swap spreads.  The 10-year bond yield fell 4bps, to 2.58%, while the 30-year yield was down 6bps.  Government bonds appear to be attracting offshore demand again with offshore volatility settling down and NZ yields standing out like a beacon compared to other markets like Australia and the US.

Fed officials Clarida and Waller are both speaking tonight, and the market will be listening out for any change in tone after the big inflation surprise earlier in the month.  It’s also possible we could get an announcement from Biden on his nomination for the next Fed Chair, with betting markets and economists still favouring Powell to win a second term.