Global rates continue to trend higher - US 10yr hits 2-year high with market pricing small chance of 50bps Fed hike in March. Equities under pressure again

In a continuation of this year’s trends, global rates continue to push higher, putting pressure on equity markets, especially tech stocks.  The US 10-year rate has reached a 2-year high, around 1.86%, with the market now putting a small chance on a 50bps Fed rate increase in March.  The NASDAQ continues to struggle, down more than 2%.  The USD has benefited from higher rates and the pickup in risk aversion, taking the NZD below 0.68.

The global bond market sell-off has continued overnight with further increases in US and European rates.  The US 2-year rate broke above 1% in Tokyo yesterday after trading resumed following the long weekend (currently 1.04%) while the 10-year rate has pushed up to 1.86%.  Again, there was no clear trigger or catalyst behind for the moves, but it seems as if rates are following the typical historical pattern of increasing into the first Fed hike of the cycle.  The market is now pricing more than four Fed hikes this year (around a 15% chance of a 5th hike) as well as a small chance of a 50bps Fed hike at the March meeting (around 5%).  Meanwhile the UK 10-year bond rate hit a fresh 2½-year high and Germany’s 10-year bund yield edged closer to the 0% mark, up 1bps on the day.

A further increase in oil prices has probably played a part in the move higher in rates, adding to already elevated inflationary pressures.  Brent crude oil hit its highest level since 2014 yesterday, just above $88 per barrel, taking its year-to-date increase to 12%.  The market appears to have become more confident in the demand outlook, with Omicron appearing much less deadly than Delta, while supply increases from OPEC+ have been restrained.  Meanwhile, supply disruptions in Libya and a drone attack near oil facilities in the UAE have added to supply fears.   Goldman Sachs raised its forecasts overnight, now calling for $100 per barrel oil prices next year.

Equity markets have been under pressure amidst the continued push higher in global rates.  Interest rate-sensitive tech stocks continue to underperform, with the NASDAQ off more than 2% overnight, bringing its year-to-date performance to -5.8%.  The S&P500 is down 1.7%, with the Financials sector surprisingly leading declines.   Banks are typically seen as beneficiaries of higher rates and a steeper curve, but this has been overshadowed by disappointing earnings from Goldman Sachs overnight, especially in terms of trading revenue.  Goldman’s share price is down more than 8%, following on from similarly disappointing results last week from JPM.

Against a backdrop of higher US rates and weaker equity markets, the USD is broadly stronger.  The BBDXY is up 0.5% on the day and it is now back to flat year-to-date.  One puzzle earlier this year had been squaring the weakness in the USD with the increase in Fed rate hike expectations and pick up in risk aversion, both of which would ordinarily be expected to help the USD appreciate.  Heavy USD long positioning might have been part of the explanation, although the price action over the past few days suggests the correlation hasn’t completely broken yet.

The EUR has fallen 0.75% to 1.1325 while the NZD and AUD are both off around 0.6% over the past 24 hours, with the NZD falling to around 0.6750, near its lows for the year.  A strong Global Dairy Trade auction overnight, with the overall price index 4.6% higher and whole milk powder prices up 5.6% to a 7-month high of $4,082, hasn’t provided much support to the NZD.

The JPY has outperformed overnight (unchanged on the day despite a broadly stronger USD), with the pickup in risk aversion seemingly outweighing the influence of higher US rates.  At yesterday’s policy update, the BoJ slightly raised its inflation forecasts and upgraded its risk assessment of the inflation outlook to “balanced” for the first time since 2014.  Governor Kuroda quashed speculation of an early end to its stimulatory settings, saying “raising rates is unthinkable.”

Economic data overnight has been mixed and not a major driver of markets.   The New York Fed’s Empire manufacturing survey was very weak, with the headline index dropping to its lowest level since mid-2020.  The Omicron wave in January might have dampened optimism, but forward-looking measures were more positive, with the capital expenditure index hitting its highest level since 2006.  Similar positivity about the future was seen in the German ZEW survey, which reported a sharp increase in expectations.  In the UK, payrolled employment rose a stronger than expected 184k in December, while the unemployment rate edged lower to 4.1%, indicative of a tight UK labour market.

China reported another two new Omicron cases in Beijing alongside a separate case of Delta. The market remains worried about the potential fallout to growth (and global supply chains) if China needs to broaden its restrictions to eliminate Omicron ahead of the winter Olympics in a few weeks’ time.  On a more optimistic note, African researchers reported that vaccinated people who caught Omicron were much less likely to be subsequently infected with Delta, with the researchers suggesting this could mean Covid-19 is less disruptive going forward.

A day after it cut two of its policy rates by 10bps, the PBOC’s Deputy Governor confirmed that the PBOC is now in an easing cycle,  saying it would “open monetary policy tool box wider, maintain stable overall money supply and avoid a collapse in credit”.   Despite China being a global outlier in embarking on easier monetary policy, the CNY hit a 3-½ year high yesterday, although it has given back its gains overnight.

Turning to local developments, yesterday’s QSBO business survey highlighted the intense inflationary pressures and skills shortages in the economy at present. A net 52% of businesses reported that they raised prices in Q4 with a staggering 65% saying they intended to do so this quarter, which points to the risk that CPI inflation peaks higher and/or later than we currently expect (we have pencilled in a peak of annual inflation of 5.7% for Q4/Q1). Meanwhile, employment intentions remained very strong, pointing to further declines in the unemployment rate with the border closed and firms reporting extreme difficulty finding labour.  Trading conditions, which provide a steer on activity levels, were lower in Q4, suggesting cautious on near-term GDP.  Meanwhile, REINZ housing data showed a modest 0.5% seasonally adjusted fall in house prices in December (+21.5% y/y) as the housing market shows further signs of losing momentum.

NZ rates continue to outperform other markets, especially the US.  The NZ 10-year swap rate was down 4bps yesterday, to 2.77%, despite US rates extending their moves higher.  The 10-year spread, in swaps, has moved around 20bps lower year-to-date, to 87bps.  The spread compression this year mainly reflects the more hawkish rhetoric coming out of the Fed but also, to an extent, the fact that the NZ market entered 2022 with much more tightening priced into the curve than the US.

Ahead of the Bank of Canada’s policy meeting next week, Canadian CPI is released tonight, with headline inflation expected to hit a new cycle high of 4.8% y/y.  The market now prices an almost 70% chance of a rate hike by the Bank of Canada next week, which would make it the fourth developed market central bank to raise rates post-Covid, following the RBNZ, BoE and Norges Bank.  UK CPI is also released tonight, with headline inflation expected to nudge up to 5.2% y/y.