Choppy trading conditions continued on Friday but the net result was a strong bounce-back in US equities. US Treasury yields turned lower after the employment cost index was weaker than expected. Selling pressure continued for the NZD and AUD, as they fell to fresh lows and solidified their place at the bottom of the weekly performance table, down 2½% and 2¾% respectively.
With heightened fear about the macro economic environment of extraordinary high inflation, slowing growth and the beginning of a major tightening cycle by central banks, it was another volatile trading session on Friday. A strong rally in the last hour and a half of trading saw the S&P500 close 2.4% higher and save the index from recording another weekly loss, up 0.8% for the week overall. Strong earnings results from Apple and Visa had some impact on market sentiment, rising 7% and 10½% respectively.
Ukraine remains a key hotspot, with the US playing up the risk of Russia invading the country, saying that Russia had moved blood and medical supplies close to the Ukrainian border, a signal of impending war. Ukraine is trying to downplay the risks, arguing that the US was stoking panic and that its intelligence wasn’t true. President Biden said that he would be sending troops to Eastern Europe.
On the economic front, data released Sunday showed official China PMIs slipped further as expected, close to the 50 mark, indicative of slowing and soft economic momentum and not helped by the zero-COVID strategy, resulting in widespread lockdowns, and orders to reduce output to reduce air pollution ahead of the Beijing Olympics. The Caixin manufacturing version, which is more exposed to smaller exporters, fell below the 50 mark to 49.1.
In the euro area, economic confidence – reflecting a mix of business and consumer confidence – fell to a nine-month low. Germany GDP slumped 0.7% q/q in Q4, much weaker than expected, while growth for France and Spain was stronger than expected at 0.7% q/q and 2.0% q/q respectively.
US wages growth, as measured by the employment cost index, remained very strong in Q4, rising by 1.0% q/q, although not as high as feared after the even larger 1.3% lift in the previous quarter. Still, annual wage inflation of 4.0% y/y was the strongest in two decades and broadly based, consistent with the very tight labour market. The core PCE deflator rose 4.9% y/y, consistent with other surging inflation indicators. The final University of Michigan consumer sentiment reading for January dropped to its lowest level in over a decade, with three-quarters of Americans saying inflation was the biggest problem for the economy.
In a radio interview on Friday, Minneapolis Fed President Kashkari, known for his previously uber-dovish stance, refused to be drawn into how many hikes he now expects this year and he replied “we just don’t know”, when asked if three rate hikes would be enough. In an interview with the FT over the weekend, Atlanta Fed President Bostic conveyed the same flexibility with policy as Chair Powell suggested last week – that every meeting was live and a 50bps increment couldn’t be ruled out, even if his base case remained three hikes this year.
The inflationary backdrop and recent hawkish commentary from Fed officials has encouraged economists to revise up their Fed Funds rate predictions for this year. Bank of America now expects seven 25bps hikes this year and a peak rate of 2¾-3%. JP Morgan and Goldman Sachs both now expect five hikes this year. About five hikes are currently priced into the Fed Funds and OIS curves for 2022.
Given the extent of hikes priced in for this year already, the hawkish commentary from Fed officials and trading banks didn’t do any further net harm to the Treasuries market, although a large trading range was evident. Yields moved higher ahead of the US data releases, taking the 2-year Treasury yield to a fresh high for the cycle of 1.23% and the 10-year rate up to 1.85%, before they tumbled after the employment cost index wasn’t as high as feared. Both bonds ended the day lower in yield by about 3bps, to 1.16% and 1.77% respectively.
Most of the key major currencies were rangebound, showing modest movements. Over the weekend, Italy re-elected Mattarella as President, which reduces political risks that were overhanging the country by allowing Draghi to continue in his role as Prime Minister, a net positive factor for the euro as the new week begins.
Against the grain, the NZD and AUD showed more unidirectional movements to the downside, the NZD trading down to 0.6530, its lowest level since September 2020 and the AUD trading at its lowest level since July 2020 at 0.6968, both closing slightly above those levels. Both are getting down to key technical support levels and one might be brave enough to argue that they are due for some consolidation after tumbling 2½-2¾% for the week and sitting on year-to-date losses of about 4%.
We can justify the lack of bounce-back on Friday of the NZD and AUD by referring to our risk appetite index, which actually fell slightly further to a fresh low for the cycle, just above the 40% mark. The fall in the VIX index (consistent with the rally in the S&P500) was more than offset by the lift in the North American high yield index bond spread, which also feeds into our risk appetite measure.
On the back of global forces, domestic rates showed notable moves to the downside on Friday, reversing some of the prior lifts, but still ending the week net higher in yield. Both the swaps and NZGB curves showed flattening pressure, with 2-year swap down 2bps to 2.46% and 10-year swap down 7bps to 2.83%. The 10-year NZGB fell 6bps to 2.61%. Early in the day, the ANZ consumer confidence index showed a further fall to 97.7, taking it further away from its long-term average near 120. When seasonally adjusted, the fall in the index was more marked, taking it to levels seen near previous recessions. It wouldn’t surprise to see a mini-recession ahead, as Omicron cases skyrocket, consumers behave more cautiously and businesses are interrupted by supply chain and staffing issues.
On the economic calendar, euro-area GDP and German inflation data are the headline acts. It is another action-packed week ahead with policy updates from the RBA, ECB and BoE, and expect to hear more from Fed speakers. Domestically, focus turns to Wednesday’s labour market reports, while key data in the US include the ISM indicators and the employment report at the end of the week.
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