Market ignores RBA's policy message. More positive inflation surprise for Europe, adding focus to German yields and ECB meeting later this week. Key NZ labour market data today

The new month has begun with a positive vibe for risk appetite, following the big hit taken in January. Equity markets are flat to higher, global rates are higher (with some focus on key German yields), and the USD is broadly weaker. The NZD and AUD have recovered further from oversold levels, back above 0.66 and 0.71 respectively.

After strong back-to-back gains, the US equity market has started February on a flat note, with the S&P500 flat lining in and out of positive territory. European markets have played catch-up to the late-day rally in US equities yesterday, with the Euro Stoxx 600 index up 1.3%.

The headline for bond markets is Germany’s 2-year bond rising above the ECB deposit rate of minus 0.5% for the first time since 2015, after the government sold a new line of 2-year bonds. Germany’s 10-year rate is now trading decisively in positive territory at 0.03%, up just under 3bps for the day. The market has been increasingly seeing the chance of the ECB hiking rates this year, as the inflationary impulse grows. Overnight, French CPI inflation positively surprised, following the stonking German and Spanish CPI reports yesterday, adding further upside risk to the prevailing consensus for euro area CPI data tonight, ahead of the ECB meeting later this week. On market pricing, the ECB is expected to increase the deposit rate by 10bps to minus 0.4% in September, with a full 25bps priced by year-end. Both don’t expect the ECB to sanction this view later this week.

The US 10-year rate has traded a decent range of 1.74-1.82% and currently sits just 1bp higher for the day at 1.79%, with the curve showing a slight steepening bias, with the 2-year rate down 2bps.

The ISM manufacturing index slipped for a third successive month to a still-high 57.6, as expected.  Of some relief, the key measures of supply chain disruptions eased again, notably the order backlogs index falling over 6pts to a 15-month low. Prices paid jumped nearly 8pts, but this can be put down to the rise in oil prices. The employment component surprisingly increased, and meanwhile the JOLTS survey was also surprisingly strong in the face of the Omicron hit to the economy – job openings rose to 10.9m, to near record highs, while the quits rate barely fell at 2.9%, still near its record high.

Canadian GDP was stronger than expected, with November beating estimates and the stats department estimating growth of 1.6% q/q in Q4, or an annualised rate of 6½%, ahead of the Bank of Canada’s projection of 5.8%, reinforcing the likelihood of a first rate hike for the cycle at its next meeting.

The GDT auction was another strong one, with the price index rising by 4.1%, following the gain at the previous auction of 4.6%.  Whole milk powder rose by 5.8% while skim milk powder rose by 2.1%. Prices are up over 30% from a year ago, against a backdrop of a softer NZD through much of the past year, creating the environment of strong returns for dairy farmers, who are on track for a record milk payout this year, with futures close to $9.45 per kgs of milk solids – a year of very strong income even if production is currently weaker than usual as dry conditions develop across the country.

Yesterday, the RBA announced an end to QE, a policy measure well past its due-by date, increased its underlying inflation forecasts to above the 2-3% band near term and in the top half of the range through to the end of next year, alongside a fall in the unemployment rate to below 4% next year. Despite these projections the Bank remained stubborn, indicating it was “prepared to be patient” and gave no timing on when it thought it might be appropriate to move away from the emergency 0.10% level of the cash rate, for an emergency that ended over a year ago. The initial market reaction of a weaker AUD and lower rates didn’t last long, with the market rightly questioning the Bank’s sanity, still believing it to be only a matter of time before the RBA capitulates. The 3-yr and 10-year bond futures are little changed from their pre-RBA levels.

In currency markets, the risk-on vibe has supported the NZD and AUD against a backdrop of a weaker USD. On Monday, we noted that the NZD was looking oversold, as the RSI technical indicator had moved below 25 and the 30 level is considered the oversold threshold. The recovery in the NZD (and AUD to a lesser extent) should be seen in that context.  After both tumbled through January, some consolidation has been overdue. The NZD has trended higher overnight rising to 0.6630. After the brief dip to 0.7035 in the immediate aftermath of the RBA statement, the AUD has climbed up through 0.71.  NZD/AUD shot up to just under 0.9350 post-RBA and has since consolidated around 0.9320.

Of the other majors, GBP is one of the better performers, up 0.5% to 1.35. Despite the focus on German yields and where the ECB might take rates this year, the euro has remained on the softer side of the ledger, barely higher at 1.1240, with the NZD/EUR recovering to just under 0.59.

The domestic rates market showed little movement yesterday, closing ahead of the RBA announcement and with attention directed towards today’s HLFS and LCI labour market reports today. The consensus expects the unemployment rate to nudge down to 3.3%, which would take it to its lowest level since the 1970s. However, in these pandemic times, with this survey anything is possible, ranging from a sub-3% reading to a modest increase up through 3½%. Whatever the number, the story will remain one of a very tight labour market with rising wage inflation pressure.

RBA Governor Lowe speaks this afternoon, giving him a forum to expand on the policy outlook. Hopefully some tough questions are asked of the Bank’s willingness to ignore the significant inflationary impulse and policy direction of other similar central banks. As noted, after the stonking regional inflation reports, there is upside risk to the prevailing consensus for the euro area CPI, while the US ADP employment report is expected to be weak, coming ahead of the more important payrolls report at the end of the week.