Equities continue to recover, while UST 10-year remains range-bound. European rates and EUR higher after big upside surprise to European inflation data. RBA's Lowe acknowledges a rate hike later this year is "plausible"

Market moves have been relatively modest overnight ahead of the ECB and Bank of England meetings tonight and nonfarm payrolls on Friday night.  US equities have pushed slightly higher while the US 10-year rate has drifted lower.  The NZD and AUD have consolidated after their strong gains over the past few days.  NZ rates moved lower yesterday after the HLFS labour market data weren’t as strong as some had feared.

Equity markets continue to recover after the sharp sell-off in January.  The S&P500 is up 0.7% overnight, adding to its 5% gain over the three previous trading sessions, while, in Europe, the EuroStoxx index was 0.5% higher.  The NASDAQ is 0.4% higher, helped by bumper earnings (and a 20-for-1 stock split) from Google’s parent Alphabet, continuing the positive trend in corporate earnings for this reporting season.

As foreshadowed by country-level inflation data the past few days, European headline CPI inflation pushed up to a new record (post-2000) high of 5.1% y/y.  This was much stronger than the median estimate among economists of 4.4%, most of whom hadn’t updated their forecasts in advance of the Euro-wide figure.  Core inflation decelerated to 2.3% y/y, owing mainly to base effects related to Germany’s VAT cut in the second half of 2020, but again this was much stronger than expected and is above the ECB’s 2% target.

The market responded by further bringing forward the expected timing of ECB rate hikes, with the first 10bps increase now priced for July.  The 10-year German has pushed up slightly, to a fresh 2½-year high of 0.04%.  Focus now turns to the ECB meeting tonight, with the market now clearly challenging the ECB’s previous guidance that rate hikes are very unlikely this year.  Indeed, the ECB has indicated that, while its pandemic bond buying programme will end in March, it plans to be buying bonds (under its separate Asset Purchase Programme) until at least October, which would seem to rule out rate increases  before then. The ECB expects inflation to moderate over the next year and we suspect Lagarde will stick to that view for now, while acknowledging that upside risks have risen.

In contrast to the moves in Europe, US rates are lower overnight, with the 10-year bond rate down 4bps, to 1.75%.  A weak ADP employment survey (see below) added some downward pressure to rates while the market has taken some comfort from Fed speakers this week, none of whom have endorsed a 50bps rate hike nor a significantly accelerated pace of tightening.

The ADP employment estimate showed a 301k job loss in January, much lower than the +180k consensus.  The weak result was mainly blamed on Omicron, with a broad range of indicators still suggesting the US labour market remains exceptionally tight.  While ADP has a patchy track record in predicting nonfarm payrolls, its notable that several high-profile forecasters (including Goldman Sachs, Bank of America, and Pantheon Macroeconomics) are likewise picking a negative monthly payrolls number for January, even though the median estimate still sits at +150k (the data are released tomorrow night).

Like the bond market, European currencies are a bit stronger overnight, partly reflecting the European inflation data.  The EUR has appreciated 0.4% to 1.1310, now almost 2 cents above the lows reached last week.  The   NZD and AUD have consolidated after their strong gains over the past few days.  The NZD is sitting around 0.6640 this morning, effectively unchanged on the day, having briefly traded above 0.6660 overnight.

In Australia, RBA Governor Lowe yesterday finally conceded that a rate hike in 2022 was a “plausible scenario”, even as he continued to push the line that the RBA could be “patient ”.  Key to Lowe’s argument for patience is that the RBA still wants to see wage growth, a typically lagging indicator, moving higher.  With the RBA digging its heels in, the market has pared back the probability of near-term rate hikes.  Around 45bps of hikes were priced in by the July meeting as recently as the 27th of January, but that is now back to 28bps.  Interest rate expectations beyond the next 6 months have been less affected, with the market expecting the RBA will ultimately capitulate on its dovish rhetoric and be forced to catch up with a quick series of rate hikes.  Likewise, there was little reaction in the AUD to Lowe’s comments yesterday.

In local developments, the HLFS labour market report confirmed an extremely tight NZ labour market, with the unemployment rate falling to a record low of 3.2% in Q4.  This was in-line with the RBNZ’s November MPS forecast, and a smidgen below the market’s 3.3% estimate.  Wage growth has also clearly picked up, as businesses compete to find and retain workers with the border still largely closed.   The LCI wage measure (ex-overtime) increased to an annual rate of 2.8%, its highest rate since 2009, albeit slightly below market expectations.  The unadjusted LCI measure, which doesn’t make ‘quality adjustments’ so arguably gives a better sense of nominal wage growth, is now running at 4.5%.  While wage growth is increasing, its still not keeping pace with inflation, which is one of the factors undoubtedly weighing on consumer confidence at present.

The interest rate market was clearly apprehensive the labour market data could have been even stronger, with some talk the unemployment rate might even have printed below 3%.  Swap rates drifted lower during the day, eventually ending down 4bps for 2-to-5 year maturities, with the market lowering the probability of a 50bps OCR hike at the upcoming MPS to around 20%.  There is still a significant amount of tightening priced in for the RBNZ this year, with the November OIS rate sitting just below 2.50%, implying almost a hike at each of the seven meetings this year.

Finally, OPEC+ announced that oil supply would increase 400k barrels per day from March, in line with expectations and the eight consecutive monthly increase.  WTI oil futures hit a fresh 7-year high of almost $90 shortly after the OPEC+ announcement but it has since given back those gains and is now down around 1% on the day.

The Bank of England and ECB monetary policy meetings take place tonight.  A 25bp hike by the Bank of England, to 0.50%, is expected by 38 of the 42 economists polled by Bloomberg and is fully priced by the market.  The BoE has also signalled it will start the process of balance sheet reduction (so-called ‘quantitative tightening’) once the cash rate reaches this mark, with the Bank set to stop reinvestments on its QE bond holdings.   The market prices around five 25bps rate hikes by the BoE by the end of the year.  The ECB meeting follows shortly after the BoE.  In the US, the ISM Services index is expected to slip to 59.6 in January, whiich would still be an extremely high level on a historical basis.