ECB makes its hawkish pivot overnight. European and UK rates much higher, flowing through to other markets. Equity markets under pressure again. US nonfarm payrolls tonight, with a material negative risk

The hawkish shift among global central banks continues.  European rates have spiked higher overnight, and the EUR is much stronger, after ECB President Lagarde refused to rule out a rate increase this year.  In the UK, four Bank of England MPC members voted for a 50bps rate increase at its meeting overnight (the five other members voted for 25bps).  Higher UK and European rates have flowed through to higher US Treasury rates and we should see NZ rates open higher this morning.  Likewise, the NZD has benefited from the stronger EUR, appreciating to 0.6665.  Equity markets have come amidst renewed concern about global central bank tightening and after Meta (formerly Facebook) reported disappointing results (share price -25%).

It was the ECB’s turn to execute a hawkish pivot overnight, with President Lagarde repeatedly declining to rule out a rate hike this year, a big change from December when she said this was “very unlikely”.  Lagarde said the ECB now believed inflation risks were to the upside and it was “getting closer” to its inflation target.  European inflation reached a post-euro high of 5.1% y/y last month while core inflation was above the ECB’s 2% target and the unemployment rate stood a record low of 7%.

Lagarde confirmed the ECB’s pandemic bond buying programme would stop in March, although a separate bond buying programme would continue, at a temporarily increased rate, from this point.  Bloomberg later reported that the ECB could stop all bond purchases as early as Q3, which would be earlier than previous guidance.  When the ECB stops buying bonds is important because Lagarde has repeatedly said that it would only raise rates after this point.

The market ramped up pricing for ECB rate hikes this year following the press conference, with around a 70% chance of a 10bps move now priced for June and more than 40bps now priced-in by the end of the year.  The 2-year German yield, which crossed above the -0.5% deposit rate for the first time since 2015 just days ago, spiked 13bps higher, to -0.33%.  10-year yields were higher by 10bps in Germany, to 0.14%, and as much as 21bps in Italy, the main beneficiary of the ECB’s huge bond buying programme and ultra-easy monetary policy stance.  The EUR has experienced a big rally, up by more than 1% to 1.1440.

Over in the UK, there was also a hawkish surprise from the Bank of England.  The BoE raised its cash rate from 0.25% to 0.5%, as expected, but the surprise came in the form of four committee members dissenting in favour of a 50bps increase (making it a narrow 5-to-4 vote for 25bps).  The BoE now see inflation peaking at around 7¼%, more than 1% higher than previously, even though it is projected to be slightly below target in two years’ time (based on market pricing for rate hikes).  The four members who voted for the 50bps increase (three external members and Deputy Governor Ramsden) argued that inflation pressures were broadening, and a larger rate move would reduce the risk that inflation and wage expectations become embedded at uncomfortably high levels.  The majority argued that raising the cash rate 50bps would increase rate expectations further, which would push down inflation in the medium term (which was already projected to be slightly below 2%) and further slow the economy.

Now the BoE’s cash rate has reached 0.5%, it will stop reinvestments on its bond portfolio, which will see its holdings shrink over time (a process sometimes referred to as ‘quantitative tightening’), with active sales of its government bond holdings planned once the cash rate reaches 1%.  Finally, in a surprise move, the BoE said it would start to sell down its £20b corporate bond holdings, judging that the relatively small size of the holdings and well-functioning state of the market meant that this could be done with relatively little impact.

UK rates were higher by 9-11 bps across the curve, with the market increasing its BoE rate hike expectations (and now putting a small chance on a 50bps increase at the upcoming March meeting).  The 10-year rate hit a fresh 3-year high of 1.37% although the reaction in the GBP has been more muted, just 0.2% higher on the day, to 1.3605.

Higher UK and European rates have flowed through other markets, with the US 10-year rate 6bps higher, to 1.83%, and the Australian 10-year bond futures yield up by a similar amount.  In currencies, the stronger EUR has helped the NZD and AUD move higher overnight, with the NZD up around 0.5% to 0.6665.

The other major story over the past 24 hours has been the weakness in equity markets.   The NASDAQ is down 2.6%, giving back some its recent strong rally, while the S&P500 is down 1.7%.  Social media giant Meta (formerly Facebook) reported disappointing results, notably a decline in daily active users for the first time amidst rising competition from the likes of TikTok, which saw its share price collapse 25%.  Given Meta’s chunky weight in both the S&P and NASDAQ indices, its share price is responsible for around a third of the S&P500 decline and half the NASDAQ fall on its own.  Equities have had another leg lower over the past few hours following the ECB’s hawkish turn, which has reignited concerns about global monetary policy tightening.

Economic data have been completely overshadowed by the central bank news overnight and the Meta results, but, for the record, the ISM Services index slipped to 59.9, which is still a very healthy level on a historical basis, while US jobless claims were lower last week, as the impact of Omicron fades.

Turning to domestic developments, PM Ardern announced the long-awaited schedule for reopening the border yesterday.  It will be a multi-stage process, starting with vaccinated New Zealanders from Australia later this month and then from elsewhere, including critical and skilled workers, from mid-March.  A substantive opening for international tourism is not envisaged until October.  The proposal isn’t a major surprise, more a delay from what the previous plan was.  In time, the prospect of more open international travel might help ease some of NZ’s extreme skill shortages, although there is also the possibility of greater departures to other countries (especially with the Australian labour market extremely tight too).

NZ rates pushed lower yesterday, with 2-3bps falls across the swap curve and slightly bigger moves in government bonds (20 and 30-year bond rates were 6-7bps lower on the day).  At one point, the 2-year swap rate was down 8bps, although most of this move reversed as the day wore on.  With the CPI and HLFS data having now passed, and the market more confident that the RBNZ will hike by ‘only’ 25bps at the upcoming MPS, receiving interest appears to have returned to the swaps market, although rates are set to open sharply higher this morning based on overnight moves.

Yesterday we upgraded our milk price forecast for the 2021/22 season to $9.40 per kg, up from $8.90 previously.  The combination of a significant increase in international dairy prices (the Global Dairy Trade price index is up 9% in 2022 and 28% on a year ago) and a softer NZD is an extremely supportive backdrop for the local milk price, albeit with higher costs taking some gloss off profits and recent dry weather inhibiting production.  We also upgraded our preliminary forecast for the 2022/23 season from $8.30 to $8.90, which factors in some moderation in international dairy prices and some appreciation in the NZD.

The focus in the session ahead is the US nonfarm payrolls release.  The median market estimate is for a 150k jobs gain in January, although there is a wide range of estimates, with several high-profile forecasters looking for a negative print (Goldman Sachs is at -250k).  Canada also releases its employment report tonight.  The RBA Statement of Monetary Policy is released this afternoon, although the market reaction should be limited given most of the relevant information has already been revealed in the statement from earlier in the week and Governor Lowe’s speech and Q&A.