Russia-Ukraine developments remain in the spotlight; no evidence of Russian military pullback. US equities and global rates head lower. Stonker US retail sales report, but market reaction contained

The market remains on edge on Russia-Ukraine news, with doubt that Russia is de-escalating its military action.  US equities are down and global rates are lower.  But there is no obvious risk-off tone in currency market, with a broadly based fall in the USD, even in the face of super-strong US retail sales data.

All eyes remain on the Russia-Ukraine situation, which has dominated financial markets this week. After the positive mood music yesterday, doubts have emerged that much has changed at all. NATO’s secretary general said that there is no proof of Russia withdrawing forces and it appeared it continued with its military build-up.  These comments were endorsed by US Secretary of State Blinken. Russia dismissed NATO claims that the military pullback wasn’t happening. Leaders are still looking for a diplomatic solution, with President Biden and Chancellor Scholz meeting today, ahead of an emergency summit of European leaders and then a G7 foreign ministers meeting at the weekend.

So US equity markets have taken back some of yesterday’s gains, with the S&P500 currently down 0.7%. Bonds are better bid, although this is more evident in Europe than the US. French and German 10-year rates are down 3bps, UK’s 10-year rate is down 6bps, but the US 10-year rate is barely lower at 2.04%. This partly reflects the strong US retail sales print, with German and US 10-year rates highly correlated until that point and diverging thereafter.

US retail sales surged in January after the fall in December, up 3.8% m/m for both the headline and ex auto and gas series, well above market expectations of 2% and 1% respectively. As well as some underlying strength in domestic demand, the recent volatility could be explained by earlier bringing forward of sales ahead of Christmas due to supply concerns which depressed December figures, but then spending patterns returning to normal and more than offsetting any lingering impact from Omicron. Much stronger than expected industrial production for January was inflated by utilities, with weather colder than usual for the month, while manufacturing production was in line at 0.2% m/m.

Despite the strong data, the market has, this week, become less convinced that the Fed will kick off the tightening cycle with a 50bps hike, with the odds of this receding towards a 50/50 bet, and the US 2-year rate is actually down 4bps on the day to 1.54%.  Philadelphia Fed President Harker, who is a voting FOMC member this year, backed a 25bps move in March rather than 50bps, arguing for a methodical process to raise rates than surprising anyone.

UK and Canadian CPI inflation data were both stronger than expected, continuing the recent global theme of positive inflation surprises, although China’s inflation report yesterday was a rare exception to this rule. UK headline inflation of 5.5% y/y took it to a fresh 30-year year high, but next month’s figure will be even higher after it incorporates a more than 50% lift in household energy costs, with a print of around 7¼% expected. As with the US Fed, the debate within the UK MPC will be whether the central banks moves by 50bps or 25bps next month, with market pricing finely balanced.

Canada’s CPI blasted up through 5% and the average of the core measures rose to 3.2% y/y, both at 30-year highs. The market is well priced for a long series of hikes from the Bank of Canada, expected to hike 25bps at every meeting this year, with a 50bps initial move not ruled out.

While bond and equity markets are trading with a mild risk-off tone, there is no evidence of this in currency markets. The USD shows a broadly based decline, although modest at about 0.3% for the BBDXY index. This has seen the NZD push up to 0.6675 and the AUD to 0.7185, up 0.5-0.6% overnight. The lack of USD upside to reduced risk appetite and strong data might well be a sign that its days as a strong currency are becoming numbered. On medium-long term metrics, the USD has been significantly over-valued for some time and ultimately much higher inflation than other developed countries should act to put the dollar under downward pressure.

The domestic rates market continued to track the ebb and flow of global rates and this resulted in a net 1-2bps upward move in swaps and NZGB rates, with 10-year swap back at 3.0%, its highest close this  cycle, even though it traded above that level late last week.

In the day ahead, this morning the Fed releases the minutes of the late-January FOMC meeting where the market will be interested in the extent of the discussion on balance sheet reduction.  The Australian labour market report for January is expected to show flat employment, as Omicron hit the economy, and an unchanged unemployment rate of 4.2%. However, there is the risk that the unemployment rate falls sharply if those normally deemed unemployed gave up searching for work during disruptions from Omicron.

Only second tier US economic data are released tonight but the Fed’s Bullard will speaking again and he has recently perturbed the market with his hawkish comments of late. ECB Chief Economist Lane also speaks, and he is on the dovish side of the spectrum.