Risk sentiment sours as focus remains on war in Ukraine. Money markets show signs of stress with a collateral squeeze. Alongside flood to safe-havens, global rates rally massively

Risk appetite has soured and some turmoil in money markets is flowing through into bond markets, resulting in a massive rally in global rates. Global equities are much weaker and the VIX index has risen to its highest level in over a year. Oil prices are surging to fresh highs. Downward pressure remains on European currencies, while the other majors are fairly well contained. The NZD has performed well under the circumstances and is flat around 0.6760.

Russia’s war against Ukraine continues to escalate, with its second largest city Kharkiv bombarded, including in civilian areas, while a long convoy of military forces estimated at over 60km heads into Kyiv. Experts are saying that, after a slow start, Russia has changed its strategy, and the war is about to become a lot more intense and uglier.

Global companies and countries continue to disassociate themselves from Russian companies wherever possible, reinforcing the view that Russia will become a pariah state with a devastated economy.  An exception is that Russian gas still seems to be flowing to Europe, but countries like Germany are looking at ways to wean them off this reliance on Russian supply. China’s foreign minister deplored the conflict and said “in view of the current crisis, China calls on Ukraine and Russia to find a solution to the issue through negotiations”.

The war continues to reverberate across markets. The most notable mover overnight has been a massive rally in global rates, with falls in 10-year rates in the order of 20-30bps across Europe (France -24bps, Germany -21bps and UK -28bps). This puts German’s 10-year rate back into negative territory. This has spilled over into US Treasuries, with 2 and 10-year rates down in the order of 11-12bps, the 10-year rate falling below 1.7% at one stage.

Money markets are showing some signs of becoming stressed, with a squeeze on collateral, given the high proportion of EUR in Russia’s FX reserves that are now unusable given the sanctions. There is also an evident lift in demand for USD funding, which shows up in a significant lift in FRA/OIS spreads and cross-currency basis spreads. Emergency EUR and USD swap lines from central banks are expected to be activated over coming days to contain the fallout.

Traders continue to pare back expectations of global policy tightening. It wasn’t that long ago that a 50bps hike by the Fed mid-March was seen as a high chance, but pricing now sits just under 25bps. The same for the BoE’s next meeting. Less than five 25bps hikes are now priced for the Fed this year. A 25bps hike from the Bank of Canada tonight was widely seen as a given until recently and this is now only 79% priced.

The risk-off move has seen global equity markets lower, with the Euro Stoxx 600 falling 2.4% and the S&P500 is currently down 1¼%.  The VIX index has shot up to 34, its highest level in over a year. Oil prices are up in the order of 10%, with Brent crude trading above USD107 per barrel. Commodity prices show widespread gains, with wheat and corn continuing to show strong gains of 5%.

Dairy prices continue their relentless upwards surge, with the overnight GDT dairy auction showing a 5.1% lift, the fourth fortnightly auction in a row where prices have gained in in the order of 4-5%. All products increased in price, with whole milk powder up 5.7% and skim milk powder 4.7%. Butter and cheddar were even stronger, at 5.9% and 10.9% respectively. The strong trend adds yet further upside pressure to Fonterra’s milk payout, a further windfall for dairy farmers.

European currencies remain under pressure. EUR fell below 1.11 for the first time in nearly two years and GBP is down to just over 1.33. SEK and NOK are also weak, but the other majors are all well contained, plus or minus 0.3% against the USD in overnight trading and over the past 24 hours. The NZD appreciated to around 0.6790 late last night before falling below 0.6750. It remains a tug of war between the commodity price tailwind and the risk appetite headwind, keeping it within its familiar trading range. The AUD made a charge towards 0.73 last night, but is back to around 0.7250. NZD crosses against EUR and GBP continue to show upside pressure, at 0.5075 and 0.6080 respectively.

Economic data remain a sideshow to the market’s focus on Ukraine developments, but for the record, the US ISM manufacturing index was slightly stronger than expected. While previous surveys had showed some easing of supply side pressures, this one showed a notable lift in order backlogs and a small lift in supplier delivery times. The commentary pointed to strong demand and higher prices. Germany CPI data showed a small upside surprise, with the headline rate rising 5.5% y/y. Canada GDP in Q4 was strong and at 6.7% annualised was better than the sub-6 reading assumed by the Bank of Canada, thereby supporting a rate hike tonight.

Yesterday, China PMI data unexpectedly showed a lift for the manufacturing and non-manufacturing indices, possibly supported by the government’s easing measures, although the level of the indices remain consistent with sluggish growth by China’s standards.

Domestic rates showed a steepening bias yesterday in the swaps market, with the 2-year rate unchanged and the 10-year rate up 4bps. Long-term NZGB yields were up in the order of 1-2bps. The RBA’s policy update was just before the NZ close, but it continued to run the line of being “patient” and didn’t move the market. Given the massive move in global rates overnight, NZ yields will open a lot lower. The Australian 10-year bond future has fallen about 15bps in yield since the NZ close.

Economic data today include NZ building consents and terms of trade data, followed by Australian Q4 GDP, where a punchy 3.0% q/q rebound in growth is expected.  Euro area CPI data are expected to show a further lift in inflation and the recent trend has been upside surprises. US ADP employment will be watched, but often gives a misleading signal on the more important employment report at the end of the week. Fed Chair Powell appears in front of lawmakers, where he will be grilled on the surge in inflation and what he intends to do about it. We noted earlier the Bank of Canada meeting.