Risk appetite rebounds overnight - equities and rates increase sharply. Commodity prices surge. Powell signals a 25bps rate hike this month. Bank of Canada raises rates 25bps, indicates more to come

Risk appetite has improved overnight, with equities and global rates both rebounding sharply.  Fed Chair Powell endorsed a 25bps rate hike this month and kept the option of a 50bps move on the table for the future.  Commodity prices continue to surge higher and this has helped support commodity currencies, with the NZD again approaching the 0.68 mark.

The war in Ukraine continues to rage, with heavy Russian shelling of major cities including Kyiv and Kharkiv.  But Russia’s armed convoy to Kyiv, estimated at over 60km, has not made any further progress according to a report from Reuters.  Ukraine and Russia are due to hold a second round of talks in Belarus, although hopes for a breakthrough are slim with Ukraine’s president saying Russia needed to “stop bombing people” first.

Despite the ongoing conflict, risk appetite has rebounded overnight.  Equity markets are higher across the board in Europe and the US.  The S&P500 is up 2.1%, more than reversing yesterday’s sell-off, while the NASDAQ has gained 1.7% and the EuroStoxx 600 index 0.9%.  Volatility remains elevated though, with the VIX index still tracking above 30.

Meanwhile, there has been some easing in money market pressures, with USD FRA-OIS spreads and cross currency basis swap spreads normalising overnight.

Fed Chair Powell appeared to rubber stamp a rate hike later this month, telling the House Financial Services Committee that he was “inclined to propose and support a 25 basis-point rate hike”.  Powell said the impact of recent events in Ukraine were “highly uncertain” and warranted a “nimble” policy response.  But with inflation elevated, the economy at maximum employment (“at least ”) and the cash rate at an emergency setting, rate hikes were clearly justified.  Powell also warned that the committee was prepared to raise rates by 50bps if inflation was higher or more persistent than expected. Comments from other Fed officials were also consistent with the Fed sticking with its tightening plans.   Chicago Fed President Evans called the current global environment “a complication” but said the Fed would “get going” with rate hikes soon while St Louis Fed President Bullard reiterated that he wanted to see a “rapid withdrawal of policy accommodation.”

After their big falls the previous night, global rates have rebounded significantly.  The US 10-year rate, which briefly traded under 1.70% yesterday morning, is back to 1.84%, 11bps higher on the day.  The yield curve has flattened, with the 2-year rate up by 15bps as the market has priced more tightening for the Fed.  A 25bps Fed hike is now fully priced for later this month with six hikes priced in for the seven remaining meetings this year.  In Europe, 10-year rates were 10bps to 15bps higher, with the German 10-year rate returning back into positive territory after yesterday’s plunge.

Commodity prices continue to surge higher amidst fears that the war in Ukraine and sanctions on Russia could disrupt supplies.  Wheat futures jumped 13%, to their highest level since 2008, European natural gas futures rallied almost 40% while spot Brent crude oil broke $120 per barrel for the first time since 2012.  Bloomberg reported that Shell and Spanish gas company Naturgy were still buying oil and gas from Russia, but most buyers were avoiding Russian supplies for now even though sanctions haven’t yet directly targeted Russian energy exports.  Meanwhile, OPEC+ said it would increase oil output by 400k barrels per day next month, sticking with its plan to increase supply only gradually. The oil futures curve remains in severe ‘backwardation’, a sign that supplies are very tight and the OPEC+ announcement is unlikely to relieve much, if any, pressure.

Currencies have been relatively calm in comparison to the moves in equities and bonds.  The EUR has made a fresh 18-month low as the Russia-Ukrainian war continues to rumble on, down 0.1% overnight.  Higher commodity prices and firmer risk appetite have supported commodity currencies, with the NZD and AUD both gaining around 0.5%.  The NZD is again approaching the 0.68 mark.

The Bank of Canada became the latest central bank to join the global tightening cycle, raising rates by 25bps, to 0.50%, overnight while signalling further rate hikes lie ahead.  The Bank noted inflation had become “more pervasive” and there was a risk that inflation expectations could drift upwards.  The BoC said it would consider when to start reducing the size of its holdings, a process often referred to as quantitative tightening or ‘QT’, while keeping its balance sheet unchanged for now.   The CAD is the top performing currency overnight, up by 0.7%.

In Europe, core inflation again surprised to the upside, coming in at 2.7% y/y, above the ECB’s 2% target.  Headline inflation hit a new high of 5.8% y/y and, given recent moves in oil and gas prices, is likely to rise further in the coming months.  Meanwhile the German unemployment rate fell to 5%, matching its pre-Covid level and indicative of a tight labour market.  In the US, the ADP employment survey showed 475k new jobs created in February.  The survey hasn’t had a good track record in predicting nonfarm payrolls in recent months and the market reaction was limited.  The market is looking for Frida night’s payrolls report to show a 410k job gain.

NZ rates were lower yesterday, but by much less than global counterparts like US Treasuries and European government bonds.  Swap rates were around 3bps lower across the swap curve compared to the almost 15bps fall in the US 10-year rate the previous night.  We’d attribute this, in part, to an overhang of received positions in the local swaps market and a lack of investor appetite to take on fresh positions amidst elevated market volatility and the RBNZ’s recent hawkish messaging.  NZ rates will open higher this morning following the overnight moves in global rates markets.

The market is likely to remain focused on Russia-Ukraine developments over the coming 24 hours.  The minutes to the ECB’s February meeting, at which President Lagarde repeatedly refused to rule out a rate hike this year, should be interesting, although recent developments in Ukraine mean they will likely get less attention than they otherwise would have.  Fed Chair Powell is speaking in front of the Senate, although he is unlikely to provide anything additional to his comments overnight.  The ISM Services index is the main data release over the coming session.