Market volatility continues. China in the spotlight with its zero-COVID strategy continuing. Global rates surge to multi-year highs, even as oil prices plunge

Markets remain volatile but as the new week has begun, movements in oil, bonds and currency markets have been more interesting than equities.  The latest serving of volatility has seen a chunky fall in oil prices and another surge in global bond yields. Hopes of a Russia-Ukraine peace deal have been a factor, as well as a focus on China. European currencies have outperformed, while JPY and the AUD have been the hardest hit.

The mood music around the war in Ukraine has been one of hope, even if the bombardment of cities relentlessly continues. Diplomatic efforts to end the war continue. US and China are talking at a high diplomatic level, for the first time since Russia’s invasion, while President Biden is planning a trip to Europe. On talks between Russia and Ukraine negotiators, an advisor to Ukraine President Zelensky said that negotiations would continue tomorrow after a technical pause in talks on Monday. He said that negotiators would focus on achieving a cease-fire, the immediate withdrawal of Russian troops and security guarantees for the country.

Hope has seen a lift in European equity markets and the euro, amongst other European currencies. The Stoxx 600 index rose 1.2%, extending the recovery seen last week, against a backdrop of weaker US equities. The S&P500 has been in and out of positive territory, and is currently down 0.7%. EUR is up 0.6% to 1.0975.

As well as the war in Ukraine, the new week has begun with a focus on China. Yesterday, the PBoC set a weak fix above 6.35 on USD/CNY, a strong hint that the central bank has become uncomfortable with CNY strength. This follows weak money and credit data released Friday night, despite the modest easing in policy to date. A front-page article in the China Securities Journal highlighted the need for further policy easing, including a further cut in the reserve requirement ratio and lower lending rates.

Additionally, a surge in COVID19 cases led China to lock down the entire province of Jilin (population 24m) in North East China and Shenzhen (population 17.5m), a large manufacturing hub for the tech industry. These major lockdowns suggest that China is continuing with its zero-COVID strategy, causing significant economic disruption that will add to global supply chain issues.

Brent crude fell to as low as USD103.50 and is currently down about 5% to USD106, which traders put down to negotiations between Russia and Ukraine and China’s lockdowns. The latter has also seen some falls in hard commodities, with falls for iron ore, copper and aluminium in the order of 2-3%. China plans an increase in coal mining of about 10% that will reduce its reliance on imports.

Global bond markets remain weak, with rates rising to fresh highs across the US and Europe. Germany’s 10-year rate rose 12bps to 0.37%, its highest level since November 2018, while the US 10-year rate broke up through the 2.1% mark for the first time since July 2019, currently up 12bps to 2.12%. There has been some curve steepening, with the 2-year rate up “only” 7bps to 1.82%.

These increases in bond yields come ahead of expected rate hikes by the Fed and BoE this week, with central banks seen putting much more weight on the strong inflationary impulse than concerns about the economic outlook from the war in Ukraine. Lockdowns in China are also leading to concerns that supply shortages will continue to add to inflationary pressure. The US Fed Funds curve prices close to seven rate hikes this year, equivalent to a 25bps hike at all seven meetings.

The fall in oil prices has meant that the overnight lift in rates has been driven by real increases, rather than the break-even inflation component. Still, the 15bps lift in the US real 10-year rate still leaves it at an historically low minus 0.84%, still some 20bps below the level ahead of Russia’s invasion of Ukraine.

In currency markets, we already noted the outperformance of the euro.  GBP is flat at 1.3030. On the weak side of the ledger, JPY is the worst performing, as the BoJ’s yield curve control policy keeps Japanese bond yields suppressed against a backdrop of surging global rates. USD/JPY broke above 118 for the first time since 2016, and is currently up 0.5% to just shy of that mark.

The focus on China and the weaker CNY have seen the AUD underperform, currently down over 1% to just above 0.72. With this focus, the NZD is also weak, down 0.7% to 0.6760. NZD/AUD is up 0.5% to 0.9380. While NZD/JPY is flat, the NZD is lower on the other crosses, with NZD/EUR down over 1% to 0.6160.

In domestic news, the REINZ house price index rose by 0.5% m/m in February, but was weaker on our seasonally adjusted estimate to be down 3% from the peak just three months ago, well on its way towards a possible double-digit fall by the end of the year. Sales volumes fell 33% y/y, another indicator of weakness in the housing market.

Bowing to intense political pressure on the cost-of-living crisis, the government temporarily sliced 25 cents per litre from the petrol excise tax for three months, and noted it would gradually lift it thereafter.  There will be an equivalent reduction in road user charges for diesel users and public transport fees will be halved for three months. The moves slice 0.5 percentage points off CPI inflation, but the June quarter peak is still on track for just over 7%.

Domestic rates continued to be push higher by global forces, taking them to fresh multi-year highs, and expect more of the same today. The 2-year swap rate closed up 3bps to 3.01%, while the 10-year rate rose 5bps to 3.28%. NZGB yields were up 4-5bps across the curve, with the 10-year rate reaching 3.03%.

In the day ahead, the NZ PSI is released this morning, with last month’s reading already savaged by the hit to the retail, hospitality and tourism sectors from the impact of Omicron. China activity data for January-February are expected to be weak, adding to the call for easier policy settings. UK labour market data, eurozone industrial production and US PPI data are released tonight, with the latter expected to show annual PPI final demand inflation cracking the 10% mark.