Oil prices plunge below USD100 per barrel. Supporting a lift in US equities while bond market sell-off takes a breather. FOMC 25bps hike well anticipated

A further plunge in oil prices has helped support a recovery in US equities. Anxiety in the bond market has settled for a day, with small changes in US Treasuries and European rates pushing lower. Currency movements have been modest, with the NZD showing a small gain overnight to 0.6760, recovering the small loss seen during local trading hours.

The key market movement overnight has been another plunge in oil prices. Brent crude fell as low as USD97.50 and is currently down 6% at USD100. The fall has been attributed to comments from Russia’s Foreign Minister that sanctions on his country won’t affect the Iranian nuclear deal, which could revive the deal and bring Iranian oil back onto global markets. In addition, traders note the surge in COVID19 cases in China that is leading to increasing lockdown restrictions across the country will temper demand for oil. Furthermore, some of the recent surge in oil prices reflected speculators pushing prices higher, rather than an actual shortage of oil, and the increased margins imposed by clearing houses has reduced speculative behaviour and a closing of active positions.

Weaker oil prices have boosted sentiment for US equities, with the S&P500 opening stronger and index currently up 1½% for the session. All sectors are in positive territory apart from Energy.

The fall in oil prices this week has helped reduce break-even inflation rates.  The US 10-year BE rate is down 9bps to 2.86%, but this has been offset by a lift in the real rate, so the 10-year nominal Treasury yield remains relatively steady for the day at 2.14%, albeit down from the 2.17% high reached during the Asian trading session. European 10-year rates showed modest falls for day.

The 2-year Treasury rate is down 2bps, its first fall in seven trading days ahead of the next FOMC policy announcement due 7am NZ time tomorrow morning. A 25bps hike has been well guided by the Fed, including Chair Powell, so that wouldn’t surprise. There will be interest in the Fed Fund projections, with the median number of hikes for this year expected to be around 5 (up from 3), but below current market pricing of just under 7 hikes. Key questions will be whether this is simply seen as a bringing forward of rate hikes from 2023/24, and whether the policy rate will need to go higher than the current neutral rate of 2.5% to tame medium-term inflation.

In key economic data released overnight, US annual PPI inflation cracked the 10% mark for the first time this cycle, but the core measure was 0.3 percentage points weaker than expected at 8.4% y/y. The Empire State manufacturing index fell into negative territory, to reach minus 11.8, its lowest level in almost two years, indicative of some weaker economic momentum before the Fed even begins to raise rates.

In war developments, talks between Russian and Ukrainian officials continued, with a Ukrainian negotiator tweeting that that talks were focused on the general outlines of a settlement, a ceasefire, and the withdrawal of Russian troops. There remains some doubt whether agreement can be reached, but military experts are noting that the war from the Russian side is not going as planned and this might force Russia to negotiate. Ukraine President Zelensky reportedly told military officials that it won’t become a member of NATO, “...we have heard for years that the doors were open, but we also heard that we could not join. It’s a truth and it must be recognised”. Not ever joining NATO would satisfy one of the Kremlin’s conditions to end the war, but President Putin told EC President Michel that Ukraine “is not showing a serious attitude toward finding mutually acceptable solutions”.

Currency movements over the past 24 hours have been modest. Against market expectations, the PBoC didn’t trim the 1-year medium lending facility rate, leaving it at 2.85% but instead injected a net 100 billion yuan into the financial system. For a second day the PBoC also set the CNY reference rate at a weaker level than expected, driving further yuan weakness. China activity data on investment, retail sales and industrial production for the January-February period were much stronger than expected across the board, but analysts are sceptical that economic momentum can improve against a backdrop of rising COVID19 cases and lockdowns.

The CNY strengthened overnight after a WSJ report that Saudi Arabia is in active talks with Beijing to price some of its oil sales to China in yuan, a move that would dent the USD’s dominance of the global petroleum market. Talks with China over yuan-priced oil contracts have been off and on for six years but have accelerated this year over unhappiness with US security commitments defend Saudi Arabia and its withdrawal from Afghanistan.

After a soft trading session during local trading hours, not helped by CNY weakness, the NZD recovered overnight and is currently flat from this time yesterday at 0.6760. When focus turns to China and concerns develop, the AUD is often affected more than the NZD and this has been the case this week, seeing NZD/AUD break just above 0.94, as the AUD languishes just below 0.72.

The GDT auction price index fell by 0.9%, the first fall since early January and after a massive upward run. Whole milk powder prices fell 2.1%, going against the grain of the lift in futures prices since the previous auction on the SGX-NZX, while skim milk powder prices rose 1.6%.

GBP is modestly stronger at 1.3040. UK labour market data were stronger than expected, with payrolls of 275k in February and the unemployment rate back down to a pre-COVID level of 3.9%, data which can only encourage the BoE to raise rates at its meeting later this week.

The NZ rates market continued to be pummelled by global forces, with the juicy yields on offer still not tempting offshore investors to buy NZGBs or receive swaps, given the turbulent global backdrop. Rates rose significantly to fresh multi-year highs. The 2-year swap rate rose 7bps to 3.08% while the 10-year rate rose 10bps to 3.38%. NZGB yields rose 9-10bps across much of the curve, with the 10-year rate closing at 3.13%.

In the day ahead, NZ’s current account deficit is expected to widen further, to 5.6% of GDP. Media are reporting that today the government will announce a bringing forward of the reopening of the border to tourists by a few months to early April for Australian and visa-waiver countries. This would give the economy a much-needed boost from Q2 and help the services balance of the current account to recover in due course.

After recent volatility, including a surge in January, US retail sales growth is expected to only show modest growth, below the rate of inflation. Canada CPI inflation data should lift to fresh heights, with the average of core measures rising further away from target. As noted earlier, the US FOMC policy update is released at 7am NZ time, and we’ll hold off the next Markets Today report to capture the announcement.