Market sentiment remains upbeat - US equities push higher. European PMIs highlight softer growth/higher inflation tension. US 10-year breakeven inflation hits 3% for first time on record

Market sentiment remains surprisingly upbeat given the ongoing war in Ukraine and central banks’ push towards tighter monetary policy.  The S&P500 is up around 1% overnight and the NASDAQ 1.3%, with both indices now trading well above the levels prior to Putin’s invasion of Ukraine.  The US 10-year rate has shown some tentative signs of consolidation overnight after its recent surge higher while the German 10-year rate reached a new multi-year high.  The JPY remains under pressure, with USD/JPY hitting a fresh 6-year high.  Movements in other currencies have been more modest, although the NZD has underperformed, and the NZD/AUD cross has fallen to its lowest level since last June.

There hasn’t been any major market-moving news on the Russia-Ukraine war overnight.  The FT reports that the US will announce plans to supply the EU with up to 15b m3 of LNG by the end of the year to help the region wean itself off Russian gas dependence.  But analysts are sceptical this will be a quick fix, with Europe lacking the infrastructure to get large quantities of gas to Germany and other parts of Eastern Europe and much of the US LNG output already committed to other countries.

The trend in global rates remains higher although there have been tentative signs of consolidation in US Treasury yields overnight.  The US 10-year rate traded back up towards 2.40% overnight, near its recent 3-year high, but it has since slipped back to 2.34%.  The 10-year German bund yield reached a fresh 3½-year high, rising 6bps to 0.53%.

Chicago Fed President Evans, traditionally seen as a ‘dove’, added his voice to the chorus of Fed officials expressing an openness to hike the cash rate by 50bps next month.  Evans said his base case was a series of 25bps hikes, taking the cash rate to 3% next year, but he said the Fed should be “humble and nimble ” and open to a 50bps move.  Market expectations for a 50bps hike next month, currently seen as around a 75% chance, have been significantly raised by recent Fed commentary.  While there is still a fair amount of economic data to come between now and the Fed’s May meeting, the Fed typically wouldn’t build up market expectations of a rate move like this unless it thought there was a good chance it would follow through.

The main economic data of interest overnight have been the European PMIs which showed an unsurprising tilt towards slower growth but higher inflation.  The Manufacturing PMI fell to 57, its lowest level in over 12 months, amidst rising energy costs and increased uncertainty associated with the war in Ukraine. The Manufacturing PMI is still consistent with a healthy rate of growth in the Euro area but the trend, more worryingly, remains downwards.  The Services PMI held up better, dipping to 54.8, with the removal of Covid-related restrictions helping to support the services sector.  The main story though was the “unprecedented ” increase in cost and price pressures coming through the surveys.  The input cost index hit 81.6, up sharply from February’s 74.8 and eclipsing the survey’s previous record high.  S&P Global, which has taken the surveys over from Markit, attributed the increased price pressures to rising energy and raw material costs, further upward pressure on wages and renewed supply chain disruptions.

Hot on the heels of yesterday’s upside surprise to UK CPI, the UK PMIs registered a record increase in output prices, indicating inflation pressures continue to intensify. Meanwhile, in the US, the Composite PMI, which tends to get less market attention than the ISM surveys, showed a surprising lift to 58, an 8-month high, while price pressures remained extremely elevated.  Initial jobless claims fell to a post-1969 low, indicative of an extremely low level of layoffs amidst the tight labour market.

Consistent with growing global inflationary pressures, the US 10-year ‘breakeven inflation’ rate hit 3% for the first time on record, currently up 2bps on the day despite a modest (-1.5%) pullback in oil prices.  The 10-year German breakeven inflation rate also a hit a new record of 2.63% despite the finance minister announcing a temporary (three month) reduction to the tax on gasoline of 30c a litre.

The main story in the FX market remains the weakness in the JPY.  USD/JPY is up around 1% from this time yesterday and has broken above 122 for the first time since late 2015.  The recent appreciation in USD/JPY has been primarily driven by the surge in US Treasury yields which, with the BoJ keeping Japanese rates suppressed with its Yield Curve Control policy, has led to a sharp widening in US-Japan interest rate differentials.  The recent improvement in risk sentiment and rebound in equity markets, including overnight, has also assisted the move.  NZD/JPY has reached 85, its highest level since mid-2015 and now 2 standard deviations above its 15-year PPP valuation.

Movements in the other currencies have been much more modest and contained to within +/-0.3% vs the USD.  The NZD has underperformed, falling to around 0.6945, while the AUD continues to hover around the 0.75 level, seeing the NZD/AUD cross hit its lowest level since last June, at around 0.9255.

In central banking news, the Norges Bank raised its deposit rate, as expected, to 0.75%, while significantly lifting its projected interest rate track.  The revised projections now see the deposit rate peaking at 2.5% at the end of 2023, some 75bps higher than previous signalled.

After their sharp increases in recent weeks, yesterday saw a small pullback in domestic rates.  Swap rates were 1-2bps lower across the curve, mainly reflecting the falls in global bond yields the previous night.  NZ rates have had big moves higher this month.  The 5-year swap rate is up 40bps since the end of February, on track for its third largest monthly increase since 2012 (the two largest monthly increases were seen last year).

There are more Fed officials on the speaking circuit tonight, with most attention likely to be paid to New York Fed President Williams.  The German IFO business survey is also released.