The global bond sell-off picked up pace on Friday with the market ramping up expectations of Fed tightening after Citi called for consecutive 50bps hikes at the next four meetings. The US 10-year hit 2.50% for the first time since mid-2019. Equities remain surprisingly resilient to the carnage in the bond market, with the S&P500 managing to post a modest gain on Friday. Likewise, currency moves were limited on Friday, USD/JPY consolidating around the 122 level and NZD hovering under 0.70.
The market continues to ramp up Fed tightening expectations as the central bank’s recent hawkish rhetoric sinks in. On Friday, US bank Citi changed its Fed forecast, calling for four consecutive 50bps hikes and a cash rate of 3.75% in 2023. Citi also warned that a 75bps move wasn’t out of the question, nor 50bps hikes at the final two meetings this year, if inflation or long-term inflation expectations unexpectedly accelerated. Meanwhile, Bank of America said it expected the Fed to hike 25bps at the upcoming meeting in May but pencilled in 50bps hikes in the following two meetings alongside a terminal cash rate of 3.25%.
Fed officials are certainly making no effort to push back against growing market expectations of aggressive tightening. New York Fed President Williams, whose views are often seen as aligned with Chair Powell, said “if it’s appropriate to raise interest rates by 50 basis points at a meeting, then I would think that we should do that” while adding the Fed would hike ‘just’ 25bps if the data was pointing in that direction. The Fed has a long track record of meeting market expectations of rate hikes, so the lack of push back on market pricing for 50bps moves in the coming meetings is notable and suggests it is likely the base case for most committee members at this point.
To recap market pricing, there is around a 75% chance of 50bps hikes at each of the two upcoming Fed meetings, in May and June, and around a 50% chance of 50bps of 50bps hikes at the following two meetings. In total, the market is now pricing 206bps (i.e., 8.2 hikes) for the remaining six Fed meetings this year. The cash rate is seen peaking around 3% in mid-2023 after which the market sees the risks turning towards rate cuts.
The global bond sell-off continues at a relentless pace. US Treasury yields blasted higher after Citi’s Fed call change, with the US 10-year moving up from around 2.35% to as high as 2.50% (it closed the week at 2.47%). The long-end of the yield curve continues to aggressively flatten, with the 30-year rate up just 5bps on the session and the 5y30y yield curve collapsing to just 4bps, its narrowest level since 2006. The 2y10y yield curve, which has a long track record as a leading indicator of US recession, is still in positive territory, at just under 20bps, but forward pricing shows this is expected to invert within the next three months. The US moves ricocheted to other bond markets, with Canada’s 10-year rate jumping by 15bps, Germany’s by 5bps and the implied yield on the 10-year Australian bond future increasing by 10bps. NZ rates were relatively stable on Friday, with the market taking a breather after the recent surge higher, but rates will open sharply higher again this morning on the back of these global forces.
The stock market took the bond sell-off in its stride, with the S&P500 managing a 0.5% gain on Friday while the NASDAQ, which is often considered more interest rate sensitive, was down just 0.2%. The resilience of equities to the sharp repricing in Fed rate expectations remains a bit of a mystery, although one school of thought is that investors think aggressive ‘early’ action from the Fed might increase the chances of a soft landing, like that seen in 1994. On this, the verdict remains very much still out. More often than not, Fed rate hike cycles end with an accident somewhere in markets and usually with recession.
There weren’t any fresh, market-moving developments in the war in Ukraine. Russia said the first phase of its ‘special military operation’ was mostly complete and it would now focus its attention on the Eastern Donbas region, which it aims to “liberate”. This could potentially signal a shift away from the assaults on Kyiv and other cities, at least temporarily. Peace talks resume in Turkey today.
In news over the weekend, half of Shanghai is going to go into a four-day lockdown, starting today, as the authorities undertake mass Covid testing. The other half of Shanghai will go into a four-day lockdown afterwards. Shanghai recorded 2,676 new cases on Saturday, highlighting the difficulty of maintaining the zero-Covid strategy in the face of Omicron. The risk is that new Covid-related restrictions in China could make supply-chain disruptions even worse.
While extreme volatility continues in rates, FX markets were calm by comparison. The USD was marginally weaker on a BBDXY basis on Friday, by around 0.1%. USD/JPY is showing signs of consolidating after its recent run higher, tracking sideways around the 122 level on Friday despite the US bond sell-off. The BoJ decided against enforcing its Yield Curve Control policy on Friday, even with the 10-year Japan yield trading up to 0.24%, close to the top of the BoJ’s perceived tolerance threshold. There has been speculation the BoJ might widen the allowable range around its 0% 10-year yield target, say up to 0.50%, in response to the recent sharp depreciation in the JPY, which is adding cost pressures to the Japanese economy (although, unlike most countries, Japanese inflation remains very low).
Movements in other currencies were limited on Friday. The EUR closed the week just under 1.10, the AUD consolidated just above 0.75, and the NZD ended the week around 0.6960.
In economic data, the German IFO slumped to its lowest level since July 2020, at 90.8. While the current assessment held at respectable levels, the expectations component plummeted from 98.4 to 85.1, likely reflecting the uncertainty associated with the war in Ukraine and crippling energy and other cost pressures. The Ifo president observed that sentiment in the German economy had “collapsed”, warning that companies were expecting tough times.
The nonfarm payrolls report is released on Friday, with the market expecting a 490k increase in jobs in March and a 0.1% fall in the unemployment rate, to 3.7%. Ordinarily, payrolls would be the single most important data release in the monthly calendar but, given the market’s preoccupation with inflation, the focus is more likely to be on the CPI release in a few weeks’ time. Domestically, the ANZ business survey is likely to show business confidence under pressure from the Omicron outbreak but the market will be as much, if not more, interested in pricing intentions, which were at record levels last month. The ANZ consumer confidence index, which hit a record low last month, is also released this week.