Global rates continue to head higher, with the US 10-year rate printing a fresh 3-year high overnight of 2.66%, although it has since drifted a little lower. Risk appetite remains cautious amidst the prospect of aggressive central bank tightening and with Shanghai in lockdown. Equity markets and oil prices are lower overnight while the NZD and AUD have both fallen. Yesterday saw a brutal move higher in domestic rates in illiquid trading conditions, as the global bond sell-off spilled over to New Zealand. The FOMC minutes released a short while ago flagged the prospect of 50bps hike(s) and relatively aggressive quantitative tightening by the Fed.
In case there was any lingering doubt, the FOMC minutes flagged that “many” members thought one or more 50bps increases could be appropriate this year. Indeed, many members thought a 50bps increase would have been appropriate in March had it not been for the uncertainty related to Russia’s invasion of Ukraine. Members thought it would be appropriate to get the cash rate to neutral “expeditiously”.
As flagged by Vice Chair-elect Brainard the previous day, the minutes highlighted plans for a more aggressive balance sheet unwind than the previous cycle. Members were generally supportive of monthly caps of $95b ($60b in US Treasuries and $35b in mortgage securities), meaning that in any given month the Fed would let up to $95b of its holdings mature while reinvesting anything in excess of this amount. The monthly caps were expected to be phased in over three months, or slightly longer if required. For context, the last time the Fed unwound its balance sheet, between 2017 and 2019, the monthly caps were phased in over a one-year period, reaching a maximum of $50b per month. The greater the caps, the faster the Fed’s balance sheet shrinks.
The global bond sell-off continues, albeit with some signs overnight that momentum is slowing. At one point overnight, the US 10-year rate was 12bps higher, reaching a fresh 3-year high of 2.66%, but it has since drifted lower, to around 2.61%. The talk of 50bps hikes in the FOMC minutes has seen a modest bounce in the 2-year rate over the past hour, to now be flat on the day, at 2.50%. In Europe, 10-year rates were 3-4bps higher while the Australian 10-year rate increased 8bps yesterday, extending its post-RBA moves higher.
The US yield curve steepened for the second day running, with the 2s10s curve increasing 8bps, to +10bps. The 2s10s curve briefly inverted last week, sparking the usual procession of recession warnings, but it is now back in positive territory. Fed Governor Brainard’s speech yesterday, at which she flagged a “rapid ” balance sheet unwind (commonly referred to as ‘quantitative tightening’), appears to have been the prompt for the recent steepening in the curve. As the Fed unwinds its balance sheet, letting its bond holdings mature, private sector investors will need to absorb more bond supply, all else equal, which would be expected to add some upward pressure to longer-term interest rates (how much is still a source of debate). And to the extent that balance sheet unwind tightens financial conditions independently of rate hikes, then fewer rate hikes would be required, all else equal, in turn restraining shorter-term rates.
Equity markets have been under pressure again, with the S&P500 down 0.6% overnight and the NASDAQ 1.5% lower. The prospect of relatively aggressive quantitative tightening from the Fed is likely weighing on sentiment, in addition to expectations of aggressive Fed hikes in the coming months. Defensive sectors have outperformed, including utilities and consumer staples. In Europe, the EuroStoxx 600 index was down 1.5% overnight.
Against a risk-off backdrop, the USD is generally stronger. The BBDXY index has increased around 0.2% and is approaching 18-month highs. In terms of the majors, the EUR is flat on the day and trading around 1.09, while USD/JPY is hovering just below 124. The NZD and AUD are 0.5% and 1% lower respectively over the past 24 hours, with the NZD briefly dipping below 0.69 after the release of the Fed minutes and the AUD 0.75. Softer commodity prices and weaker risk appetite explain the NZD and AUD underperformance overnight.
Oil prices are lower overnight, by around 4.5% on Brent crude. Bloomberg reported that US allies in the International Energy Agency (IEA) will release 60 million barrels of oil from their strategic reserves, adding to the US commitment to release 180m barrels. The move lower in oil prices was assisted by news that US crude oil inventories had unexpectedly grown last week, according to the weekly DOE report. Brent crude oil is trading just above $100 per barrel, well down on the $140 peak early last month but still 33% higher than the end of last year. Copper prices were 1.2% lower overnight on growing concerns around the global growth outlook, given lockdowns in China and the prospect of aggressive central bank tightening.
The only economic data of note over the past 24 hours has been the Caixin Services PMI, which collapsed to 42 in March from 50.2 the previous month, well below market expectations and its lowest level since the start of the pandemic. The lockdowns in various parts of China, as the authorities continue to pursue their zero-tolerance approach, were no doubt a major factor. The entire city of Shanghai is currently in an indefinite lockdown as Omicron cases have surged. Investors expect policy easing this year to support the economy.
The US announced new sanctions on Russia overnight, including measures which will prevent any US entities from transacting with two large Russian financial institutions, Sberbank and Alfa-Bank. Despite the barrage of sanctions imposed on Russia over the past six weeks, and the consequent a collapse in the Russian economy, the RUB has made it back to its pre-invasion level (USD/RUB around 80), albeit with capital controls in place.
NZ rates had a brutal move higher yesterday, catching up to the post-close moves in offshore rates the previous night. The 2-year swap rate surged 16bps, to a fresh cycle high of 3.58%, amidst a continued lack of investor appetite to stand in the way of the current market momentum. 5 and 10-year swap rates were 15bps higher on the day in very illiquid conditions. To give a sense of the scale of the recent moves, the NZ 2-year swap rate has increased 83bps since just the end of February, although this is still less than the 120bps increases in the US and Australian equivalents. At face value, the market is now pricing an OCR of 4% late next year, although we suspect this partly reflects risk premia (to entice investors to hold received swap positions) and not just ‘pure’ market expectations of the OCR.
Tonight sees the release of the minutes to the ECB’s most recent meeting, after which it announced an accelerated tapering schedule and was seen to open the door to rate hikes later this year.