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Global rates higher again overnight, as market views ECB minutes hawkishly. US 2s10s curve steepens. More reports that the Shanghai lockdown is worsening supply-chain issues

Currencies / analysis
Global rates higher again overnight, as market views ECB minutes hawkishly. US 2s10s curve steepens. More reports that the Shanghai lockdown is worsening supply-chain issues

After a modest pullback yesterday, global bond yields have resumed their upwards trend.  The US 10-year yield is back near three-year highs at 2.66% amidst further curve steepening.  Elsewhere, US equities have rebounded while the USD continues to edge closer to its recent highs.  The NZD is hovering just below 0.69 this morning.

Longer-term bond yields remain under relentless upward pressure.  After dipping lower yesterday, the US 10-year rate has pushed back to near its recent multi-year high while European 10-year rates are 3-4bps higher on the back of what were seen to be hawkish ECB minutes (see below).  The move higher in 10-year rates has been entirely driven by real yields, rather than inflation expectations, consistent with the market expecting aggressive central bank tightening ahead.  The US 10-year real yield has increased to -0.19%, its highest level in two years and some 30bps higher this month alone.

After continuously flattening since the end of last year, the US yield curve has steepened aggressively this week.  The US 2s10s curve has shifted from inversion to +20bps in just three trading sessions, with the start of that move corresponding to Brainard’s speech which warned the Fed would engage in “rapid ” balance sheet reduction.  When the Fed reduces its balance sheet, by letting its bond holdings mature, it means private sector investors need to absorb more bond supply, all else equal, which would be expected to put some upward pressure on longer-term rates.   However, the recent steepening could just as easily be a correction after what was a big move to very flat levels.  It is very early in the cycle for the 2s10s curve to invert, given the Fed is only one rate hike into the process.  It wasn’t until the Fed funds rate hit 4.25% in late 2005 (on the way to 5.25%) that the US 2s10s curve inverted while in the last tightening cycle between 2015 and 2018, the 2s10s curve only inverted after rate hikes had finished.  The recession warning brigade have been stood down, at least temporarily.

The only economic data of note overnight has been US jobless claims, which fell to 166k, matching their lows for the cycle.  The trend lower in jobless claims is consistent with an exceptionally tight labour market where firms are reluctant to leg go of staff.  Meanwhile, the Fed’s Bullard reiterated that he thought the Fed should “move forthrightly” in hiking the cash rate to 3-3.25% by year end.  Bullard’s views are well known and there was no impact on Fed rate expectations, which are centred around another 8.5 hikes by year end.

The minutes to the ECB’s last policy update revealed a central bank moving in a more hawkish direction, even as some members argued for a “wait-and-see” approach.  The meeting took place against a backdrop of surging European inflation and heightened uncertainty due to Russia’s invasion of Ukraine.  In the end, a middle ground was agreed to accelerate tapering: “a large number of members viewed that the current high level of inflation and its persistence called for immediate further steps towards monetary policy normalisation. ”  At the meeting, the ECB said it expected its QE bond buying to finish in Q3 (although it didn’t say when within the quarter), although the massive upside surprise to European inflation last month raises the risk that it stops bond purchases at the end of June, opening the door to rate hikes in Q3.  In response to the minutes, European rates pushed higher, with the 10-year German rate rising 3bps to 0.68%, near its recent four-year highs.  The impact on the EUR has been more fleeting.  Indeed, since 5pm yesterday the EUR is the weakest of the G10 currencies, down 0.3% to 1.0880.

The USD is slightly stronger, by around 0.2% on a BBDXY basis, as it continues to edge closer to its recent 18-month highs.  The appreciation in the USD has taken place against the surge higher in US real yields this month.  The NZD and AUD are around 0.3% lower over the past 24 hours amidst a broadly stronger USD.  The NZD is trading just below the 0.69 mark this morning.

Shanghai recorded a record 19,982 new Covid cases on Wednesday, as the Omicron outbreak continues to escalate.  The city is in an indefinite lockdown.   Bloomberg reported that containers were stacking up at the city’s ports amidst a truck shortage while queues of ships were starting to build off the coast, including oil tankers.  Meanwhile, the WSJ reported that the lockdown was hampering manufacturing production, citing the temporary closure of Telsa and VW plants.  Moreover, those producers which were continuing operations were being constrained by supply chain issues themselves, including parts and materials not arriving.  The situation in China threatens to worsen already stressed global supply chains with no sign yet that the government is open to pivoting away from its lockdown strategy in the face of Omicron.

Oil prices are lower overnight, with Brent crude oil futures briefly dipped below US$100 per barrel for the first time in a month.  Yesterday Bloomberg reported that US allies would release 60 million barrels of oil from their strategic reserves, adding to the US commitment to released 180 million barrels, although the weakness in oil prices may also reflect growing concerns around the demand outlook, amidst the lockdowns in parts of China. It’s been a mixed picture for other commodity prices, with aluminium down by around 1% and copper up slightly.

Following sharp falls over the previous two days, equities have rebounded overnight.  The S&P500, which was down earlier in the session, is now 0.6% higher on the day, while the NASDAQ has gained 0.4%, despite the increase in longer-term bond rates.  The S&P500 is around 10% higher than the lows seen in late February after Russia’s invasion of Ukraine.

Russia is one step closer to a default on its foreign currency bonds after it was forced to make a coupon payment on one of its USD bonds in rubles.  US authorities barred JP Morgan from processing the USD coupon payment to investors, so Russia instead is paying in rubles.  There is still a 30-day grace period to make payment but, with sanctions unlikely to be eased any time soon, a technical default at that point seems almost certain.  The market is well priced for a Russian default, with its USD bonds trading around 20 cents in the dollar.

After the huge volatility in recent days, NZ rates were broadly unchanged yesterday.  Still, the fact that the previous night’s falls in global bond yields failed to flow through to the NZ market indicates that investor demand remain cautious ahead of next week’s RBNZ meeting.  Rates are likely to open higher this morning given the overnight increases in US Treasury rates and Australian bond future yields.

The Canadian employment report takes place tonight ahead of the Bank of Canada rate decision next week at which it is expected to raise its cash rate by 50bps, to 1%. The first round of voting in the French election takes place on Sunday.  Recent opinion polls show far-right leader of the National Rally party, Marine Le Pen, has been closing the gap on current President Macron, although betting markets still ascribe around an 80% chance to a Macron re-election in the second round of voting in a fortnight.

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