Bond yields continue their relentless rise. US 10-year rate hits 2.79%; NZ 10-year NZGB rate closes above 3.5% for first time since 2015. Risk appetite weaker as China COVID outbreak spreads, leading to more restrictions

Risk appetite is weaker as investors focus on increasing lockdowns in China and the relentless rise in longer term bond rates. Global equities are weaker and global 10-year rates have risen to fresh multi-year highs. Oil prices have fallen back below USD100 on weaker demand fears from China lockdowns, amid ongoing supply from Russia. Against that backdrop, commodity currencies and JPY have underperformed.

The new week has got off to a bad start, with global rates pushing higher as if they haven’t risen enough. While the US short end has shown signs of consolidation over recent trading sessions, with the 2-year rate hovering around the 2.5% mark, consistent with a view that enough policy tightening has been priced through the next year or two, an ever-rising revision of the terminal rate and fears of how a rapid shrinkage of the Fed’s balance sheet might play out, continue to put upward pressure on longer term rates. The US-year rate rose to a fresh three-year high of 2.79% within the last hour or two and is currently up 8bps since Friday’s close at 2.78%.

European yields are also a lot higher, with Germany’s 10-year rate up a chunky 11bps to 0.81%, its highest level since 2015, as traders price in more ECB hikes in anticipation of more hawkish language at the meeting later this week. Around 67bps of hikes are priced into the curve for 2022 now. The UK 10-year rate is up 10bps, while France is only up 6bps, possibly reflecting a lower political risk premium after the first round of voting in the Presidential election, which saw Macron gaining the most support.

In the domestic rates market, trading activity was light but NZ rates were pushed up to fresh highs, driven by global forces. NZGB yields were up 5-6bps across much of the curve, with the 10-year rate closing above 3.5% for the first time since 2015.  The swaps curve showed a slight steepening bias, with the 2-year rate up 4bps to 3.63% and the 10-year rate up 7bps to 3.72%.  Further upside in short-end rates looks to be constrained from here, given that the terminal OCR is already priced above 4%.

The other key focus for the market has been China’s COVID outbreak, which continues to expand.  New case numbers in Shanghai rose to 26k and new cases found in the nearby city of Guangzhou has led to a series of restrictions being imposed in the large manufacturing and trading hub. Some 21 out of China’s 31 provinces are seeing rising case numbers. Port congestion has increased at Shanghai, due to trucking shortages and warehouse closures, and other ports north and south of the city are showing some congestion as ships get diverted. This impact is, and will continue to, ripple through the global supply chain, adding to delays and inflationary pressures.

On a slightly more positive note, China credit growth was much stronger than expected in March, as the government encouraged banks to lend more to support economic growth, with aggregate financing and new bank loans rising by more than the usual seasonal kicker, after the lunar New Year holiday. Aggregate financing was up 10.6% y/y to CNY4650b. The consensus is that the government will have to do a lot more to support the economy, with interest rate cuts and a cut to the reserve requirement ratio likely ahead.

With the focus on lockdowns, Chinese equity markets have been the hardest hit, with China’s CSI300 index and the Hang Seng index both down about 3%. The S&P500 is currently down over 1%, while the Euro Stoxx 600 index closed down 0.6%.

Oil prices are down over 4%, with Brent crude trading at USD98. Traders are pointing to likely reduced demand from China from the increasingly widespread lockdowns, while there is no sign that Russian oil exports are reducing. Weekly Russian oil shipments hit almost 4 million barrels a day in the first full week of April, the highest level seen this year.

In currency markets the commodity currencies have underperformed, but the yen has been the worst of the key majors, with USD/JPY up 1% to 125.50, its highest level since 2015 and 30 pips or so from reaching its highest level since 2002. In the 2007/8 and 2015/16 episodes when USD/JPY reached around 124-126, within 9-12 months the currency was back below 100. This is a warning to those currently riding the wave. Once sentiment turns, the reversal can be explosive. Japan’s Ministry of Finance has yet to ring the bell on the top for USD/JPY in the current cycle. NZD/JPY is up 0.7% to 85.8.

The NZD has struggled against the weaker risk appetite backdrop, although the low for the day around 0.6814 was during early Asian trading and the currency has recovered to 0.6840 this morning, down 0.2% from Friday’s close. As usual when negative China sentiment is in the spotlight, the AUD has performed worse, down 0.4% to 0.7430, seeing NZD/AUD regain the 0.92 handle.

GBP and EUR and have managed to hold up against the USD, with little net change from Friday’s close. In economic news, UK activity data for February were on the soft side of expectations, although a strong start to the quarter means that GDP growth for Q1 should be around 1% q/q. A 0.6% m/m fall in industrial production wasn’t helped by a sharp drop in autos, as car makers struggled to access parts.

In the day ahead, the NZ quarterly survey of business opinion should be consistent with a stagflationary environment, with poor levels of confidence and activity and extremely high inflation indicators. The key release tonight is the US CPI, expected to show inflation stretching up to fresh forty year high of 8.4%, and the core rate pushing up to 6.6%. While high inflation is well-anticipated, it’s a reminder of how much tightening is justified by the Fed this year and beyond.