It’s been another ‘risk-off’ session across markets overnight on growing concerns around the global growth outlook. Equities and bond yields have fallen sharply while the USD and JPY have appreciated. The NZD has dropped below 0.66 amidst broad-based USD strength and mounting risk aversion.
Market sentiment remains fragile amidst expectations for aggressive monetary policy tightening this year and concerns that Beijing could join Shanghai in lockdown in the coming weeks. After modestly rebounding yesterday, equity markets have slumped again overnight. The S&P500 is down around 2% while the NASDAQ is over 3% lower, the latter moving back into bear market territory. Bloomberg reported that the put-call ratio is at its highest since early 2020, signalling that investors are increasingly willing to pay up to protect portfolios from further equity market downside.
Corporate earnings season hasn’t provided much support to equity markets to date, despite around 80% of companies having beaten headline earnings expectations. Overnight, General Electric’s share price plunged 10% after providing guidance that earnings would likely be towards the lower end of its forecast range for this year, citing supply chain disruptions, including from lockdowns in China, and the war in Ukraine. Tesla slumped 11%, weighing on the NASDAQ, with investors possibly wary that Elon Musk may need to sell some of his Telsa shares to part-finance his acquisition of Twitter. Microsoft and Google are due to report after the close this morning.
The falls in equity markets has ricocheted back to the bond market, where rates have fallen sharply for the second day running. The US 10-year Treasury yield, which was trading close to 2.85% at the time of the NZ market close yesterday, has fallen to 2.78%. 10-year rates were also lower in Europe, by 2bps in Germany and 5bps in the UK. The correction in bond rates over the past few sessions follows an exceptionally sharp run-up over recent months and was arguably overdue. The recovery in bonds may also have been helped by anticipation of strong demand from fund managers at month-end as well as short covering among speculative investors. JP Morgan’s investor survey indicates that investors remain positioned for higher US rates, albeit less so than a month ago.
Deutsche Bank economists have published a report arguing that the Fed will eventually need to take its cash rate to between 5%-6% to contain inflation which, in turn, will likely cause a “significant recession” by late next year. Deutsche’s forecast is much higher than market pricing which sees a “terminal” cash rate of around 3% next year. Despite Deutsche’s bold forecast, the market pared back its Fed rate expectations overnight in response to the sharp falls in equities and the US 2-year bond rate is down by around 8bps, at 2.55%.
European gas prices spiked higher after news that Russia will cut off gas to Poland later today. Russian energy giant Gazprom has demanded immediate payment in rubles, something Poland has steadfastly refused. Poland currently gets approximately 55% of its gas supply from Russia although it has been diversifying its supply sources and last month claimed it would be independent of Russian gas in six months. It's long-term gas contract with Gazprom had been due to expire at the end of 2022. The Polish government said it had sufficient gas in storage and alternative sources of supply to deal with the situation. The question is whether Russia will adopt similar tactics with other European countries which are more dependent on Russian supplies. European natural gas futures are around 11% higher overnight, having been as much as 17% higher at one point. Even after the moves overnight, European gas futures remain almost 70% below the panic-driven levels seen in early March.
The USD continues to surge higher amidst mounting risk aversion and expectations for aggressive Fed tightening this year. The DXY USD index has broken above the 102 level (+0.6% on the day) its highest level in more than five years (excluding the brief spike during March 2020).
Against a backdrop of sharp falls in equity markets and a meaningful retracement in US Treasury rates, the JPY has rebounded over the past few days. USD/JPY is 0.4% lower over the past 24 hours, at around 127.60. JPY short covering by speculative investors may also have assisted its rebound. The EUR is down by around 0.6% while the GBP and NOK are both more than 1% lower, the latter not funding much support from the 3% rally in oil prices overnight. The NZD and AUD have performed reasonably well given the risk-off backdrop, down by around 0.4% over the past 24 hours. The NZD has dropped to around 0.6575, near its year-to-date low of 0.6530 set in late January.
After its sharp fall of over 2% last week, the CNY has shown some signs of stabilising over the past 24 hours, which has provided some support to the NZD and AUD. USD/CNH is trading just under 6.60 this morning, not far from where it was this time yesterday. The stabilisation follows the PBOC’s announcement the previous night that it would cut the FX reserve ratio, a signal that policymakers have become uncomfortable at the speed of CNY depreciation.
Markets continue to cast a wary eye over the Covid situation in China, amidst concerns that Beijing could be the next city to be plunged into lockdown, which risks further denting the global growth outlook. In a statement yesterday, the PBOC suggested it will continue with its approach of providing targeted support to the economy, such as providing funding for banks to lend to SMEs and other lockdown-affected businesses, while refraining from large-scale interest rate cuts. Meanwhile, Chinese state media reported that the government would increase infrastructure investment. After heavy falls over the past week, base metals prices have rebounded slightly (copper +0.8%, iron ore futures +0.3%) on the prospect of more fiscal spending.
Economic data over the past 24 hours has been mixed and not market moving. The US Conference Board consumer confidence index was slightly lower than expectations and near its lowest level in a year. Consumers’ assessment of their present situation remains healthy, but expectations of the future remain mired at an eight-year low. Indicative of the exceptionally tight US labour market, the so-called “jobs differential” - the difference between those reporting jobs as “plentiful” versus those saying jobs are “hard to get” – remained near its highest level on record. US new home sales were weaker than expected and are likely to trend lower as housing demand subsides amidst sharply rising mortgage rates.
The big fall in overseas rates over the long weekend didn’t flow through to the NZ market, with local swap rates ending flat to slightly higher yesterday. Ongoing hedging of NZ fixed rate mortgages continues to push up on shorter-term rates against a backdrop where investors appear wary to stand in the way of the market’s current momentum. The 2-year swap rate ended the day 1bp higher, at a new cycle high of 3.75%, with the market now ascribing a small (~5%) chance of a 75bps OCR hike by the RBNZ at next month’s meeting. The market is also pricing a modest chance of 75bps rate hikes by both the Fed and Bank of Canada in the coming months. NZ rates will open lower this morning but, like yesterday, they are unlikely to fully match the moves seen in the US overnight.
The all-important Australian CPI release takes place this afternoon. The key number for the market is the trimmed mean core inflation measure. Our NAB colleagues are in line with consensus in looking for a 1.2% q/q increase in trimmed mean CPI, which would take the annual rate to a post-2009 high of 3.4%, above the top of the RBA’s 2-3% target range. The market is pricing a high chance of a ‘mini’ 15bps RBA hike next month, which would take the cash rate back up to 0.25%.