Australian CPI blows past expectations and markets expect an RBA hike next week. NZD and AUD hold up relatively well. NZ 2-year swap rate continues to push relentlessly higher

There has been some recovery in risk appetite overnight, with equities rebounding from yesterday’s heavy falls and the US 10-year rate bouncing back to 2.82%.  However, the USD remains firmly on the front foot, with the DXY index briefly surpassing its early-2020 highs and hitting its highest level in five years.  USD strength partly reflects weakness in the EUR, which remains under pressure amidst an intensifying energy crisis on the continent, as Russia cuts off gas supplies to Poland and Bulgaria.  The NZD printed a year-to-date low overnight, although, like the AUD, it has held up relatively well amidst some signs of stability in the CNH.  The AUD was also supported by a big upside surprise to Australian CPI, cementing expectations the RBA will kick off its tightening cycle next week.  NZ short-term rates continue to relentless push higher.

Equity markets have had a better session overnight, albeit with no clear catalyst for the turnaround in sentiment.  The S&P500 has increased just over 1%, recovering some of its 2.8% fall from the previous night.  The NASDAQ is also up by 1%, but it remains in bear market territory, down more than 20% from its peak late last year.  Despite the rebound overnight, there remains a long list of headwinds facing equity markets including the prospect of aggressive monetary policy tightening, lockdowns in China, and the threat of spiralling energy prices due to the Ukraine war.  Equities are not out of the woods by any means.

After the US market close yesterday morning, Google’s parent Alphabet reported revenue marginally under market expectations and warned Q2 could also be challenging, prompting an initial 5% fall in its share price (it has since recovered somewhat to be down 3%).  In contrast, Microsoft’s share price rose almost 8% after posting stronger revenue and earnings.  While around 80% of corporates have beaten headline earnings expectations this reporting season, the market has often been underwhelmed by forecast earnings guidance ahead of what is expected to be a more challenging macro environment over the remainder of the year.  Meta (formerly Facebook) reports after the bell this morning while Amazon and Apple report earnings later this week.

US rates have rebounded overnight, in sympathy with the recovery in equities.  The US 10-year rate is 10bps higher on the session, at 2.82%.  In contrast, European rates were flat to slightly lower as the market modestly pared back its ECB rate hike expectations amidst mounting tensions with Russia.  Notably, the Italy-Germany 10-year spread increased to its highest level since mid-2020, at 178bps, as the market braces for less ECB bond buying support ahead.

Some slightly more positive headlines have emerged around China’s Covid situation, although investors remain wary.  Shanghai said it would allow some limited movement for those in areas where there is no community transmission of the virus.  New daily Covid cases in Beijing remain below 50, although the market remains concerned that the city could be put into a growth-damaging lockdown in the coming weeks.  The global experience has been that Omicron is exceptionally difficult to snuff out, even with lockdowns.

Yesterday morning, Bulgaria confirmed it was the second country, after Poland, that Russia had stopped supplying with gas after it refused to make payment in rubles.  European natural gas futures exploded almost 30% higher overnight before eventually settling 10% higher.  Despite the 16% increase over the past two days, gas futures remain almost 70% below their peak early last month.

The question now is what happens with other European countries, including Germany which still relies on Russia for 40% of its gas needs.   Despite the European Commission urging countries not to cave into Russian demands, Bloomberg reported that four European gas companies have already made payment in rubles while another ten have set up accounts to do so.  The issue is likely to come to a head again in the second half of May, when payments for most other countries come due (Bulgaria and Poland were reportedly the first countries due to make payment). Meanwhile, Bloomberg reported that Germany was set to agree to a plan to ban Russian oil imports, provided there is a transition period that smooths the adjustment.  Germany has been one of the countries resistant to a Russian oil embargo.  Major questions remain about how long the transition period might last.

The EUR remains under downward pressure amidst broad-based USD strength and an intensifying energy crisis on the continent.  The EUR fell as low as 1.0515 overnight, its lowest level in more than five years, although it has since recovered slightly to around 1.0570.  The counterpart to EUR weakness has been continued USD strength, with the DXY index rising another 0.6% overnight and briefly hitting a five-year high.  Expectations of aggressive Fed tightening and fragile risk sentiment remain supportive drivers of the USD.

Ahead of tonight’s BoJ meeting, the JPY has given back some of its gains from the past few days following the rebound in US Treasury rates.  After briefly probing below 127 yesterday morning, USD/JPY is back above 128.  Meanwhile, USD/CNH has consolidated below the 6.60 mark for the third day in a row, taking a breather after its sharp 2% increase last week.  The stabilisation in the CNH has helped support the AUD and NZD, although both are still down over the past 24 hours, by around 0.1% and 0.3% respectively, on the back of broad-based USD strength.  The NZD briefly touched a year-to-date overnight before rebounding to around 0.6540 in the past few hours.

Also lending support to the AUD over the past 24 hours has been a big upside surprise to Australian CPI inflation.  Headline CPI came in much stronger than expected, at 5.1% y/y (4.6% exp.) while the all-important trimmed mean core inflation measure was 1.4% higher on the quarter (3.7% y/y), miles above the RBA’s most recent 0.8% forecast.  With the RBA’s preferred core inflation measure now well above the top of its 2-3% inflation target range, the market has swiftly moved to bring forward RBA tightening expectations, with 22bps now priced in for the May meeting (implying a certain chance of a 15bps move and a ~30% chance of a 40bps hike).  The prevailing consensus among economists had been that the RBA would want survey upcoming wage data and steer clear of the Federal election next month, instead waiting until June to kick off its tightening cycle, but the big upside surprise to inflation has seen many, including our colleagues at NAB, bring forward the expected timing of the first move to May.

The increase in RBA rate hike expectations and Australian shorter-term rates spilled over to the New Zealand market, driving a further 5.5bps increase in the 2-year swap rate to a new cycle high of 3.81%.  The upward pressure on short-term NZ rates remains relentless against a backdrop where global rate expectations continue to trend higher, banks have ongoing mortgage hedging requirements, and investor appetite to receive remains limited.  The short end of the market remains very one-sided and illiquid at present.

The RBNZ said it would move forward with designing debt-to-income restrictions, with the framework expected to be finalised later this year, inferring the measures could be introduced – if required – by the middle of next year.  In any case, the RBNZ is sounding less committed to implementing DTIs than it has previously, perhaps conscious that the housing market is already under downward pressure amidst a host of headwinds. For more on the RBNZ’s macro-prudential thoughts, note Deputy Governor Hawkesby is speaking on the topic this morning.

The economic calendar is full over the next 24 hours.  The BoJ meeting, which takes place tonight, will attract more interest than usual after the steep fall in the JPY over recent months.  The BoJ is expected to upgrade its inflation forecasts for this year, mainly due to the increase in oil prices, but it is expected to keep its ultra-easy policy settings unchanged, including its 10-year yield curve target at 0%.  However, given the sharp weakening in the JPY, there is a chance that the BoJ could amend its forward guidance or hint at future changes to its Yield Curve Control policy.  Elsewhere, Germany releases preliminary inflation data for April, a month after inflation surged to a post-reunification high.

US Q1 GDP is also reported tonight, with the median among economists surveyed by Bloomberg looking for growth to slow to a 1% annualised rate in Q1, dragged down by inventories and net trade.  Last night’s US Trade deficit was much bigger than expected, coming in at a whopping $125b in March as imports surged 11.5% on the month (another sign of an overheated US economy).  Some economists have marked down their estimates for Q1 GDP tonight on the back of the trade data, with Citi and Pantheon Macroeconomics looking for -1% annualised quarterly growth.  Consumption and investment are expected to remain strong.

Locally, the ANZ business survey is released this afternoon.  Last month’s survey saw a modest rebound in the activity outlook, albeit to still below-average levels, and sky-high cost and pricing intentions.