There has been something of a turnaround in risk sentiment overnight, with equities bouncing back from their recent heavy falls. Long-term global rates have fallen amidst lower market-implied inflation expectations, with US 10-year rate back below the 3% mark and the German 10-year rate below 1%. The improvement in risk sentiment hasn’t done much to help the NZD however, which has hit a fresh year-to-date low below 63 cents.
Beaten up tech stocks have staged a rebound overnight, with the NASDAQ bouncing back almost 2% after its 4.3% plunge the previous night while the S&P500 has recovered almost 1%. The rebound in equities looks much more like a correction – some might say a bear market rally – rather than a change in trend. It’s fair to say investors remain very cautious about risk assets amidst a long list of headwinds for global growth, namely expectations for aggressive central bank tightening, the lockdowns in China and the risk of an energy crisis in Europe related to the Ukraine war. Volatility remains very high.
There hasn’t been an obvious catalyst for the rally in in risk assets, although some signs of stabilisation in long-term bond yields is no doubt welcome. The US 10-year rate, which hit a cycle high of 3.20% earlier this week, is down another 5bps overnight to be back below 3%. The fall in US rates has taken place against a backdrop of falling market-based inflation expectations, which the Fed will be keen to see. The US 5-year breakeven inflation rate is 10bps lower overnight, falling below 3% for the first time since February and completely erasing its move higher after Russia invaded Ukraine (it peaked at around 3.75% in March). Helping the move lower in inflation expectations and bond yields has been a fall in oil prices, with WTI futures falling around 3% to below $100 per barrel. The key US CPI report is released tonight.
The rebound in risk sentiment overnight hasn’t flowed through into currencies, with commodity currencies still under downward pressure. The NZD has broken below 0.63, hitting a fresh year-to-date low overnight, while the AUD has consolidated near two-year lows, under 0.70. The USD, on a DXY basis, continues to hover near 20-year highs.
There are no signs of a let up with the lockdowns in China. Tesla said it was having production difficulties at its Shanghai plant due to supply shortages and logistics issues, highlighting that, while many manufacturers continue to operate with staff living on site, the lockdown is hampering activity. Separately, the head of the WTO called China’s zero-Covid strategy “unsustainable” in the face of Omicron, which most, albeit not the Chinese leadership it seems, would agree with.
New York Fed President Williams, considered part of ‘core’ of the committee, said 50bps rate hikes at the next two meetings “makes sense”, a view also endorsed overnight by Cleveland Fed President Mester. Williams sounded hopeful around the prospects of a so-called ‘soft landing’, arguing that the housing and durable goods sectors, both of which are showing signs of overheating, were sensitive to interest rates and would be responsive to Fed tightening. The market appears increasingly dubious that a recession can be avoided, conscious that the Fed has a poor track record of achieving soft landings with the challenge this time around arguably much greater given inflation is so high.
Echoing similar comments from Atlanta Fed President Bostic yesterday, Cleveland Fed President Mester refused to rule out the possibility of a 75bps hike later this year, if inflation fails to moderate like the Fed expects. While Powell appeared to hose down expectations of a 75bps move at last week’s FOMC meeting, multiple Fed officials speaking since then have been less definitive, although the committee’s base case is clearly to move in 50bps clips. Shorter-term US rates are higher overnight, despite the falls at the long end of the curve, with the US 2-year rate rising 3bps to 2.62%.
In Europe, Bundesbank President and ECB Governing Council member Nagel added his voice to the growing chorus of officials who favour ending QE bond purchases at the end of June and starting rate hikes at the July meeting. Nagel added that delaying monetary policy tightening was a “risky strategy” that could ultimately require more tightening down the line. Despite the hawkish comments, admittedly from one of the more hawkish members of the committee, European rates have fallen sharply overnight, following the lead of US Treasuries. The 10-year German yield is back below 1%, 9bps lower on the day, while the Italian 10-year rate is back below 3%, down 15bps on the day. The market is still pricing around an 80% chance of a 25bps ECB hike at the July meeting and around 3.5 hikes in total by the end of the year.
In economic data, the ZEW survey showed expectations of German economic growth picked up in May, albeit to levels which would historically be associated with recession. The prospect of the ECB tightening against a backdrop of an energy crisis is undoubtedly weighing on analysts’ expectations. Unencouragingly, the US said it believed Putin was “preparing for prolonged conflict” in Ukraine and his military goals were not restricted to annexing the Donbas region.
In contrast to the softness pervading NZ business surveys, the Australian NAB Survey showed Business Conditions rose strongly to 20 in April, to be well above its long-run average of 5.9. The price and labour costs components of the survey continued to point to considerable inflationary pressure, increasing the likelihood that the RBA ploughs ahead with another rate hike next month even if wage data next week disappoints.
The NZ curve followed the global steepening trend yesterday, with the 2-year swap rate falling 5bps, to 3.83%, and the 10-year rate down 2bps, to 4.11%. NZ rates continue to lag the moves seen in the US in both directions.
The US CPI is the key release tonight. Monthly headline inflation is expected to moderate to 0.2% which, combined with more favourable base effects, is expected to see the annual rate decelerate to 8.1% (from 8.5% previously). Core inflation is expected to increase 0.4% on the month (still too high for comfort for the Fed) but, likewise, base effects are expected to see the annual rate drop to 6% y/y. Chinese inflation data is also released this afternoon while ECB President Lagarde is speaking this evening.