Risk sentiment soured after the US CPI report showed stronger than expected inflationary pressure, driving the S&P500 down to a fresh low. The US yield curve has flattened, with higher short rates and lower long-term rates. The yen has been well supported against the backdrop of a lower US 10-year rate, while GBP is weaker as Brexit headlines return to the front pages. The NZD has traded a full 1-cent range in the aftermath of the US CPI report and is currently hovering near 0.63.
The key report scheduled for this week on US inflation proved to be a disappointment and has caused some volatility in markets. US CPI data were stronger than expected. Favourable base effects (large increases a year ago dropping out of the annual calculation) meant that the annual headline and ex-food and energy core indices both fell to 8.3% y/y and 6.2% y/y respectively, but the monthly core increase of 0.6% was much too strong for comfort and two-tenths higher than expected. While there were signs of goods inflation retreating, services inflation was strong across the board. Unlike the key measures reported, alternative core measures of inflation showed rising inflation on an annual basis, with the Cleveland median and trimmed mean up to 5.2% and 6.2% respectively, and the Atlanta sticky CPI up to 4.9%.
Although still early days, the stronger data were a blow to those expecting a rapid descent in inflation. The speed at which inflation returns to a more comfortable level will be an important consideration for the Fed as to how much higher than neutral the policy rate will need to be extended.
The initial market reaction was to take rates higher across the board, before some reversal. The 2-year Treasury rate rose as much as 13bps in the aftermath of the CPI report to 2.74% and has since reversed most of that move, currently trading at 2.64%. The 10-year rate fully reversed a 14bps lift to as high as 3.07% and is currently down to 2.93%, down 6bps since the NZ close. Overall, the 2s10s yield has flattened by some 9bps on the day.
Atlanta Fed President Bostic spoke after the CPI report was released and he said that “I am going to be supporting moving more” on interest rates if inflation continued at the current high pace. He backed 50bps increments until the Fed Funds rate was raised to a neutral level.
On the ECB, Bloomberg and the FT published articles summarising what we have been hearing over the past couple of weeks, that members of the Governing Council increasingly see the deposit rate – currently at minus 0.5% – exceeding zero this year, with a series of rate hikes likely beginning in July. ECB President Lagarde has reluctantly joined her colleagues, and in a speech overnight she indicated support for a July hike, after bond purchases end earlier that month. She added that new forecasts to be published next month were “increasingly pointing towards inflation being at least on target over the medium term”.
Positive risk sentiment during Asian trading was supported by evidence of declining new case numbers of COVID 19 in China. Shanghai said half of the city’s districts have reached basically no community spread, while new case numbers in Beijing remained low. However, it is hard to see President Xi abandoning his zero-COVID strategy anytime soon, which will continue to put a brake on China’s economy. Researchers at Shanghai’s Fudan University said that China risks a “tsunami” of coronavirus infections resulting in 1.6 million deaths if the government abandons its long-held Covid Zero policy and allows the highly-infectious omicron variant to spread unchecked.
US equity markets have been choppy, with positive sentiment in early trading giving way, and S&P500 down over 1% at one stage, taking it to fresh a fresh low. Currency markets have also whipsawed. The NZD traded down to just over 0.6280 post US CPI, whipped up to 0.6380, and is now back down to around 0.63. The range in AUD was over 1 cent, from around 0.6930 to 0.7050, now back at 0.6950. Net movements overall since the NZ close have been modest. JPY has been well supported, with US 10-year rates lower.
GBP is down 0.5% overnight to 1.2270. Brexit is returning to the front pages, on speculation that UK PM Johnson intends to announce plans next week to unilaterally tear up post-Brexit trading arrangements for Northern Ireland. This would put the UK on a collision course with the EU, which would look to suspend trade if the UK revokes the Northern Ireland protocol.
The domestic rates market showed lower rates yesterday, with the swaps market outperforming bonds. The 2-year swaps rate fell 9bps to 3.74% while the 10-year rate fell 4bps to 4.07%. NZGB yields fell 3-4bps across the curve. Short rates fell notably through the afternoon after BNZ’s economics team published a bearish note “Recession Bells are Tolling”, which highlighted the downside risks facing the NZ economy.
In the day ahead, NZ Finance Minister Robertson gives another pre-Budget speech, followed closely by the latest housing market update from REINZ, which is likely to be another gloomy report. This afternoon, the RBNZ will publish the widely followed 2-year inflation expectations series, which could well show a further increase. UK GDP data are released tonight as well as US PPI inflation data.