Risk assets ended last week on a positive note, with equities rebounding strongly on Friday from their heavy falls earlier in the week. News that Shanghai was planning to start removing restrictions this week was taken positively by the market although the rebound was likely as much to do with a correction from oversold levels as a change in investors’ economic outlook. Global rates and commodity currencies rebounded as well, with the NZD ending the week back at around 0.6785. Friday saw large falls in NZ wholesale rates, with the market trimming expectations of RBNZ OCR hikes over the next year.
It has been a tumultuous few months for equity markets as the market has started to price in the risk of a global recession. Friday saw the mood brighten somewhat, with sizeable gains in both the S&P500 (+2.4%) and NASDAQ (+3.8%). The S&P500 had been skirting with a bear market on Thursday, defined as a 20% from the peak, although the rally on Friday has seen it avoid that fate, for now.
Likewise, the US 10-year rate recovered 7bps on Friday, to 2.92%, while European 10-year rates rebounded from their big falls the previous night, jumping 8-13bps higher. On the week, the US and German 10-year rates were 21bps and 18bps lower respectively, with the market starting to shift focus from inflation concerns to recession fears.
Helping the turnaround in risk sentiment, the mayor of Shanghai said the city was aiming to start an “orderly opening-up” by May 20th, finally providing some light at the end of the tunnel. The first stage of this process has been unveiled over the weekend, with supermarkets, department stores, hairdressers, and pharmacies, to be gradually reopened from today. Whether Shanghai can remain lockdown free (and whether Beijing can avoid it) is another matter. The threat of a sudden lockdown will be hanging over the population, and financial markets, for as long as China maintains its zero-Covid approach.
The negative impact of the lockdowns was visible in Chinese credit data for April, which showed new bank loans falling to just ¥645b, its lowest level since December 2017, while aggregate financing, a broader measure of lending, was only ¥910b, its lowest level since February 2020. The drop-off in lending comes despite pledges to support the economy from the Chinese authorities, although the market has viewed the policy response to date as uninspiring. There is talk that the PBOC might cut its medium-term financing rate today, but the mooted 10bps reduction suggested by some economists is hardly going to move the needle for the economic outlook.
The turnaround in risk sentiment on Friday probably represents as much a correction from oversold conditions as anything. The headwinds to global growth remain formidable, with central banks set on aggressively raising rates to contain inflation, Europe facing an energy crisis as Russia threatens to cut off gas supplies, and China battling a major growth slowdown as it tries to eliminate Omicron. Sharp rallies are customary through bear markets. It would be a brave person to say we have seen the lows in equities.
A Bloomberg survey of economists showed the probability of a US recession within the next year was seen at 30%, double what it was three months ago. If indeed we are looking at a possible US recession next year, we can look at past experience to get a sense of how far equities might have to fall. Over the past seven recessions, the average peak-to-trough fall in the S&P500 has been 36%, implying that, with the falls seen to date (around 16% from the peak), the market might be around halfway through its sell-off. Of course, history is only a guide and this cycle is already quite different from recent ones, but it gives a broad sense of potential magnitude if the recession predictions from some commentators play out.
Fed Chair Powell confirmed the Fed was planning to raise the cash rate by 50bps at both the June and July meetings, if the economy evolved in line with its expectations. Powell acknowledged that getting inflation back to target could cause “some pain” while achieving a soft landing would be “quite challenging”, which most would agree is an understatement. Powell’s comments represent the first time he has acknowledged the risk of recession is real. Earlier, San Francisco Fed President Daly confirmed the Fed won’t be riding to the rescue of the equity market any time soon, saying she “would like to see continued tightening of financial conditions ”. The market prices exactly 100bps of hikes across the Fed’s next two meetings and a further 88bps by the end of the year.
In economic data, the market looked through another very weak US consumer confidence reading from the University of Michigan survey, which showed the index falling to its lowest level in more than 10 years. Economists remain optimistic that consumer spending will hold up despite recessionary levels of consumer confidence given that households are sitting on large savings balances accumulated through the pandemic.
In other news, the FT reported that the EU was optimistic it could convince Hungary, with financial incentives, to sign up to a proposed Russian oil embargo. Hungary, alongside Slovakia and the Czech Republic, has been holding up the planned oil embargo, even though the EU has offered it a longer transition period to phase out Russian oil imports. Oil prices jumped around 4% on Friday, with WTI crude, which had traded sub-$100 on Tuesday night, ending the week back at $110. Industrial commodity prices were also stronger on Friday, paring some of their losses from earlier in the week (copper -2.7% on the week).
In news over the weekend, both Finland and Sweden confirmed they would apply for Nato membership, which is likely to further inflame tensions with Russia.
It was a similar story in currency markets, with commodity currencies heading higher on Friday. The AUD and NOK both gained more than 1% while the NZD recovered 0.9%, ending the week at around 0.6285. Still, it was a negative week overall for the commodity currency complex amidst growing global recession fears and rising risk aversion, with both the NZD and AUD down around 2%, even after their rallies on Friday. The USD, which had reached a 20-year high on Thursday on a DXY basis, was down 0.3% while the JPY was off 0.7% as US Treasury yields rebounded.
After a huge run-up in recent months, NZ rates corrected significantly last week, with swap rates falling between 35bps, at the 2-year point, and 25bps, at 10 years. The market has started to question the aggressive rate hike profile built in for the RBNZ given growing questions about the global economic outlook and further evidence of a sharply slowing NZ housing market. The 2-year swap rate, which reached as high as 3.995% late last week, fell another 9bps on Friday, to close at 3.55%. The market still prices a high chance of a 50bps hike at next week’s meeting, but the implied probability of 50bps move at subsequent meetings has been pared back.
The domestic highlight this week is the Budget on Thursday and the accompanying update to the bond programme. Bond issuance is likely to be increased, mainly on account for the RBNZ’s decision to start selling back its holdings of government bonds to Treasury from July onwards, at a planned $5b per year pace. Ordinarily, more bond supply would be expected to put some upward pressure on interest rates, all else equal, although with NZ government bonds set to join the World Government Bond Index later this year, likely bringing with it large inflows into the market from offshore investors, the impact should be relatively modest.
In offshore data, the impact of the Chinese lockdowns is likely to come through from economic activity indicators released today, with retail sales expected to fall to -6.6% y/y in April, from -3.5% the previous month, and industrial production expected to slow to just 0.5% y/y, from 5.0%. In Australia, the key Wage Price Index is released on Wednesday, with an upside surprise likely to fuel speculation of a 40-50bps hike from the RBA next month. Fed Chair Powell is speaking again later this week, although he’s unlikely to materially deviate from his recent message.