US equities plunge on weak retailer earning reports; S&P500 down 4%. Market waking up to the damage that high inflation can inflict. NZ Budget today; expecting looser fiscal policy and increased bond tender program

US equities have plunged as some poor earnings results from the retailers provide a reality check on how damaging a high inflationary environment can be. Bonds have found a safe-haven bid and so have JPY, CHF.  The USD has also been well supported. The NZD has fallen back down towards 0.63, but GBP has been the worst performing following another strong inflation report.

The notable lift in risk sentiment yesterday has proven to be a one-day wonder, with a sharp reversal overnight. The US equity market has been spooked by another poor earnings result by a large retailer, this time Target, following the poor result from Walmart yesterday. A soft result from Lowe’s added to the malaise and has sent the market into a tailspin, with the S&P500 down close to 4% led by a 6-7% decline in the Consumer Staples and Consumer Discretionary sectors.

The retailers have noted that surging costs are hitting their profit margins, with rising prices not keeping pace. It is a reminder of the scourge of inflation and the widespread damage it can cause to an economy. Fresh in the memory is Fed Chair Powell’s comments yesterday that he is determined to bring inflation down to 2% and will take policy rates above neutral if needed to do so.

Adding to the inflationary backdrop, strong CPI data from the UK and Canada were reported. UK inflation data were pretty much as bad as expected, with annual headline CPI surging to a 40-year high of 9.0% and the core rate up to 6.2%. Alongside higher fuel and food prices, a 54% rise in consumer energy bills added to the result, and another chunky lift in October is likely to send the headline rate above 10% later this year. Based on these figures, the UK is in the worst position of major developed countries, both in terms of the rate of inflation and duration of the peak.

The high chance of recession as confidence gets whacked by these figures has made the BoE reluctant to go “all-in” with a large and rapid tightening in policy, which has brought out critics like ex-Governor Mervyn King.  He said the BoE should have acted sooner and “the idea that an interest rate of 1% when wages are rising at anywhere between 5-7% is going to have much impact on that inflation rate is really very strange”. The market prices in a series of hikes through the rest of the year, but a fairly constrained track compared to other countries, given the reluctance of the BoE to be overly aggressive.

Annual headline CPI inflation in Canada hit a 30-year high of 6.2% and the average of the three core measures was much stronger than expected, hitting 4.2%, stretching further away from target. Market reaction was restrained by the fact that it already prices in a 50bps hike at the next meeting and a 3% policy rate by year-end.

US housing starts and permits showed signs of rolling over, with the downturn in its early stages, with higher mortgage rates and plunging mortgage applications suggesting a significant downturn ahead.

For the bond market, the negative equity market pulse and rising risk of global recession as central banks belatedly try to get on top of the inflation predicament have more than offset the impact of high inflation, with US Treasury yields falling across the curve. The 2-year rate is down 3bps to 2.67% and the 10-year rate is down 10bps to 2.89%, the latter reversing the gain the previous session.

In currency markets, the safe havens have outperformed, with the yen and CHF up 0.7% overnight, the latter aided by some rare hawkish comments from SNB Governor Jordan. Switzerland still has low inflation by world standards at 2.3% and has yet to raise the policy rate from the minus 0.75% level. Jordan said that the SNB was ready to act if inflation risks materialise.

The NZD has fallen 0.6% from the NZ close to still trade above the 0.63 mark, after reaching as high as 0.6370 during local trading hours.  NZD/AUD continues to hover around 0.9050, with the AUD showing a similar fall, now decisively back below 0.70.

The FT reports that foreign investors have dumped a record USD35b worth of renminbi-denominated bonds in the first four months of 2022, putting some numbers to what has been an obvious trade, with China losing its interest rate advantage to the US and the economy on a significantly weaker trajectory that can only lead to further currency weakness. A weaker yuan remains a key headwind for the NZD and AUD over coming months.

GBP has been the weakest of the key majors we follow, down 1% overnight to 1.2350 following the strong CPI data, even though it didn’t surprise. In this case, the weaker currency might by explained by the theory of purchasing power parity, with higher inflation in the UK compared to elsewhere requiring a weaker offsetting currency to maintain equilibrium, particularly with a central bank reluctant to tighten policy too aggressively. EUR is also on the soft side, down 0.5% overnight to 1.0480.

The domestic rates market performed well yesterday against the backdrop of higher US rates in the overnight session, with NZGB yields flat across much of the curve, with some lingering weakness at the very long end, with 20-30 year rates up 2bps. The swaps curve also showed little change in rates. Sentiment in the NZ rates market improved after Australian wages data wasn’t as high as feared, leading to lower Australian rates.  That move likely reflected market positioning going into the announcement, given that the RBA is more focused on the message from its business liaison and surveys which show wage inflation ramping higher. Given its construct, the official wage price index will be slow to pick up on the real world developments.

In the day ahead, during local trading hours today there will be interest in Australia’s employment report, likely to be another strong one that keeps pressure on the RBA to deliver substantial rate hikes ahead, after a slow start to the tightening cycle The NZ Budget will show a loosening in fiscal policy, as signalled by the Finance Minister, with a delay to achieving operating surpluses despite the recent run of better than expected fiscal metrics. The bond tender programme will be enlarged by at least $5b per annum to capture the RBNZ’s planned sale of bonds bought under QE back to the government. Elsewhere, only second-tier economic data are released in the US tonight.