The S&P500 briefly crossed over into bear market territory on Friday, fanning recession fears, before recovering late in the session to end unchanged. Despite the late recovery, risk appetite remains very cautious, and investors remain concerned about the outlook for global growth amidst Chinese lockdowns, aggressive central bank tightening and the ongoing war in Ukraine. Bond yields remain under downward pressure on growing recession fears, with both the US and NZ 10-year rates falling to their lowest closes in almost a month. Currency moves were relatively modest on Friday, with the NZD ending the week just above the 0.64 mark. This week brings the RBNZ MPS, where the Bank is universally expected to raise the OCR by 50bps, to 2%.
Markets remain dominated by stagflation concerns at present, with inflation at multi-decade highs in most countries, central banks set on rapidly tightening monetary policy, and recession fears mounting. US equities were under pressure for most of Friday night, the S&P500 down 2.3% at one point, before a rebound in the last hour of trading left the main US benchmarks close to flat on the day. At the low point of the day, the S&P500 had crossed into bear market territory, defined as a 20% fall from the previous high, but its late recovery means it still sitting just above that point. Bear markets in the S&P500 are often, albeit not always, associated with US recessions.
Of note, Deere and Co, often seen as a bellwether of the global economy, plunged 14%, its biggest one day fall since 2008, after reporting disappointing revenue forecasts and saying that supply chain disruptions were expected to remain an issue all year. Deere’s disappointing earnings report follows those of Walmart and Target earlier in the week which spooked the market and raised renewed concerns about the growth outlook.
There is certainly no sign that central bankers are thinking of easing back on their hawkish policy stances in the face of weakness in risk asset markets. Indeed, Fed officials have openly welcomed the correction in US equities in bringing about an overdue tightening of financial conditions, which should help to moderate inflationary pressures.
On that note, renowned hawk Bullard reiterated his view that the Fed should hike its cash rate to 3.50% by year end although he floated the idea that rates could be potentially be lowered in 2023 or 2024 if inflation were to moderate. Bullard thought the probability of recession was low, although markets appear to disagree with this assessment. Meanwhile, over the weekend, ECB President Lagarde flagged a likely rate hike in July, saying it was possible that rates could rise “a few weeks ” after its bond buying ends, which is expected to be at the start of July. The ECB’s July meeting takes place on the 21st. At the same time, Lagarde appeared to hose down expectations of a 50bps move, as floated by fellow ECB Governing Council member Knot earlier in the week, saying “we have to lift the accelerator for sure to slow inflation but we cannot be breaking any speed.” In the UK, Chief Economist Pill said the monetary policy tightening process “has further to run”, adding that there were “obvious” risks that higher headline inflation could feed through to inflation expectations.
Global rates were generally lower on Friday, the US 10-year rate falling 6bps to 2.78%, its lowest close in almost a month. The fall in rates on Friday was entirely attributable to lower inflation expectations, with the US 10-year ‘breakeven inflation rate’ hitting its lowest level since late February, at just under 2.60%. US breakeven inflation rates have reversed all their upwards moves after Russia’s invasion of Ukraine as recession concerns have started to build.
Not helping the mood in markets, Russia said it would stop supplying gas to Finland after the latter refused to pay in rubles. Unlike some other European countries, Finland is not overly reliant on Russian gas, so it is unlikely to have a major economic impact, but the move is nonetheless a reminder of the vulnerability of the European economy to Russian energy supplies.
China announced a 15bps rate cut to the 5-year loan prime rate, a benchmark for mortgages, taking the rate to 4.45%. The move is consistent with Chinese policymakers’ cautious and targeted approach to policy easing and appears aimed at providing some relief to the housing market. Chinese equities rallied, with the CSI300 index jumping almost 2% on the day, while the CNY continued its recent recovery, appreciating by 0.3% on Friday. After its big fall during April and early May, the CNY recorded its best week since 2019 last week amidst a weaker USD and the lifting of some Covid restrictions in Shanghai.
Currencies were fairly restrained on Friday, with all the G10 currency moves contained within +/-0.3%, except for the Swiss franc. After falling sharply earlier in the week, the USD stabilised on Friday. The DXY index was still down a hefty 1.4% on the week amidst the pullback in US Treasury yields. The NZD outperformed on Friday, ending the week just above 0.64 while the NZD/AUD cross closed around 0.91. After its recent torrid run, the NZD staged a meaningful recovery last week, gaining almost 2%.
There will be a change of government in Australia, with the Labor party set to take power. The election result is not expected to have a significant market impact given there were fewer significant macroeconomic policy differences between the two main parties than is often the case. Markets are likely to quickly return focus to global factors.
Continuing the global theme, Japan reported its highest inflation rate since late 2014, with headline CPI hitting 2.5% y/y. The increase to inflation was well anticipated given the surge in energy prices and as mobile phone fee reductions from a year ago dropped out of the annual calculation. But underlying inflation remains subdued, with the so-called core-core inflation measure (CPI ex fresh food and energy) still sitting at just 0.8% y/y. Unlike other central banks, which are already tightening monetary policy or preparing to do so, the BoJ is no rush to shift from its ultra-easy monetary policy stance, with Governor Kuroda saying on Friday “right now, it’s appropriate to maintain monetary easing”.
NZ rates were sharply lower on Friday on the back of the previous night’s falls in global rates. Swap rates were 4bps lower at the 2-year point and 11bps lower at 10 years, while NZGB yields fell by as much as 13bps after strong demand for the 5-year bonds on offer at Friday’s tender. Markets have been paring back RBNZ rate hike expectations over the past fortnight, albeit from what were elevated levels, as global growth concerns have intensified. The market now prices a peak in the OCR of around 3.75% next year, down from around 4.25% a few weeks back.
The big focus domestically this week is the RBNZ’s MPS on Wednesday. The RBNZ is almost certain to raise the OCR by 50bps at the meeting, taking the cash rate to 2%, around where the RBNZ has seen the neutral rate. The key market focus is on the RBNZ’s forecast OCR track and particularly the end point for the track. At the February MPS, the RBNZ projected a peak in the OCR of 3.35% and we think it might nudge a little higher, perhaps to around 3.50%, but we’re not expecting a significant upwards shift. Outside the RBNZ meeting, the ANZ consumer confidence index, which was sitting at recessionary levels last month, is released on Friday while Fonterra will provide its first forecast of its 2022/23 milk price on Thursday, likely to be $9 or higher.