Fed minutes hint at a possible pause in the tightening cycle later this year, boosting equities. NZ short-term rates spike higher, yield curve flattens aggressively as market lifts RBNZ rate expectations

The RBNZ sprung a hawkish surprise at the MPS yesterday, significantly revising up its forecast OCR track to show a peak of just under 4%.  NZ rates moved sharply higher as a result, with the market moving to broadly align itself with the RBNZ’s new projections, while the NZD/AUD cross has reached a four-week high.  It’s been a quieter night in global markets.  Equity markets are generally higher, helped by the release of the FOMC minutes which hinted at a possible pause in the tightening cycle later this year, global rates are little changed, while the USD is a touch stronger.

As universally expected by economists and markets, the RBNZ raised the OCR by 50bps at the MPS yesterday.  This takes the cash rate to 2%, around where the RBNZ sees the ‘neutral’ interest rate.  While the 50bps hike was fully anticipated, what surprised the market was the significant upwards revision to the RBNZ’s forecast OCR track, which now shows a peak in the OCR of just under 4% next year, up from the 3.35% peak outlined at the February MPS.  Moreover, the projections suggest the RBNZ intends to continue ‘frontloading’ its tightening, with a good chance of follow-up 50bps hikes at the upcoming July and August meetings. Getting inflation under control is the main concern for the RBNZ.  In that context, it saw the greatest risk as being ‘too little, too late’ with tightening policy.

With the RBNZ strongly signalling its intention to continue frontloading rate hikes, we have upgraded our OCR forecasts and now expect 50bps hikes at both the July and August meetings and a peak in the OCR of 3.50%, up from our previous forecast peak of 3%.

Domestic rates were sharply higher yesterday, despite generally lower rates in offshore markets, as the market incorporated the RBNZ’s hawkish policy signalling.  Market pricing of the ‘terminal’ OCR moved into line with the RBNZ’s updated projections, increasing from around 3.75% heading into the meeting to about 4% by the close of trading.  The 2-year swap rate was 18bps higher on day, an almost 25bps increase from its pre-MPS intraday low, to 3.73%.  Meanwhile, the yield curve flattened aggressively, with the market starting to factor in a greater risk of a hard landing and eventual rate cuts beyond 2023.  The 2y10y swap curve flattened an enormous 12bps, to just 1bps, leaving it on the cusp of inverting for the first time since 2008.

The NZD spiked to above 0.65 in the wake of the MPS, but it has since given back most of those gains overnight and trades this morning around 0.6480.  Global factors, rather than the RBNZ policy outlook, remain the key drivers for the NZD and they are generally pointing downwards.  The hawkish RBNZ surprise was more evident in the NZD/AUD cross, which made a four-week high overnight, above 0.9150.

In global markets, it’s been a quieter trading session for a change.  After we went to print yesterday morning, the S&P500 staged something of a recovery, clawing its way back from being down as much as 2.5% to closing just 0.8% lower on the session.  Risk sentiment appears to have improved further overnight, with the S&P500 around 1% higher and the NASDAQ up 1.6%.

Helping the improvement in risk sentiment has been the FOMC minutes, released about an hour ago.  The Fed’s plan is to move “expeditiously” towards neutral, while noting that restrictive policy might be appropriate at some stage, depending on the economic outlook.  However, “many” members thought the Fed would be “well positioned later this year to assess the effects of policy firming ”, potentially signalling an openness to a pause in the tightening cycle at that point.  Equity markets are higher since the release of the minutes and the USD has given back some its gains in response to those latter comments.  The market continues to price close to 100bps of hikes across the next two meetings, consistent with Chair Powell’s messaging, and a peak in the cash rate just below 3% next year.  The US 10-year rate continues to hover near its lowest level in a month, around 2.75%.

More ECB officials have come out in support of Lagarde’s plans to exit negative rates by the end of September, as set out in a blog post a few days ago.  The question for the market is whether that it involves 25bps hikes in July and September or whether there might a 50bps at one of the meetings.  On that front, overnight Vice President Guindos refused to rule out a 50bps hike in July, saying “it will depend on the outlook…let’s see what happens”.  That’s consistent with Lagarde’s recent comments to Bloomberg TV where she said “when you’re out of negative, you can be at zero, you can be slightly above zero .” The market is pricing around 65bps of hikes by the end of September, implying a slightly better-than-even chance of one 50bps hike by then.  Meanwhile, several ECB officials, including Knot and Panetta, have suggested that the central bank is in no rush to start ‘quantitative tightening’, unlike the Fed and Bank of England, which will be a relief to peripheral European government bond markets.

The ECB comments haven’t done much to support the EUR, which has given back the previous day’s rally and is down around 0.4% on the session, to 1.0695.  Movements in other currencies have been fairly limited, the AUD trading at around 0.71 this morning, close to where it was this time yesterday.

In comments that have been widely reported, Chinese Premier Li admitted the Chinese economy might struggle to grow in Q2, which was “a far cry from our 5.5% [annual GDP growth] goal.”  Li also urged more businesses to reopen, although whether this can be done while keeping Omicron at bay remains to be seen.  The lockdowns in China are part of the growing narrative around the risk of a global recession.

RBNZ Governor Orr will be speaking the Finance and Expenditure select committee this morning and there are usually media interviews with Orr and his deputies in the days after the MPS.  Up ahead tonight, the highlight is probably the release of US initial jobless claims.  Jobless claims have been gradually increasing over the past six weeks, potentially suggesting some softening in the US labour market, albeit from what were exceptionally tight levels.  Several major US tech firms have recently announced layoffs or hiring freezes including Meta, Twitter, and Netflix.