Euro area inflation hits record high; European rates continue to push higher. Higher rates backdrop leads to cautious tone in equity markets. NZ business survey highlights stagflationary fears

Inflation has returned as the market’s focus, given yesterday’s shocking German CPI data and followed up by a record lift in euro area CPI inflation. European rates are up for a second day running, and the US 10-year rate is up 10bps from Friday’s close, after the Monday holiday. The higher rates backdrop means that there has been no follow through of last week’s strong rebound in US equities, investors adopting a more cautious tone. The NZD has drifted lower, not helped by growing fears of stagflation.

US investors have come back from a long weekend adopting a more cautious tone. After last week’s chunky 6½% gain in the S&P500, the index was down as much as 1.3% in early trading, since recovered to trade flat. The backdrop of higher interest rates isn’t helping equity market sentiment, with higher rates across Europe after some poor inflation data spilling over into the Treasuries market. Germany’s 10-year rate is up 7bps to 1.12%, taking the gain over the two trading sessions this week to 16bps. Early in the week, US Treasury futures pointed to higher yields and the 10-year rate is up 10bps on the day to 2.84%, little changed from the NZ close.

Euro area CPI inflation was 8.1% y/y in May, and 3.8% for the core measure, both exceeding expectations but as forewarned by the strength in German inflation data the previous day. The data comes ahead of next week’s ECB meeting, and where the big inflation shock over the past few months will see a significant upward revision to the Bank’s inflation forecasts, last updated in March.

While an immediate end to QE and kicking off a rate hike cycle would seem perfectly reasonable to most, in the Bank’s parallel universe we are unlikely to see any sense of urgency, with all the talk from officials seeming to indicate an end to bond buying by the end of June, and maybe some debate on whether to hike by 25bps or 50bps at the following meeting in July, but the consensus on the Governing Council is still seemingly in favour of baby steps. Overnight, Italian and Spanish GC members Visco and De Cos both argued for an orderly or gentle lift in rates, consistent with a 25bps increase in July.

In other key data overnight, US consumer confidence as measured by the Conference Board slipped in May, but less than expected and remaining well above the University of Michigan measure, the former giving more weight to the labour market. On that note, the share of consumers saying jobs were “plentiful” fell to 51.8, its lowest level in a year. That measure remains well above historical average, still consistent with labour market strength, but indicative of some softening in the market, as detected in the recent trend lift in jobless claims.

Canada Q1 GDP rose by an annualised 3.1%, weaker than the market expected, but broadly in line with the BoC forecasts, with the Bank on track to deliver another 50bps hike tonight, with more to come.

Yesterday, China PMI data showed a stronger than expected bounce in May after lockdowns dragged down the April figures. Still, at 49.6 for the manufacturing sector and 47.8 for the non-manufacturing sector, the figures indicated economic contraction, but just at a more moderate rate. The easing of lockdown restrictions suggests more near-term upside in these indicators, but this could prove temporary if COVID cases pop up again. On that note China reported just 97 new cases for Monday, a three-month low. Bloomberg is running a story on how China is investing in permanent COVID testing infrastructure, setting up a network of tens of thousands lab testing booths in the major cities.  This underscores the government’s commitment to a zero-COVID strategy policy, no matter the economic consequences.

Partial indicators that feed into Australian GDP were on the strong side of expectations, nudging up the consensus estimate to 0.7% q/q for the Q1 figures that will be released later today.

In NZ, the ANZ business outlook survey painted a bleak picture of the economy, with the own-activity indicator falling further below average to minus 4.7, and other indicators also consistent with a sluggish economy. When combined with the recessionary level of consumer confidence, and the slumping housing market, the signs of an economic recession, or thereabouts, are clearly visible.  To boot, another 200bps of rate hikes on the RBNZ’s central forecast are deemed necessary to bring inflation back to target. The survey’s inflation indicators all remained at historically high levels, with the only “good” news is that the slippage in pricing intentions indicator is now more consistent with 6% than 7% CPI inflation.

Currency markets show mainly modest movements overnight. The higher rates backdrop means a weaker yen, with USD/JPY up to 128.60. The NZD has been on the soft side of the ledger, slipping below 0.65 overnight before recovering to just above that mark, not helped by the poor economic outlook. NZD/AUD has continued to slide and now sits at 0.9070, below the level just ahead of last week’s hawkish RBNZ MPS.

In the domestic rates market, there was a significant steepening in the yield curve, with higher global rates in charge, seeing the 10-year swap rate up a massive 14bps to 3.96% and ongoing shakeout from the hawkish MPS last week seeing the 2-year swap rate up 6bps to 3.92%.  At 4bps, the 2s10s swap curve is back into positive territory. Swap spreads widened further, with the NZGB 10-year rate only up 8bps to 3.57%, continuing the run of NZGB outperformance.

In the day ahead, Australian Q1 GDP is released, surely too dated to excite the market much. The Bank of Canada is expected to raise its policy rate by another 50bps, taking it to 1.5%. In the US, the key release will be the ISM manufacturing index, where the consensus is expecting a modest fall to 54.5.