Global rates blast higher again - US 10-year +9bps, Germany 10-year +7bps. Bank of Canada hikes 50bps. Equities fall on higher Fed rate expectations

Global rates have pushed sharply higher overnight after a stronger-than-expected ISM manufacturing survey and a very hawkish Bank of Canada policy update.  The US 10-year rate is 10bps higher and is approaching 3% again.  The higher US rates backdrop has seen equities come under renewed pressure, albeit the S&P500 is well off its intraday lows, and the USD strengthen.  The NZD is back below the 0.65 mark while a stronger-than-expected Australian GDP release has seen the NZD/AUD cross fall to 0.9030.  The NZ curve continued its recent steepening trend yesterday, led by a sharp fall in the 2-year swap rate.

Global rates have taken off again overnight, with chunky increases across all the major bond markets.  US rates are higher across the curve, led by the shorter end (3-year rate +13bps) while the US 10-year rate is 9bps higher, at 2.94%.  The US 10-year rate has increased 20bps this week alone, albeit from the bottom of the recent trading range.  Germany’s 10-year rate was 7bps higher, closing at its highest level since 2014 at 1.19%.

Supporting the move higher in rates, the ISM survey came in stronger than expected in May, rebounding to a healthy 56.1 (from 55.4).  The market had been braced for a fall to 54.5 given the generally downbeat tone of the regional manufacturing surveys.  The prices paid index moderated to 82.2, down on the previous month but still consistent with extremely strong inflationary pressures, while the employment index fell below 50 for the first time since late 2020, indicating, at face value, negative employment growth in the manufacturing sector.  Meanwhile, job openings in the US fell slightly in April, albeit to still exceptionally high levels.  There are almost two job openings for every unemployed person in the US.

Released at the same time as the ISM survey was a hawkish policy update from the Bank of Canada.  The Bank raised its policy rate by 50bps overnight, to 1.50%, as widely expected, but the accompanying statement was unambiguously hawkish.   The Bank noted inflation had come in much higher than expected while “the risk of elevated inflation becoming entrenched has risen” and “the economy is clearly operating in excess demand”.  Pointedly, the Bank said it “is prepared to act more forcefully if needed”, a hint that it might even consider a 75bps hike in the future if inflation again surprised to the upside.  Canadian short-term rates blasted higher, with the market now attaching a moderate probability to a 75bps hike in July (~20% priced) and pricing a terminal rate of around 3.20%.

Contributing to the higher rates backdrop, oil prices are higher overnight, with spot Brent crude up by almost 2% and on track for its highest close since March.  The move in oil prices took place ahead of the OPEC+ meeting today at which the cartel is expected to agree to another 430k increase in supply from July, as it continues to slowly rebuild production levels after the pandemic.  The market has been seemingly unruffled by reports from earlier in the week that Russia could be suspended from OPEC+ production caps, which some have suggested could possibly allow Saudi Arabia to make up for the shortfall.

US equities had come under pressure from the increase in rates, although they have recovered over the past few hours to now be only modestly lower on the day (S&P500 -0.3%, NASDAQ -0.2%).  The upside surprise to the ISM manufacturing survey might ordinarily have been seen as a sign that the economy is in good health, but at the moment the market seems to be trading with a ‘good news is bad news’ mindset for equities because it increases the chances of more aggressive Fed action.  JP Morgan CEO Dimon’s comments that a “hurricane is right out there down the road coming our way”, referring to downside risks to the economic outlook, didn’t help sentiment.

The USD is stronger on the back of the increase in Fed rate hike expectations and as risk sentiment turns more cautious.  The higher rates backdrop has seen USD/JPY (+1.1%) break above the 130 mark for the first time in four weeks while the EUR has fallen to around 1.0660.  The commodity currencies have held in better, with the Bank of Canada’s hawkish policy update helping the CAD appreciate around 0.1% and the AUD up by a similar amount.  The NZD is just below 0.65, down around 0.4% over the past 24 hours but slightly higher than it was at the NZ market close.

ECB Governing Council member - and one of the hawks on the committee – Holzmann reiterated his call for a 50bps rate hike in July, calling for “decisive action” to reduce the risk that inflation expectations become unanchored.  Holzmann added that a 50bps hike would help support the EUR, noting that the downtrend in the currency was exacerbating inflationary pressures in the region.  The committee still seems fairly split between the hawks, such as Holzmann, arguing the case for aggressive and frontloaded action and the more moderate members, such as President Lagarde and Chief Economist Lane, who appear to prefer the standard 25bps rate hike pace.  Deutsche Bank is now calling for a 50bps ECB hike in either July or September while the market is pricing just under a 50% chance of a 50bps ECB hike in July.  The increase in ECB rate hike expectations hasn’t done much to support the EUR overnight, however.

The Fed’s Beige Book reported mixed anecdotes from the regions, highlighting the complex policy challenge facing the Fed.  Four of the twelve regions explicitly highlighted a slowdown in the pace of economic growth while labour shortages were noted as the main difficulty facing businesses at present.  Inflation was “strong or robust” across all the regions although three regions observed some moderation in price pressures. Meanwhile, San Francisco Fed President Daly voiced her support for getting the cash rate to neutral quickly, including 50bps hikes at the upcoming two meetings, with the policy outlook beyond that point to be guided by the data.  Daly added that if supply constraints remained elevated and demand didn’t soften, “then we need to go into restrictive territory.”  The market has recently been debating the possibility the Fed could pause its tightening cycle later this year, once the cash rate is closer to neutral, to assess the impact of its tightening.  Separately, the Fed starts quantitative tightening, or ‘QT’ this month, as it starts to gradually unwind its huge balance sheet.

Like the official PMIs released the previous day, the Caixin manufacturing PMI rebounded in May, although not by as much as the market had expected and it remains below the 50 mark.  The output sub-index was up to just 43.2 (from 38.5), so still deep in outright contraction territory, just not falling as fast as in April.  The authorities continue to deploy targeted stimulus measures, with the State Council yesterday instructing state-owned banks to set up an ¥800b ($120b) line of credit to support infrastructure projects.

Australian GDP was slightly higher than expectations, with the economy recording quarterly growth of 0.8% (0.7% expected). The market prices 35bps for the RBA’s meeting next week, consistent with a good chance of a 40bps or 50bps hike.  The NZD/AUD cross has fallen to 0.9030, near its lowest level in two weeks, consistent with the compression in NZ-AU interest rate differentials this week.

NZ rates had another wild day yesterday.  The 2-year swap rate pushed up to as high as 3.95%, near its recent 7½-year highs, before aggressively reversing, eventually ending 6bps lower on the day, at 3.86% (a strong performance given the Australian 2-year equivalent was 5bps higher on the session).  After a sharp move higher in the wake of the hawkish RBNZ MPS, receivers appear to have returned to the shorter end of the swaps market.  Meanwhile, the yield curve continued its recent steepening trend.  The 2y10y swaps curve, which had inverted after the MPS, steepened 5bps on the day, leaving it at +9bps.

Tonight sees the release of the ADP survey, although it has recently had a patchy track record as a predictor of payrolls (released Friday night).  US initial jobless claims, which have been gently trending higher over the past two months, are also released tonight.