Risk sentiment improved at the end of last week, with evidently less concern about inflation or a possible hard landing for the US economy. The S&P500 surged over 3% on Friday, adding to gains seen earlier in the week. After falling as low as 3.00% late last week the US 10-year rate closed at 3.13%. Positive risk sentiment drove the NZD and AUD higher, to about 0.6320 and 0.6940 respectively.
Since we signed off on Thursday for a long weekend in NZ, there has been plenty of data to digest and some of it moving the market. Flash PMI data for June fell by much more than expected across the euro area and the US, while the data were more reassuringly flat for the UK. The chunky falls for both the manufacturing and services PMIs for the euro area were meaningful enough to drive rates lower across the region, with Germany’s 10-year rate falling by 20bps from 1.65% to 1.45% in the immediate aftermath, and down another 10bps on top of that 24 hours later to a low of 1.35%, before closing the week at 1.44%. The data also drove the euro down almost one big figure to 1.0485 before regaining some poise on Friday, closing the week about 1.0550.
There was some spillover effect of lower European rates for US Treasuries and, in addition, the much weaker prints for the US manufacturing and services PMIs saw the US 10-year rate down to as low as 3.00% in the early hours of Friday morning before reversing course, closing the week at 3.13%. This data is a precursor to the more widely followed ISM indices, with the manufacturing data due at the end of this week.
The other data releases that moved the market were the final University of Michigan survey and US new homes sales, released simultaneously. The final release of the former, which includes data captured later in the month, showed a nudge down in consumer sentiment to a fresh record low. New home sales in May surprisingly surged by over 10% in May, but this series has wide error bounds and can be revised significantly. Most housing market data point towards weaker, not stronger, activity levels.
The market was more fixated on the inflation expectations section of the University of Michigan survey, which showed the final estimate revised down from 3.3% to 3.1% for the 5-10 years ahead measure. The significance of this was at the last FOMC meeting, Chair Powell indicated that the surprising lift in long-term inflation expectations was a factor in the Fed opting for a super-sized 75bps hike. A lower inflation expectations print logically meant that the odds for future super-sized hikes were reduced, so the market pared back tightening expectations through to early 2023. But the market also pared back the easing of policy priced from late 2023. The net effect for the 2-year rate was that it actually closed up 5bps for the day to 3.06%.
San Francisco Fed President Daly joined some of her colleagues in seeing a 75bps hike in July as appropriate, following hot on the heels of Fed Board Governor Bowman who said the same on Thursday night. St Louis Fed President Bullard, who the market pays much more regard to than other Fed Presidents given his early cries to stop printing money and aggressively raise rates, gave an upbeat take on the US economy in a speech on Friday. He noted that households were in a great position to spend as they are flush with cash and he thought “it is a little too early to have this debate about recession probabilities in the US”, believing that the US economy was still in the early stages of a post pandemic recovery.
Overall, last week was a week in which there was much debate over whether economies faced hard or soft landings, how inflation might fare over the next couple of years and how much more work central banks needed to do. Market movements towards the end of the week appeared to be consistent with a more optimistic take of the outlook, with the net result being reduced policy tightening priced in, deemed necessary to bring inflation down, and hope that a coveted soft landing could ensue. A 3.1% gain in the S&P500 took its weekly gain to 6½%, while the Nasdaq index showed an even bigger recovery, ending the week up 7½%. The Euro Stoxx 600 index closed up 2.6% for a weekly gain of 2.4%.
A more positive turn in risk sentiment towards the end of the week supported the commodity currencies. If we take the 5pm NZ close of Thursday as a reference point, the NZD was up 0.9% to 0. 6320, the AUD rose 0.8% to 0.6945 and CAD rose 0.5%. But despite the notable movements in bonds and equities, over that time frame, EUR, GBP and JPY showed little net movement. For the week as a whole, net currency movements were insignificant, with NZD/USD and NZD/AUD barely changed and other NZD crosses also showing little or modest movements.
In other noteworthy news from late last week, Germany triggered phase two of the three-stage emergency gas plan, one step below the final emergency stage which would trigger state control over distribution. Phase 2, planned for when the government sees a high risk of long-term supply shortages of gas, theoretically enables utilities to pass on high prices to customers and thereby help to lower demand. The head of the gas agency warned that prices for consumers could triple and warned that it “won’t be pretty” if Germany has a very cold winter. Russia playing politics with gas supply to Europe ahead of ahead of winter forms a central part of our euro area view.
The domestic rates market showed a significant rally on Thursday on the back of global forces, namely Australian rates continuing to fall in the aftermath of commentary by RBA Governor Lowe. NZ’s 2-year swap rate fell 11bps to 4.24%, while longer term rates were down in the order of 16-18bps, with similar moves seen for NZGBs. Since Thursday’s NZ close, the Australian 10-year bond future has fallen 14bps in yield terms, while the 3-year rate is down 17bps in yield terms, setting the scene for lower NZ rates on the market open. In a panel discussion on Friday night, RBA Governor Lowe reiterated that the Australian central bank would be hiking in 25bps or 50bps increments.
In the week ahead, the domestic calendar remains light, but with interest later in the week on how much deeper NZ business confidence and activity indicators might have fallen and whether consumer confidence can fall any further from an already rocket-bottom level on the ANZ survey. The annual ECB symposium in Sintra, Portugal will get a lot of airtime, featuring much discussion on European central banking and also bringing in other heavy hitters like the BoE’s Bailey and Fed Chair Powell. There is a smattering of key global data during the week, culminating in the US ISM manufacturing survey at the end of the week.