ECB hikes rates 50bps, unveils new anti-fragmentation tool. Draghi's Italian govt collapses. Big fall in US rates helped by lower oil prices, tentative signs of a shift in the US labour market

It’s been another action-packed 24 hours in markets.  The ECB hiked rates by a larger-than-expected 50bps, but the initial spike higher in the EUR and German rates has faded, both now little changed on the day.  Italian bonds have come under pressure from the political uncertainty in the country (new elections are set for September), with the ECB’s new anti-fragmentation tool getting a lukewarm reception.  The US 10-year rate has fallen sharply overnight, back to around 2.90%, amidst a fall in oil prices and weaker economic data.  Equity markets haven’t been perturbed however, with the key US indices up for a third day in a row. Currency movements overall have been relatively contained, the NZD still sitting above 0.62.

The ECB hiked rates by 50bps overnight, taking the deposit rate back to 0% and ending its negative rate policy that has been in place since 2014.  The market was pricing around a 50% chance of a 50bps hike leading into the meeting, following press reports earlier in the week that the ECB would consider such a move.  Going forward the ECB would take a “meeting-by-meeting approach ”, sensibly signalling the end of its forward guidance in an environment of huge economic uncertainty.  The market has brought forward rate hike pricing for the ECB, with some chance of a 75bps at the next meeting in September and around a 70% chance of another 50bps hike priced for October but little change in the expected peak in the cycle.  The 2-year Germany rate was only 4bps higher on the day, just above 0.6%.

Separately, the ECB unveiled its anti-fragmentation tool, called the 'Transmission Protection Instrument', an “unlimited” bond buying programme which could be deployed to prevent “unwarranted ” moves in peripheral bond markets, like Italy’s. The operative word here is “unwarranted”.  The sharp widening in Italian bond spreads to Germany is arguably justified given the political turmoil in the country (see below) and likely doesn’t provide cover for the ECB to start buying its bonds.  But there would be a stronger case for the ECB to step-in in other peripheral markets, such as Portugal and Spain, if contagion from Italy were to spread.  Unlike regular QE, the new bond buying tool is expected to be a backstop, with countries expected to comply with EU fiscal rules, although the ECB was suitably vague about the exact conditions under which it would be deployed.

As we reported yesterday, Italy is back in political turmoil following Draghi’s resignation as PM after the three main coalition partners refused to back him in a confidence vote, setting the country up for fresh elections, to be held on 25 September. The Italy-Germany 10-year bond spread is back above 230bps, some 20bps wider on the day, reflecting greater political risk premia, with the ECB’s anti-fragmentation tool announcement having little market impact.

As foreshadowed by Putin the previous night, gas flows have resumed through the Nord Stream 1 pipeline from Russia to Germany, averting the worst-case scenario of a sudden stop of gas supplies. Indications are the gas flow will restart at 40% of capacity, around what it was before the annual maintenance shutdown, which is more than the market was expecting.  However, Putin has suggested flows could yet drop to around 20% as soon as next week.  After initially falling as much as 8%, European natural gas futures are back to unchanged on the day, given the still-high risks of gas shortages going forward.

Despite the ECB’s larger-than-expected rate hike, global rates are lower overnight, with the US 10-year rate falling 11bps to 2.92%.  The fall in US rates coincided with the release of weaker than expected US jobless claims data and a softer Philadelphia Fed business survey (see below).  Also likely contributing to the move was a fall in oil prices (Brent crude -3%), with most of the decline in the US 10-year rate accounted for by lower breakeven inflation (-8bps on the day).  The US 10-year rate still remains broadly contained within a 2.75%-3.25% trading range, with recession fears capping the upside and still-high inflation limiting the downside.

Jobless claims ticked up to 251k, continuing their gradual trend up over recent months, to now their highest level since November.  While jobless claims can be distorted at this time of year by seasonal adjustment issues, the trend higher seems clear and is consistent with growing anecdotes of hiring freezes and layoffs at several multinational companies (see below).  Separately, the Philadelphia Fed business survey was much weaker than expected, with forward capex intentions falling to a 9-year low and prices paid hitting their lowest level since early last year.

Following on from news earlier this week that Google was evaluating its headcount requirements and Apple was scaling back hiring and investment plans, Microsoft said it was planning to cut back on hiring while removing most job openings at the company, blaming the more challenging economic environment.  Separately, Ford said it was planning to cut 8,000 workers as part of a cost cutting exercise.  Most of the major US tech firms have now announced plans to pull back on hiring.  The US labour market remains extremely tight, but the momentum appears to have shifted, even if there are only tentative signs in the economic data at this stage.

In another sign that the economic outlook is deteriorating, US telco AT&T said there had been an increase in overdue payments of phone bills. The company lowered its free cash flow projection for this year from $14b to $12b, around half of the fall due to the increase in overdue payments, seeing its share price slump by almost 8%.

US equities haven’t been troubled by the weaker US economic data, with the S&P500 up by 0.6% and the NASDAQ 1% higher, helped by stronger-than-expected earnings by Tesla after the bell yesterday.  In Europe, the EuroStoxx index was up 0.4%, despite the ECB’s larger-than-expected rate hike, while Italy’s benchmark was down 0.7% amidst the political drama in the country.

Currency moves have been relatively modest overall.  The JPY is the strongest currency on the day, USD/JPY down around 0.5% to 137.50 against a backdrop of sharply lower US bond rates.  Most currencies are modestly higher against the USD over the past 24 hours, the NZD being one exception, down 0.2%, although it is still sitting above the 0.62 mark this morning.

There were no major surprises at yesterday’s Bank of Japan meeting, the central bank sticking with its ultra-easy monetary policy stance, including its 0.25% cap on the 10-year bond rate. The BoJ upgraded its inflation forecasts, with CPI ex fresh food forecast to be 2.3% this year (largely due to higher oil prices) before falling back to 1.4% next year.  Inflation risks are now seen to the upside, but given underlying inflation remains low, Kuroda signalled the BoJ was in no rush to abandon its accommodative stance, saying it had “no intention at all” of raising rates and “zero intention ” of lifting the 0.25% cap on the 10-year bond rate. Kuroda also pushed back against suggestions that a small increase in the cash rate could support the yen, which recently hit a 24-year low, claiming it would require “significant hikes” to reverse the currency’s trend which, in turn, would hit the economy hard.

It was a quieter day in the local rates market yesterday with swap rates drifting 1-3bps lower after the previous day’s big sell-off.  Yesterday’s government bond tender saw all three bonds sold at yields 1-2bps below prevailing secondary market levels, but there was little follow-through, the 10-year yield down only 1bp on the day.  Australian 10-year bond future is around 8bps lower than at the time of the NZ market close yesterday, suggesting we should expect a decent move lower in NZ rates when trading resumes this morning.

The European PMIs will take focus tonight, with the market looking for further slippage in both services and manufacturing activity in the region.  The PMIs for the US are also released, although these tend to have less market significance than the longer-running ISM surveys.