Recession concerns come back to the fore after very weak US and European PMIs. Big falls in global rates as markets pare back rate hike expectations

Friday saw big falls in global rates with recession fears returning to markets.  The European composite PMI fell below 50, signalling negative growth in the region, while the US Services PMI dropped into contractionary territory as well, leading markets to aggressively pare back rate hike expectations.  Equities were lower on recession concerns, with tech stocks underperforming over concerns around online advertising spending.  The big mover in the currency market was the JPY, which appreciated almost 1% amidst sharply lower global rates and more cautious risk appetite.  The NZD briefly touched 0.63 Friday night, the first time in almost a month, before ending the week around 0.6250.  NZ rates fell sharply on Friday, with the market now pricing ‘only’ a 30% chance of a 75bps RBNZ hike next month, and those moves set to extend this morning.

Economic data came back to the forefront of investors’ attention on Friday night after a series of very weak PMI surveys in the US and Europe.  Both the Services and Manufacturing PMIs in Germany fell below the 50 mark, signalling contraction in both sectors, while the European Composite PMI fell from 52 to 49.4, the first time it has fallen into contractionary territory (excluding Covid-related lockdowns) since 2013.  The European Composite PMI is consistent with the Eurozone economy contracting at a 0.1% q/q rate.  It’s not difficult to understand the slowing growth momentum given the sharp increase in energy prices in Europe this year (and fears of possible rationing ahead of winter), the war in Ukraine, and a weaker global growth pulse.  To add to this, the ECB kicked off its tightening cycle this week, with President Lagarde saying on Friday it will “raise interest rates for as long as it takes to bring inflation back to our target.”  The ECB has form with mistiming rate hikes, infamously raising rates on the eve of Lehman Brother’s collapse in 2008 and again just before the European sovereign crisis in 2011.

European rates plunged after the PMI release, with the market aggressively paring back ECB rate hike expectations only a day after the central bank’s larger-than-expected 50bps hike.  The market still sees a 50bps hike in September, but it now only prices an additional ~75bps of hikes after that.  The 2-year German rate fell an extraordinary 26bps on the day, to 0.36%, while the 10-year rate, which peaked at 1.94% little over a month ago, plunged 19bps, falling below the 1% mark at one stage.  There was some temporary respite for Italy after the recent political drama in the country, the 10-year Italian bond rate falling 23bps.

Later in the session, the US Composite PMI slumped from 52.3 to 47.5, well below expectations and now at its lowest level since 2009 (excluding the period in early 2020). S&P Global, which now administers the index, said more firms reported plans to cut costs and reduce employees, consistent with recent anecdotes from big tech firms such as Meta and Apple, even though the employment gauge remained firmly above 50.  More encouragingly, there were further falls in pricing gauges, the output price index hitting its lowest level since March 2021, potentially a sign that inflation pressures might be moderating.  The market is on board with this view; it prices annual CPI inflation to fall to just 2.75% by the end of 2023, which would be a huge fall from the current 9.1% y/y rate.

Ordinarily, the market tends to put greater weight on the ISM surveys in the US, which have a longer track record than the PMIs.  But, with recession concerns already heightened, there was a meaningful market reaction to data.  US 2-year and 10-year rates fell by 12bps on the session, the latter now near its lowest levels since April, sitting right at the bottom of the trading range, around 2.75%.  The Fed is still expected to raise its cash rate by 75bps this week, but the market now sees a 50bps hike in September as the most likely outcome (previously 75bps) and a peak in the cash rate under 3.50%.  Additionally, the market is pricing almost three rate cuts in 2023, consistent with a view that the economy is likely to head into recession and inflation likely to rapidly decelerate.  Market positioning may also be at play with the aggressive turnaround in the bond market, with short duration (betting on higher rates) having previously been a widely held consensus view, albeit with some signs from JP Morgan’s investor survey that investors have been buying back bonds over the past few months.

US equities headed lower after the US PMI data, with the S&P500 ending down almost 1% and the NASDAQ down almost 2%.  Adding to the negative sentiment towards tech stocks, Twitter and Snap reported disappointing earnings results, the latter plunging almost 40% and spilling over into other social media and tech firms, such as Meta (-7.6%) and Google’s parent Alphabet (-5.8%), with investors wondering whether it could signal a broader softening in online ad spending by companies amidst the economic slowdown.  It’s a big week ahead in the earnings season with Apple, Amazon, Meta and Alphabet all reporting.

Despite growing recession fears evident in other markets, both the S&P500 and NASDAQ were higher on the week (+2.5% and +3.3% respectively), with the most likely explanation being a technical correction from oversold levels rather than a more optimistic fundamental outlook.

Currencies were volatile on Friday, but with little net change aside from the JPY.  The EUR was whipsawed by the economic data, falling to as low as 1.0130 after the dreadful European PMIs before rallying back after the equally weak US surveys.  The EUR ended little changed on the day, just above 1.02.  The JPY was the key mover in the currency market, with USD/JPY falling almost 1%, to around 136, with the sharp slide in US bond rates narrowing the interest rate differential between Japan and the US.  The NZD hit 0.63 on Friday night for the first time in almost a month before reversing back to 0.6250, little changed on the day.  The story of the week was one of USD weakness (BBDXY -1%), albeit after what has been a very strong run which saw it reach multi-year highs.

In other news, Russia and Ukraine signed a deal to allow grain shipments from Ukraine to pass through the Black sea.  US wheat futures plunged almost 6% and are now trading below the levels seen immediately prior to Russia’s invasion of Ukraine.  Note Russia has since attacked the Ukrainian port of Odesa, casting doubt about whether the deal will hold.  Food prices have been one of a number of factors which have contributed to sky-high inflation around the world.

The falls in global bond rates ricocheted to the New Zealand market on Friday, driving swap rates 7-10bps lower across the curve.  The market has started to pare back RBNZ rate hike expectations in-line with the trend in offshore markets.  The market now sees around a 30% chance of a 75bps hike by the RBNZ next month, down from more than 50% immediately after the higher-than-expected NZ CPI release at the start of last week.  The market is set for further large falls in NZ rates today, with the implied yield on the Australian 10-year bond future some 15bps lower than at the NZ market close.

There isn’t much on the agenda tonight, just the German IFO business survey, although market interest is likely to be limited given the more widely followed PMIs were released on Friday.

Looking beyond tonight, it’s another big week ahead offshore.  The centrepiece is the FOMC meeting on Thursday night, with the Fed now widely expected to raise its cash rate by 75bps for the second successive meeting, although most of the focus is likely to be on how Chair Powell couches the outlook for policy amidst the slowdown in activity indicators.  US GDP is released in the US, with the market looking for subdued quarterly growth of just 0.5% (annualised).   Note the Atlanta Fed’s GDPNow estimate is pointing to negative growth in Q2, which would see the US enter a ‘technical recession’. Probably the most important US data point though is the Employment Cost Index on Friday, the most comprehensive measure of wage growth.  Elsewhere, Australia sees the all-important CPI release, with the market looking for annual headline inflation to hit 6.3% and core inflation to reach 4.7% y/y, well above the top of the RBA’s 2-3% target range.  Domestically, there are the ANZ business and consumer confidence indexes released, with both likely to show confidence remains depressed.