Markets digest the downside surprise to US CPI. Big move higher in 10-year rates and sharp steepening of curves with the market paring back rate cut expectations for next year

The most notable feature of market moves overnight has been a big lift in long-term rates and an aggressive steepening of the US curve.  The US 10-year rate is 10ps higher overnight, at 2.88%, with similar-sized moves seen in other markets.  In contrast, US equities and the USD have largely consolidated overnight after their big post-CPI moves.  The NZD has outperformed, now trading at a two-month high of around 0.6430.  NZ rates were higher yesterday, especially at the long end of the curve, and those moves look set to extend today.

There hasn’t been much news to drive markets over the past 24 hours, rather investors continue to digest the downside surprise to US CPI on Wednesday night and its implications for Fed policy and asset classes.

The initial take, at least from the Fed, is that the job on inflation is not done yet.  San Francisco Fed President Daly told the FT that inflation was still “far too high” and “we’re not near done [with tightening] yet ”, similar messages to those of Evans and Kashkari immediately after the CPI release.  However, while not ruling out another 75bps hike, Daly said her baseline was for a step down in the pace of tightening in September, to a 50bps move.  The market has reduced its pricing for a 75bps Fed rate hike in September to around 40% (down from around 80% prior to the CPI release) while, at the same time, pared back its expectations of rate cuts next year.  The net result is there hasn’t been much change to the expected peak in the cash rate this cycle, still expected to be around 3.65%.  The US 2-year rate is little unchanged from yesterday’s close.

While short-term US rates are little changed over the past 24 hours, there has been a big move higher in longer-term rates and a sharp steepening of the curve.  The US 10-year rate is up 10bps overnight, at 2.88%, now noticeably higher than it was before the CPI release.  The US 2y10y curve, which reached a more-than 20-year low of -50bps ahead of the CPI release, is back to -35bps, still deeply inverted and warning of a recession next year, but now at less extreme levels.  The increase in long-term rates has been felt globally, with the UK 10-year rate up 11bps, Germany’s 10-year rate up 8bps and the implied yield on the Australian 10-year bond future around 12bps higher than at the time of the NZ market close.

US equities have largely consolidated overnight after their big post-CPI rallies.  The S&P500 is around 0.1% higher and has now recovered roughly half of its ‘bear market’ sell-off.  The NASDAQ is down slightly, but only by 0.4%, after the previous day’s 2.9% rally.  At face value, the equity market appears to be taking the view that the Fed will not necessarily need to tighten as aggressively as previously thought, which might prolong the economic cycle and support corporate earnings.  Disney reported better than expected earnings after the bell yesterday, including higher-than-expected subscriber numbers to its Disney+ service, seeing its share price increase 6%.

Like equities, the USD has been in consolidation mode overnight.  The BBDXY index is down 0.1% on the session, following its 1% post-CPI sell-off, with most currency moves overnight restricted to +/-0.2%.  The NZD has been one exception, up 0.4% to 0.6430, its highest level in over two months.  The rally in the NZD from its July lows has accompanied a broad-based improvement in risk appetite, including a more-than 10% increase in the S&P500.

Economic data overnight has been second-tier and not market moving.  Initial jobless claims continue to trend gradually higher, suggesting some softening in the labour market, although analysts warn that seasonal adjustment issues at this time of year make interpreting the data a bit more challenging.  US PPI inflation was lower than expected although market interest was minimal given the previous day’s CPI release.

Oil prices are higher overnight, with Brent crude oil futures hitting the $100 mark, 2.5% higher on the day.  The IEA increased its global oil consumption estimate by 380k barrels per day, partly due to greater gas-to-oil switching, especially in Europe which is facing shortages of gas.  Base metals were also higher overnight, copper increasing 1.1% to a six-week high.

The NZ curve also saw a sharp steepening yesterday.  The 10-year swap rate was 8bps higher, at 3.61%, while the 2-year rate was only 3bps higher.  The underperformance in NZ rates on the session (the NZ-US 10-year spread increased almost 10bps) likely reflects some investor nerves around the possibility of a hawkish RBNZ MPS next week.  We can expect higher domestic rates and a steeper curve again today after the overnight moves in US Treasuries.

There was more negative housing data yesterday, with REINZ reporting another 1.4% fall in house prices, bringing the cumulative decline since the peak in November to around 8% (seasonally adjusted).  Further falls in house prices look in store, with the number of days to sell increasing to 47 (from 31 a year ago) and REINZ reporting rising inventory levels while falling new listings.  We still have a 15-20% peak to trough fall pencilled in for house prices, similar-to-a-little-larger than the decline the RBNZ projected in its May MPS.

This morning sees the release of the NZ Manufacturing PMI, which was sitting just below the 50 threshold in June, and food prices.  The University of Michigan consumer sentiment survey is out tonight, with confidence expected to remain at rock bottom levels.