Fed officials priming the market for a hawkish message from Powell. NZD underperforms again. NZ curve steepens with the market growing comfortable with a 4% peak in the OCR

Global bond yields continued their recent rebound on Friday night, the US 10-year rate going within a whisker of hitting 3% for the first time in a month.  Continued hawkish rhetoric from Fed officials appears to be setting the market up for a hawkish message from Chair Powell at Jackson Hole on Friday night.  Higher rates weighed on equity markets (S&P500 -1.3%) and supported a big move higher in the USD.  The EUR ended the weak just above parity while the NZD underperformed, closing below 0.62.

There wasn’t much fresh news to drive markets on Friday, but investors are already looking ahead to Fed Chair Powell’s annual speech at the Jackson Hole Symposium this coming Friday night.  Jackson Hole has historically been a platform where the Fed Chair has foreshadowed future policy announcements and delivered market-moving messages.  Powell’s 2021 Jackson Hole address focused heavily on the Fed’s view that inflation was likely to be “transitory”, but the message this time is surely likely to be along the lines of ‘the job is not done yet’ on getting inflation back to target.

Certainly, recent comments from Fed officials seem to priming the market for a hawkish message from Powell.  After the barrage of Fed speakers earlier in the week talking up the need to take the cash rate to restrictive levels, Richmond Fed President Barkin was out on Friday night saying the Fed would do what was needed to get inflation back down, even if that meant causing a recession.  The market is delicately balanced ahead of Jackson Hole, with around a 50% chance of a 75bps hike priced in for next month’s meeting and Powell’s messaging likely to be influential in steering the market towards a 50bps hike or a 75bps move.

Global rates were sharply higher again on Friday amidst the continued hawkish rhetoric from the Fed, the US 10-year rate up another 9bps, to 2.97%, now within touching distance of the 3% mark for the first time in a month.  Curve steepening was the order of the day, with the US 2y10y yield curve steepening 5bps although, at -26bps, it remains deeply inverted and consistent with the US economy heading into recession next year.

Spill overs were felt in other bond markets, with UK and German 10-year rates 10bps and 13bps higher respectively.  Adding upward pressure to European rates, European gas prices were another 8% higher on Friday, closing at a fresh record high, after Gazprom said that it would close the Nord Stream 1 pipeline for 3 days later this month for unscheduled maintenance work, fuelling fears that Russia could restrict supply even further. Skyrocketing gas prices are exacerbating already extremely high inflation in the UK and Europe.  Europe’s 10-year inflation swap is 40bps higher over the past month, now at 2.75%, as the market has priced in ramped up its inflation expectations.

Equity markets came under renewed pressure amidst the higher rates backdrop, the S&P500 down 1.3% on Friday and the NASDAQ off 2%.  After the head scratching rally in equities over the past two months, driven by some emerging optimism that US inflation has peaked and the Fed might downsize its rate hike pace, but also reportedly heavy buying from trend-following investors, the market was arguably vulnerable to a correction.  It was a similar story in Europe, with the EuroStoxx off by 0.8% on Friday.

The USD continued to surge higher, the BBDXY up another 0.5% on Friday and more than 2% on the week, its strongest weekly gain since April 2020.  The recent repricing of the Fed rate outlook, and expectations Powell will reinforce that hawkish message later this week, alongside a pickup in risk aversion, have contributed to the recent rebound in the USD.

USD strength is also a by-product of weakness in the EUR, which is battling surging gas prices and staring down the barrel at a recession.   The EUR was 0.5% weaker on Friday, ending around 1.0040, with another charge below parity looking just a matter of time.  USD/JPY was 0.8% higher amidst the sharp increase in US Treasury rates, closing the week just below the 137 mark.

The NZD was the weakest of the G10 currencies on Friday, down 1.4% to around 0.6175.  After the previous week’s 3.5% surge higher, the NZD came back down to Earth last week as risk appetite faltered, falling a chunky 4.3%.  The NZD/AUD cross ended the week back below 0.90.

USD/CNH hit a two-year high on Friday, above 6.84, on diverging monetary policy between the US and China.  While all the rhetoric coming from Fed officials has been uniformly hawkish, the PBOC is expected to follow up last week’s surprise cut to the medium-term lending facility rate with 10bps cuts to the 1-year and 5-year loan prime rates today.  China’s monetary policy is in very different place to most developed market central banks given CPI inflation remains low and the Chinese economy is struggling due to the slowdown in the property sector and the uncertainty created by the constant threat of new lockdowns.  The psychologically important 7.0 level is now around 2.5% away.

NZ rates were higher and steeper again on Friday, taking their lead from offshore markets.  The 10-year swap rate was up a hefty 7bps, at 3.83%, while the 2-year rate was up 4bps, at 3.995%.  Market expectations for the terminal OCR have been relatively steady at around 4% since the RBNZ MPS.

In an interview with the NZ Herald published on Friday, RBNZ Governor Orr suggested the RBNZ’s base case was to get the OCR to 4% by the end of the year, seen as “unambiguously” above neutral, and then to be “patient” leaving rates at that restrictive level for some time.  Orr added he thought “we’re close” to the end of the tightening cycle.

In news over the weekend, the government said certain sectors would be temporarily exempt from the new median wage requirements for recruiting workers from overseas, in response to intense labour shortages. The number of working holiday visas would also be doubled for 2022/23.  The news is unlikely to be a gamechanger for the labour market, given many countries are competing for those same workers at present (the global labour market is very tight), but it might help labour supply at the margin.

It’s a quieter week for economic data ahead with the market’s focus squarely on Powell’s Jackson Hole address on Friday night.  Other central bankers attending Jackson Hole include Bank of England Governor Bailey and ECB board member Schnabel.  The European PMIs are released tomorrow night, with economists looking for the composite index to fall further into contractionary territory, at 48.9, portending recession in the region.  There are only second-tier data released in NZ, the main one being Q2 retail sales, where we are looking for a 2% rebound in volume terms over the quarter.