Week begins with a hit to risk appetite. But no safety from bonds as global rates rise. UK inflation projected by Citigroup to hit 18.6% on surging energy costs

Fear of a hawkish update from Fed Chair Powell at Jackson Hole at the end of the week and fear of an earlier end to Russian gas supply have driven weaker risk sentiment. US equities have fallen significantly for a second consecutive day, gas prices are soaring, global rates are higher and the USD is on the verge of breaking up through its July peak. The NZD and AUD have showed some surprising resilience, although this follows their hammering dealt to last week.

The market is focused on what Powell might say in his Jackson Hole speech early Saturday morning NZ time. Following a run of hawkish commentary from his colleagues that sit around the FOMC table, the realisation is hitting that Powell will be similarly hawkish, not likely swaying from his resolve to get on top of the inflation problem and in no way endorsing market pricing of rate cuts next year, as the market prices in a dovish pivot at some stage. That pivot is unlikely to be the message at the end of the week.

Alongside that market theme, energy costs continue to surge across Europe, reacting to Friday’s announcement from Gasprom that Russian gas supplies through the Nordstream pipeline into Germany would stop for three days at the end of the month for some unscheduled maintenance. There are fears that the gas supply won’t return after that period, or that stoppages will become more regular heading into winter as Russia weaponises gas supply. The Dutch TTF gas benchmark rose 13% to close at another fresh record high of EUR277/MWh – more than 14 fold higher than the average of the past decade –  feeding into further record wholesale electricity prices across many European countries.

Citigroup economists revised up their estimate of peak UK CPI inflation to a massive 18.6% y/y for January 2023 – with upside risk – building in estimates of the forthcoming upside to the likely retail energy price cap, which limits how much households pay for heating and electricity. Without any offsetting government support package, annual household energy costs would increase by thousands of pounds.

The focus on Jackson Hole and surging energy prices is seeing a reversal of the recent lift in risk appetite that took global equity prices much higher over the past couple of months. The S&P500 is currently down over 2%, following Friday’s 1.3% fall, with all sectors lower. US Treasury yields are higher across the curve, led by the short end, with the 2-year rate up 11bps to 3.34%. The 10-year rate is up 6bps to be back above 3%, now up more than 50bps from the early August trough but still below the 3.5% mid-June peak. European 10-year rates are also higher, in the order of 7-10bps.

The USD shows broadly based gains, with the DXY index up 0.8% to over 109 and within spitting distance of the mid-July high. The EUR has made its inevitable re-entry below parity, down over 1% to a fresh two-decade low of 0.9926. GBP is down 0.6% and fell to its lowest level since the Brexit referendum vote, tracking below 1.1750. JPY has struggled against the higher rates backdrop, down 0.4% and seeing USD/JPY up to 137.50.

The NZD and AUD have showed some surprising resilience, both only slightly lower from their close last week, although this must be seen in the context of large week’s chunky depreciation, which saw the NZD plunge over 4% and the AUD down 3½%. Further yuan weakness hasn’t spilled over in the NZD or AUD. Overnight, USD/CNY hit a two-year high of 6.85.

In the wake of China’s key policy rates being reduced by 10bps last week, banks cut the 1-year loan prime rate by 5bps and the 5-year loan prime rate by 15bps. The latter is used as a benchmark for setting mortgage rates, and the larger cut signalled a desire to boost demand for mortgages. But with China’s zero-COVID policy and the government’s crackdown on the property market, demand for loans has been weak and the economy has become less sensitive to interest rates. The government will have to do a lot more if it wants to stimulate the economy.

There are signs that Saudi Arabia isn’t happy with the recent fall in oil prices, with the oil minister stating that futures prices don’t reflect the underlying fundamentals of supply and demand, which might require OPEC to tighten production when it meets next month to consider output targets. Brent crude recovered $4 from just over USD92 per barrel to over USD96, albeit the price is still down slightly from last week’s close.

The domestic rates market saw a significant sell-off in response to global forces and interpreting Assistant RBNZ Governor Hawkesby’s comments in an interview in a hawkish light.  The 5-year through to 10-year NZGB and swap rates rose in the order of 13-15bps. The 2-year swap rate closed 9bps higher at 4.09%. Since the NZ close, the Australian 10-year bond future is up 6bps in yield, likely putting further upside pressure on NZ rates on the open.

Hawkesbury reiterated the clear message we got from the RBNZ last week of some intent to get the OCR to 4%, a rate which it saw as comfortably above a neutral level and thereby working to bring inflation pressure down. The 4.1% projected peak in the OCR was “deliberately ambiguous to reflect uncertainty of where the end point may be”, noting that it could be as high as 4.25%, or a balanced range around 4.1%.

On the calendar ahead, PMI data tonight are expected to show further slippage in growth momentum across the euro area and UK. The PMIs for the US are expected to be better compared to Europe. Last month the US PMI services index caused a market reaction when it plunged, but that proved to be a false signal and the more widely followed ISM services indicator didn’t follow that move.