Market retraces recent moves - equities modestly lower, bond yields higher, USD recovers

There has been a modest reversal of some of the market moves seen over the past week, with equities falling, bond yields rising and a stronger USD. The Fed’s Bullard has added to the downbeat mood, with a more hawkish assessment of how high rates might need to go. The UK fiscal update showed some austerity ahead, but mostly backloaded until after the next election in over two years. US Treasury yields are up 7-10bps, while the NZD traded below 0.61 overnight.

After some notable moves seen in the wake of last week’s big downside miss in the US CPI, the market has retraced a little. Since that data, there has been a convoy of Fed speakers trying to hose down market excitement about a possible downshift in inflation and St Louis Fed President Bullard, who sits at the hawkish end of the FOMC, has shared his views. He told reporters after a speech that in the past he had said the Fed Funds rate needed to get to 4.75-5% but he now thought 5-5.25% was needed and “that’s a minimum level”. His presentation showed charts indicating rates need to be between 5-7% to be sufficiently restrictive to bring inflation back down to target, based on variations of the well-known Taylor Rule. The market has been well aware of what the Taylor Rule suggests, and the higher end estimates better fit the current situation, but hearing it come from an FOMC member is confronting.

Bullard’s hawkish update has driven a lift in US Treasuries, led by the short end, with the 2-year rate up over 10bps to 4.46%, albeit still down some 35bps lower from the peak two weeks ago. The 10-year rate is up 7bps to 3.76%, trading a wide range of 3.67-3.80%.  Higher rates have dampened the mood in equity markets, with the S&P500 currently down 0.3%, paring an earlier loss of 1.3%.

In US economic data released overnight, the Philly Fed business survey reading was much weaker than expected, falling nearly 11 pts to minus 19.4 and the employment index falling 21pts to 7.1, adding to the case of a manufacturing sector in, or near, recession. However, jobless claims continue to point to a tight labour market. Housing starts and building permits both fell in October, down 4.2% m/m and 2.4% m/m respectively, continuing their significant downward trends.

In the UK, Chancellor Hunt outlined a £55b package of tax rises and spending cuts, although most of the fiscal austerity won’t hit until after the election due in just over two years. The OBR forecasts a 1.4% contraction in GDP next year, with inflation remaining high at 7.4%. The DMO cut its bond programme for the current fiscal year to March 2023 by a £24b to a £170b, but gross financing will surge to £305b next year. On top of this the market will also have to absorb £40b of bond sales from the BoE. The UK 10-year rate is up only 5bps to 3.20%, with the market liking the reduced financing need over the rest of the fiscal year.

In currency markets, the USD is broadly stronger, up 0.5% on the DXY index, with CAD managing to keep pace. The NZD has traded down to about 0.6065 overnight and currently sits just over 0.61.  The AUD is down to 0.6680, with NZD/AUD slightly higher at 0.9150. NZD crosses against EUR, GBP and JPY are little changed.

Following on the heels of stronger wage inflation data on Wednesday, Australia’s employment report showed strength in employment, and the unemployment rate falling back down to 3.4%. It adds to the case for the RBA to continue to tighten policy, having gotten off to a late start and, with the recent step down to 25bps hikes, the likelihood of a more drawn-out tightening cycle remains in play.

NZ rates continued to push lower yesterday, on global forces, with both the NZGB and swaps curve showing larger falls at the long end of the curve and swaps outperforming. The 10-year NZGB fell 8bps to 4.11% while 10-year swap rate fell 12bps to 4.37%. Since the NZ close, the Australian 10-year bond future has traded a 10bps range, but shows little net change against the backdrop of higher US and European yields.

In the day ahead, Japan CPI data is expected to show inflation rising to fresh multi-decade highs, with headline at 3.6% y/y and the so-called core-core at 2.4%. Elsewhere, only second tier data are released with a speech by ECB President Lagarde thrown into the mix.