US Treasury rates higher. German business confidence higher, NZ consumer confidence low, but NZ rates market outperforms

Newsflow has been light and will remain so in the lead-up to Christmas. US Treasury yields have pushed higher, with the 10-year rate up 10bps to 3.59%, with the curve steepening. US equities are lower, but so is the VIX index. Currency movements have been modest, with the NZD underperforming AUD and CAD, sending NZD/AUD back below 0.95.

With the new week underway there are no obvious market themes, with modest changes overall apart from a decent selloff in US Treasuries for no obvious reason. Rates are higher across the curve with a steepening bias, with the 2-year rate up 7bps to 4.25% and the 10-year rate up 10bps to 3.59% – the latter has now fully unwound the chunky fall seen after last week’s softer than expected US CPI report. The subsequent hawkish Fed policy update remains fresh in the minds of investors.

The run of negative US economic surprises continues, with the NAHB housing market index down for the twelfth consecutive month – the longest downward streak on record – to 31.  The index is now close to the nadir at the height of COVID lockdowns in April 2020 and is the lowest in over ten years excluding that period. The US housing market recession reflects the combination of higher mortgage rates reducing demand and higher labour and material costs making it more expensive to build.

By contrast, Germany’s IFO business survey was better than expected, continuing the run of positive economic surprises in the euro area.  The business climate index increase rose for the third consecutive month to 88.6, with both the current conditions and expectations components increasing. Economic recession is still likely, but could prove to be shallower than previously expected.

In equity markets, the S&P500 is on track for the fourth consecutive daily fall, currently down 0.5%. But we wouldn’t suggest a risk-off vibe as the VIX index has fallen below 22, fully unwinding the lift seen ahead of last week’s CPI report as investors sought some downside market protection ahead of that release.

Currency movements have been modest. JPY has underperformed against the backdrop of higher Treasury yields, with USD/JPY up to 136.75, 100 pips above the low yesterday.  The yen opened the week strong, before unwinding the move, following the weekend article in the Japan Times that the government was set to revise the accord with the BoJ to make its price target more flexible. That may well be the case, but not for a while, and certainly after current Governor Kuroda leaves next April.  In the meantime, the BoJ’s ultra-easy policy stance is likely to remain in place, keeping the yen depressed. The Bank meets today and no change in policy is expected.

The NZD saw some selling pressure into the London close, falling to just above 0.6340 but has since recovered to trade at 0.6385. It has underperformed the other commodity currencies, seeing NZD/AUD back below 0.95 after reaching its highest level in a year at the end of last week.  In our weekly currency update yesterday we noted that recent NZD/AUD strength has been driven by higher NZ-Australia rate spreads. Our outlook is for NZ-Australian rate compression, with too-much tightening priced into the NZ rates curve and too-little for the Australian rates curve. The market has yet to embrace this view (although note yesterday’s rates move mentioned below) but ultimately a change in sentiment on the rates outlook is expected to trigger a reversal in NZD/AUD. Our projections have the cross settling into the low 0.90s, and we see levels above 0.95 as a good selling opportunity.

NZ consumer confidence fell to a record low on the quarterly Westpac index, to 75.6, indicative of the cost-of-living crisis facing consumers against a backdrop of much higher mortgage rates. No prizes for guessing where the economy is headed, with the RBNZ determined to drive the economy into recession, a feature not a bug of the current policy stance. The performance of services index fell to 53.7, held up recently by the COVID-related reopening and boost to tourism, but it’s only a matter of time before it heads into contractionary territory below 50.

It was a quiet session for the domestic rates market, with yields about 3-4bps lower across the NZGB and swaps curves, unwinding some of the recent underperformance on a cross market basis.  The fall in rates went against the rise in Australian rates, supporting a 10bps narrowing in the NZ-Australian 10-year rate spread.

On the calendar ahead, the ANZ business outlook survey is expected to continue to show depressed confidence and activity indicators already at levels consistent with economic recession. As noted above the BoJ meets and little change from its ultra-easy policy stance is expected, even though current inflation is running well ahead of target. Elsewhere, only second tier data are released.

This is the last BNZ Markets Today for the year. Regular publication will resume in late-January. We thank you for your readership over the year and hope you have a good break during the festive season.