Powell not seen as pushing back overly hard on the market's more dovish policy outlook. This gives market vindication to the view the tightening cycle is drawing to a close. Big rally in rates and equity markets gets extended. ECB and BofE hike +50 bps

The prevailing narrative so far this year that lower inflation will soon see an end to the global policy tightening cycle got an extra kicker over the past 24 hours, following the policy meetings of the Fed, BoE and ECB. All three central banks gave nothing to fear about that narrative and the fear of missing out on the rally has given further impetus towards lower rates and higher equity markets, with some significant movements. The USD has recovered overnight, alongside a strong yen against the lower rates backdrop, while the NZD is back in familiar territory, just under 0.65 after earlier touching a fresh 8-month high.

Soon after we went to press yesterday, the Fed delivered the expected dialled-down 25bps hike in the Fed Funds target range to 4.5-4.75% and forward guidance remained unchanged with the FOMC looking for “ongoing increases” in rates, implying more than one more hike to come. Fed Chair Powell stuck to the script and said if the economy performs as expected, he doesn’t see any rate cut occurring in 2023, continuing to run the line that rates will need to stay at a restrictive level for some time.

However, financial conditions eased as Powell spoke, with the Chair not providing much pushback to a question on the recent easing in financial conditions, nor lamenting the market’s view that policy could ease from the second half of the year.  So overall, the Chair was not as hawkish as feared, seeing equities grind higher, rates falling and the USD weakening.  By the end of it all, the market was seemingly more convinced that weaker inflation and labour market reports will see the Fed only deliver one more hike this cycle before easing later in the year.

Overnight, the Bank of England hiked its policy rate by 50bps to 4.0% in a 7-2 decision by the MPC (two members voting for no change). Updated projections showed CPI inflation falling sharply from 10.5% to “around 4%” towards the end of this year, alongside a much shallower recession than previously forecast, although inflation risks were said to be “skewed significantly to the upside”. But forward guidance on rates was softened considerably and suggested a conditional tightening bias, but also raised the chance of an imminent pause, viz “if there were to be evidence of more persistent pressure, then further tightening in monetary policy would be required”.

The market pared back policy expectations from here, bringing into play some chance of a pause at the March meeting (20bps priced) and this flowed through into the gilts market, with the 2-year rate down a hefty 25bps and the 10-year rate down 30bps.

The ECB hiked its deposit rate by 50bps to 2.5% and said it “intends” to raise it by another 50bps in March and “it will then evaluate the subsequent path of its monetary policy”. ECB President Lagarde said that risks to the growth outlook have become more balanced (previously saw negative risks), while risks to the inflation outlook were also balanced (previously saw upside risks).

The market saw this as a less hawkish outlook than expected and pared back expected further tightening, slicing about 15bps off the peak policy rate to 3.28%.  The market is prepared to run with the further 50bsp hike in March, but with about another 25bps hike priced after that. This spilled over in the bond market, with Germany’s 2-year rate down 19bps and 10-year rate down 21bps on the day. Peripheral market bonds have outperformed, with Italy’s 10-year rate down a massive 40bps.

So, after a big 24 hours capturing three key central bank meetings the market is even more convinced that the global policy tightening cycle is drawing to a close and this has fuelled another big rally in bond and equity markets. Alongside the chunky falls in UK and European rates noted, US rates are down 3-4bps, with the 2-year rate down some 15bps since pre-Fed meeting and the 10-year down closer to 10bps – the latter down to as low as 3.33%, just above the mid-January nadir that followed the squeeze post-BoJ.

The S&P500 is currently up 1½%, while the tech-heavy Nasdaq index continues to outperform, up 3%, supported by a 25% gain in Meta, although just as a feel for some of the price movements, even that strong gain for Meta only makes it the 14th best stock on the Nasdaq today.

The large falls in European rates have seen EUR and GBP underperform, down in the order of 1-1.2% overnight to just over 1.09 and 1.2230 respectively, but modest net changes from this time yesterday, which pre-dated the Fed meeting.  JPY has been well-supported against the lower global rates backdrop and USD/JPY is down to 128.50.  Of note, former Deputy Governor Nakaso – one of the leading contenders to replace Kuroda as Governor – has taken on an expanded advisory role for APEC. This raises a question mark over his likelihood of being appointed the new Governor and adds to the chance of current Deputy Governor Amamiya winning the role – seen to be more dovish than Nakaso.

The USD’s overnight recovery – despite the backdrop of stronger risk appetite – sees the NZD and AUD dragged down albeit from multi-month highs. The NZD peaked at 0.6537 but has fallen back into familiar territory just under 0.65. The AUD met some resistance just under 0.7160 and is back below 0.71. The NZD has been the top performer of the key majors over the past 24 hours and is therefore higher on all the crosses over that timeframe, even if losing some ground overnight against CAD and JPY.  NZD/AUD is over 0.9150, NZD/EUR is back comfortably above 0.59 and NZD/GBP briefly ticked over 0.53.

In economic news, which has played second fiddle to the policy meetings, US jobless claims fell for the fourth time in five weeks to 183k, the lowest since April last year. Pantheon Macroeconomics cautions about reading too much into the data, which is distorted by seasonal factors, and the surge in the Challenger job layoffs report portends a sharp lift in jobless claims, but with a lag. More importantly, productivity figures for Q4 came in stronger than expected and implied unit labour cost inflation of only 1.1% annualised, the weakest in two years, playing to the theme of weaker inflationary pressure sourced from the labour market.

Domestic rates fell significantly on the back of follow-through from Wednesday’s softer labour market report and the tailwind from lower US rates. The 2-year swap rate fell a chunky 14bps to 4.77% a fresh multi-month low, with further curve flattening, with both 5-year and 10-year swap rates down “only” 9bps. Add in strong demand at the weekly tender, and NZGBs were down 11-12bps across the curve. The further paring of RBNZ rate hike expectations sees the February meeting priced at 4.80% (so a 55bps hike priced), with the peak rate a touch below 5.25%, down 34bps from the beginning of the year. With the global bond market rally overnight and the Australian 10-year bond future down 10bps in yield since the NZ close, NZ rates are likely to gap lower on the open today.

In the day ahead, NZ consumer confidence should show a lift if the survey captures the change in Prime Minister. The US employment report is expected to show still-healthy employment growth (190k) and a nudge up in the unemployment rate, but the wages data are probably of most interest, with some moderation expected. The ISM service index will be equally important after its recent plunge to a sub-50 level and where the market expects some reversal.