Strong US payrolls and ISM services reports Friday night rock the market. Market adds another full 25bps Fed hike into the mix and sends rates much higher

Friday night’s super-strong US payrolls and ISM services reports sent markets into a tailspin and there has been some follow-through overnight, driving weaker global equity markets, higher global rates and a big rebound in the USD. The US 10-year rate is back up through 3.6% and the two-day sell-off will spill over into the domestic rates market today, from their multi-month lows recorded on Friday. The NZD has fallen nearly 3% since Friday afternoon to below 0.63.

For locals returning from the long-weekend, there has been some notable price action across markets both Friday night and, to a lesser extent, last night. Key US data released Friday were surprisingly strong and raised more questions than answers about the state of the US economy, the likelihood of recession and how the Fed should respond. As the data up-ended the prevailing narrative and caught markets offguard, there has been a significant market reaction, seeing a strong reversal of price action seen across asset markets so far this year.

The US employment report was unmistakably strong, with non-farm payrolls surging 517k in January, alongside significant upside revisions to prior data and a strong rebound in average weekly hours. Stronger employment drove the unemployment rate down to a 53-year low of 3.4%. Some might point to seasonal adjustment issues for January, but the strength of employment fits the pattern seen in the strong JOLTs report and the surprisingly lower trend for initial jobless claims over the past couple of months. It played to the theme of the US job market remaining very tight, despite the economic slowdown. Of some consolidation was that average hourly earnings growth was moderate at 0.3% m/m, as expected, seeing a slowing in annual wage inflation to 4.4%.

Soon after that release the ISM services index unexpectedly recovered strongly to 55.2, after December’s plunge. That plunge had corrected the gap with the alternative PMI services index, but with the latter only revised up slightly to 46.8, the inexplicable gap has returned. Of note, the new orders component surged 15pts to 60.4, while the prices paid series moderated further to a still-high 67.8. The data suggested that the services sector of the economy was still in reasonable shape, despite 450bps of rate hikes, and this raised the question of how quickly inflation could fall against that backdrop and how much more policy might need to tighten.

So much for the narrative that the US economy was on the verge of economic recession. The data triggered a significant market reaction, with the market moving towards the Fed’s view on rate hikes ahead, having only just moved in the opposite direction post-FOMC meeting, resulting in much higher Treasury yields. Over two trading sessions, the market has priced in a full extra 25bps hike from the Fed over coming months, with the peak rate of 5.15% now consistent with the Fed’s December projection of a peak 5-5.25% target range for the Fed Funds rate, up from the 4.90% level preceding the data. Add to that, the market’s pricing of easier policy over the second half of the year has been pared back.

The change in policy expectations has fed through into Treasury yields with the 2-year rate up 17bps for the day, adding to the 18bps lift on Friday, to 4.45%. The 10-year rate is up 11bps for the day, adding to the 13bps lift on Friday, to 3.63%.  The move has spilled over into other markets, with European yields notably higher as well, Germany’s 10-year rate up 21bps over the two sessions to 2.30%. Since the NZ close on Friday, the US 10-year rate is up 26bps, while the Australian 10-year bond future is up 15bps in yield terms.

The US-led rise in rates and the stronger US economic backdrop have driven the USD much higher, with the DXY index almost back to where it began the year. Reflecting their higher beta status, the NZD and AUD have been two of the worst performing major currencies, down in the order of 2.7-2.8% since we left the office on Friday. It was only last week that the NZD traded at a fresh 8-month high 0.6537, but all of 2023’s gain, plus some, has been wiped out and it currently trades at 0.6285, below the 0.6350 level it began the year. After trading above 0.7150 on Friday, the AUD is currently 0.6870.

Some added geopolitical tension between the US and China won’t be helping these risk-currencies, after the US shot down a Chinese spy balloon that had been moving across the country. Fears of some sort of tit-for-tat economic retaliation now overhangs the market.

JPY has been the worst of the majors, with USD/JPY heading up towards 133, and over 3% weaker over the two trading sessions.  While the much higher global rates backdrop has been ostensibly yen-negative, there was an extra kicker yesterday after a media report that Deputy Governor Amamiya had been approached to replace Kuroda as Governor. Even though he was already the hot favourite the market reacted, not liking this vote for continuity of the BoJ’s current ultra-easy policy stance. A Japanese government official refuted the report, but where there’s smoke there’s fire.

EUR, GBP and CAD have all fallen by less against the USD than the NZD, so NZD crosses are lower against these since Friday. NZD/AUD has been relatively steady around 0.9150 while NZD/JPY is up slightly to 83.5.

In equity markets, the S&P500 is currently down 0.6%, following the 1% fall on Friday, damage limited to the extent that while rates might be higher, a stronger US economy than expected is more earnings supportive. Dell Technologies became the latest US tech firm to announce big job cuts, with the company looking to cut about 6,650 roles or 5% of its workforce. The recent rise in announced job layoffs that is plain to see, being widely reported and quantitatively measured by the Challenger job layoff series, has yet to flow through into the initial jobless claims series.  This could simply reflect lagged effects, with unemployment insurance not available until severance pay has been accounted for.

In other overnight news, German factory orders rebounded by a larger than expected 3.2% m/m in December, continuing the positive economic surprise theme that has been in play for the Euro area over recent months.

The domestic rates market rallied strongly on Friday, reflecting the chunky falls in global rates seen Thursday night in response to the less hawkish ECB and BoE policy outlooks. Curves showed a flattening bias, with falls led by the long end of the curve, NZGBs down in the order of 10-15bps, the 10-year down to a fresh multi-month low of 3.92%. Swap rates were down 7-13bps, showing the same flattening bias and multi-month lows for the 2-year rate at 4.70% and the 10-year rate at 4.04%.  These rates will seem a distant memory today, as the market plays catch-up to the big overseas moves seen since the Friday close, as noted earlier.

It is an uneventful week on the economic calendar but market conditions could remain volatile on a reassessment  of economic and policy views.  This afternoon’s RBA meeting is one of the few highlights, where most economists expect a 25bps hike to 3.35%, and this is well priced by the market. The RBA was late to join the tightening cycle, rates remain low by global standards, and core inflation continues to surprise on the upside, so expect forward guidance to continue to show a bias to tighten further. Fed speakers will be on the circuit this week and first up is Chair Powell early tomorrow morning, where he has a chance to comment on the strong jobs report.