Global rates sell-off continues as market prices in tighter US policy trajectory. NZ rates and NZD weaker after inflation expectations fall. Market homes in towards picking 50bps hike next week

The key US inflation report was in line with the consensus, but there is some impatience with how slow inflation pressures are moderating. US equities are modestly weaker and Treasury yields have risen as the market prices in a tighter policy trajectory from the Fed, continuing the theme in the lead-up to the release. Net currency moves have been modest, with the NZD spending most of the night between 0.63-0.6350, consolidating after some weakness during NZ session.

The highlight of the calendar this week, the US CPI release, showed both the headline and core measures were in line with the consensus, at 0.5% m/m% and 0.4% m/m% respectively, with the annual figures showing some modest moderation to 6.4% and 5.6% respectively.  The key core measure that strips out energy and housing rose 0.3% m/m, down from 0.4% the previous month, according to Bloomberg calculations.  The key message is that inflation pressures are gradually moderating but remain too-high for comfort. Inflation still looks a bit sticky, even if leading indicators suggest much weaker inflation.

Amidst a liquidity vacuum in the immediate aftermath of the release, the market wasn’t sure how to react to the data, causing some volatility in rates and the USD, before rates climbed much higher while the USD settled modestly higher. 

The 2-year Treasury yield is currently up 10bps for the day at 4.62%, after trading at a fresh 3-month high of 4.64%, while the 10-year rate is up 7bps to 3.77%.  With annual core inflation still running close to 5%, it seems that the Fed’s 450bps of tightening so far has made only modest inroads into driving inflation down, despite some sectors of the economy like housing clearly in recession.  Naturally, the market has become more accepting of the Fed’s view that more work needs to be done, with two more rate hikes fully priced and a growing chance of a third hike.

Speaking after the report, Richmond Fed President Barkin seemed to convey the sentiment of the market, noting that inflation was “coming down slowly” and added “I just think there’s going to be a lot more inertia, a lot more persistence to inflation than maybe we all want”. He noted that if inflation remained persistent then interest rates may need to rise higher than previously anticipated, a sentiment shared by Dallas Fed President Logan who also spoke after the release.

Of the other notable economic reports released overnight, UK labour market data showed still-strong wage inflation pressures with tight conditions, the key average earnings excluding bonuses figure providing another upside surprise and rising to 6.7% q/q in Q4 and with the unemployment rate remaining at a historically low 3.7%. Despite the economy being close to recession, fears of a wage-price spiral dynamic will keep the hawks on the BoE awake at night. While the data only had a small passing impact on GBP, UK rates were higher, with the 2-year gilt rising 18bps, a much bigger move that seen across other markets and the 10-year rate rose 12bps, with an increased chance that the BoE has more work to do.

Looking through the volatility in the immediate aftermath of the US CPI report, currency movements have been modest, with the key majors all within 0.2% against the USD overnight. The NZD has spent most of the night trading between 0.63-0.6350, with a temporary spike higher in the immediate aftermath of the US CPI release.

There was a market reaction to the softer inflation expectations print, more noticeable when looking at NZD/AUD, which gapped lower and has pushed below 0.91 overnight to 0.9080. The key 2-year ahead inflation expectations figure from the RBNZ’s survey fell 32bps to 3.30%, giving some relief that inflation expectations haven’t increased further, even if they are still at the second highest reading since 1991.

Alongside the weaker NZD, an outsized fall in short-end rates followed, breaking the massive upswing seen over the past week.  The 2-year swap rate closed the day down 9bps to 5.14%, as the market finally made up its mind that a 50bps hike next week was more likely than 75bps (OIS pricing for the meeting down 4bps to 4.83%) and about 10bps knocked out the assumed peak OCR rate, down to about 5.4%.  The long end of the curve was less affected by the data, with 5-year swap down 1bp and 10-year swap up 1bp. A similar curve steepening move was seen for NZGBs, with longer-end rates little changed amidst a 7bps fall for the 2-year rate.

Earlier in the day, REINZ housing market data continued to show a picture of depressed sales and deflation, with the fall in house prices from the November 2021 peak extending to 16.2%.  Food price inflation also showed some moderation in January, seeing the annual increase drop to “only” 10.3% (from 11.3% in December).  Rental price inflation was also weaker, adding the chance that Q1 CPI inflation will show a second consecutive quarterly downside miss relative to the RBNZ’s November projection.

It’s too early to count the cost of the devastation wrecked across a vast track of the North Island by ex-tropical cyclone Gabrielle.  But it is clear the impact will be higher inflation, an initial hit to growth due to electricity outages and weaker demand followed by stronger growth during the rebuilding phase, and considerable fiscal cost to local and central government. The lesson of past shocks for monetary policy is to not over-react, or even react, to the changed economic circumstances.

In the day ahead, soon after we go to print, NY Fed President Williams will be talking, but we don’t expect to hear anything new, given the recent barrage of Fed speakers. RBA Governor Lowe will be facing the Senate and his words will monitored carefully after last week’s more hawkish tilt on the policy outlook.

Key data releases tonight include the UK CPI and US retail sales, with the consensus picking a bounce-back in spending in January.