Strong US ISM services print. But positive sign for bond market in that Treasury yields still finished the day down 10bps, back below 4%. Equities like the combo of robust data and lower rates, S&P up 1.6%

Despite a strong US ISM services report Friday night, US Treasury yields fell, with the 10-year rate down 10bps, closing at its low for the day at 3.95%, a positive sign for the bond market that the brutal selloff might have run its course. US equities finished the week strongly. Higher risk appetite saw a broadly weaker USD, but the NZD underperformed and was flat at 0.6220, although it still ended up at the top of the leaderboard for the week.  NZ rates finished the week higher, but the bias will be for some reversal on the open this morning.

The US ISM services survey for February conveyed a picture of a robust services sector and ongoing growth. The overall index was slightly stronger than expected at 55.1, little changed from January, and with new orders rising to their highest level since November 2021 and the employment index up 4 points to its highest level in more than a year of 54.0. The prices paid index fell just over 2pts but remained high at 65.6.  The data fed the narrative that the US economy was showing little sign of being near recession and that inflationary pressures could remain sticky.

Despite the survey results, the bond market was little perturbed.  The US 10-year Treasury yield headed lower from the European open and the survey only triggered a temporary reversal of that trend, before the yield fell further and closed the day at its low – finishing at 3.95%, down 10bps on the day. The 2-year rate climbed as much as 5bps higher after the survey, before falling back to end the day at 4.86%, down 3bps.  The market reaction is a positive sign for the bond market.  While the 10-year rate was still up for the sixth week in a row, even if only 1bp, the closing yield was well down from the 4.09% peak in the previous session and suggests that the move up through 4% was perhaps a step too far.

There was plenty of Fed-speak on Friday and none of it was particularly aggressive relative to market pricing. Richmond Fed President Barkin signalled that he favoured hiking in 25bps steps from here saying “the beauty of a shallower rate increase path is if you’re wrong you’re not that far wrong”. This followed Atlanta Fed President Bostic’s comments soon after we went to print Friday, who was also in favour of moving in 25bps steps. He noted the risk around his view of two more 25bps rate hikes was that rate increases could well continue into the following meeting or two if the data continued to be strong, but he expected the Fed could be in a position by the middle of summer, late summer, to pause on rate hikes.

Going against the narrative, former Treasury Chief Larry Summers said that the Fed is behind the curve and he urged Powell to “have the door wide open to a 50bps move in March”. The market clearly favours the Fed moving in 25bps steps, with Fed Fund futures for the March meeting showing 31bps priced in, much closer to 25bps than 50bps.

The US Fed’s semi-annual monetary report to Congress published on Friday stuck to the script of the early-February FOMC meeting. Chair Powell faces lawmakers this week, where the Q&A sessions will reveal whether Powell has become more hawkish or not, following the dose of stronger than expected activity and inflation data over the past month.

Falls in European rates were more modest, with German and UK 10-year rates down in the order of 3-4bps. The move earlier in the week of the market pricing in an ECB policy rate of 4%, or 150bps of tightening from here, has seen a number of economists revise their forecasts to that level. Furthermore, the Belgian member of the ECB GC Pierre Wunsch said that market bet may prove accurate if underlying price pressures remain elevated.

The combination of lower Treasury yields and the strong ISM services survey meant a strong finish for the week for US equities, with the S&P500 up 1.6%, taking the weekly gain to 1.9%, going a long way to recovering the larger loss over the previous week. Overall, it’s fair to say that US equities have been resilient in the face of the sharp re-pricing in monetary policy expectations for the rest of 2023, with investors seeing better economic activity as a counterweight to the generally higher rates backdrop.

The higher risk appetite backdrop saw a generally weaker USD on Friday night, but the NZD underperformed – temporarily falling back below 0.62 before closing at just over 0.6220. This might have reflected some payback from its outperformance mid-week after the strong China PMI data, with the NZD ending up being the strongest of the majors for the week overall, with a 0.9% gain, although the distribution of the weekly gains against the USD was fairly tight.

Thus, while NZD crosses were flat-to-higher for the week, they were modestly lower on Friday night. The AUD closed the week at 0.6770, with NZD/AUD heading back below 0.92. NZD/GBP ended the week around 0.5170 and NZD/EUR at 0.5850. The lower rates backdrop supported the yen, with USD/JPY back below 136, and NZD/JPY at 84.5.

Earlier Friday, Tokyo CPI data were stronger than expected.  Energy subsidies kicking in for February meant the headline CPI fell to 3.4% y/y while the core measure that excludes fresh food and energy increased to a new multi-decade high of 3.2%. Governor Kuroda has one last chance to make his mark at his final BoJ meeting this week before handing over the reins. While the consensus is expecting no change in policy, the BoJ likes to surprise the market to get some bang for its buck and the meeting will be much anticipated this week.

The domestic rates market saw higher bond and swap rates on Friday, a combination of global forces and some cross-market underperformance. NZGB’s were 7-9bps higher across the curve while swaps were 3-7bps higher, both curves showing a modest steepening bias. Consumer confidence data were ignored, which showed weaker confidence in February from the jump in January, and remaining deeply depressed against a backdrop of the higher cost of living and depressed housing market. In addition to some some key global releases, the domestic market this week will be focused on the syndication of the new 2030s nominal bond.

In news over the weekend, China set an underwhelming growth target of 5% for 2023, which currently sits below the Bloomberg consensus forecast of 5.3%, the bounce-back from 2022 reflecting the post-COVID recovery. The lowball target is seen by analysts as reducing the likelihood of monetary and fiscal policy stimulus this year to drive economic growth.

In addition to the BoJ meeting later this week, the RBA is highly likely to raise its cash rate by 25bps to 3.6% tomorrow, which is well-priced and with some focus on Governor Lowe’s speech the following day for a drill down on the outlook ahead. The Bank of Canada is likely to pause its tightening cycle, as guided at its last meeting and with the dataflow unlikely to ruffle that view. We’ve noted Chair Powell’s testimony to lawmakers this week, while the employment report at the end of the week is the key global data release to watch out for. The week starts off on a quiet note, with NZ building work giving some guidance as to the construction sector’s contribution to GDP.