US monetary policy expectations reverse course. Bank collapse overshadows US employment report; strong employment but unemployment rises and wages soft

The collapse of Silicon Valley Bank, a large US bank, was a key driver of markets at the end of last week.  That event, alongside a mixed US employment growth, encouraged a significant reversal of US monetary policy pricing, driving the US 2-year Treasury yield down 28bps on Friday, with the 10-year rate down “only” 20bps. The S&P500 fell 1½% and lower US rates more than offset the impact of weaker risk appetite, seeing the USD broadly weaker. The NZD finished the week just over 0.6130, outperforming other commodity currencies to see NZD/AUD back over 0.93.

Soon after we went to print on Friday, markets took an ominous turn as focus turned to the impending collapse of the 16th largest bank in the US, Silicon Valley Bank – a bank that specialised in supporting tech startups. Some unique features of the bank – reduced deposits from struggling tech companies and a large chunk of its assets held in “safe” Treasuries due to a lack of demand for loans – made it a victim of the higher rates environment when it needed to sell Treasuries at a loss to cover demand for liquidity. The lack of its use of swaps to hedge rate interest rate risk was inexplicable. A run of deposit withdrawals made it impossible to raise fresh capital and the FDIC called time on the bank, placing it in receivership Friday night. And with that it became the first major financial casualty of the current tightening cycle, outside of companies in the cryptospace.

The threat of contagion saw a big fall in risk appetite, from Friday morning NZ time, resulting in a weak close for US equities in Thursday’s session and falling Treasury yields. Those trends persisted through the Asian trading session and US trading on Friday.  The unique features of SVB, the quick actions of the FDIC and the stronger equity positions of large US banks in the post-GFC environment suggest that a GFC-style market collapse isn’t likely. But the spotlight will be put on the small regional US banks and, given the rapid rise in global rates, only an optimist would suggest that SVB will be the only casualty this cycle. The fact that domestic US investors can buy tax-advantaged risk-free Treasury bills around 5%, well above the deposit rates offered by most banks, is an interesting pricing dynamic at present, to say the least.

The focus on SVB drew some attention away from the key economic release of the week. In the event, the US employment report was mixed with stronger than expected growth in non-farm payrolls of 311k in February, backing up the slightly downwardly revised 504k in February.  However, a lift in the participation rate and the more modest growth in employment measured by the household survey drove the unemployment rate up 2 ticks to 3.6%. Average hourly earnings rose by just 0.2% m/m, the weakest rate in a year, albeit with some likely compositional impact with stronger employment growth in the lower-paid hospitality industry.

While the labour market clearly remained tight there was no smoking gun for the Fed to upscale its rate hike path next week to 50bps.  Pricing for the meeting slipped to 33bps, suggesting the market believes that a 25bps hike is the more likely path. Probably only a much stronger than expected CPI report this week could tilt the balance towards 50bps. The ongoing fallout from a major bank collapse is another reason for the Fed to adopt a more market-friendly path.

Weaker risk appetite and a paring of rate hike expectations drove the 2-year Treasury yield down 28bps to 4.59% taking its two-day fall to a massive 48bps. The curve steepened, with the 10-year rate down a mere 20bps to 3.70%. The S&P500 fell 1½%, taking its weekly decline to 4½%, with notable weekly underperformance by banks, with the KBW bank index falling 15.7%. The VIX index closed just under 25, the highest close for the year, with the MOVE index also closing at its high for the year, consistent with the recent volatility seen in the Treasuries market.

In other news, BoJ Governor Kuroda went out with a whimper than a bang, leaving policy settings unchanged and entrusting any potential change in policy direction to the new incoming Governor Ueda. Given the outside chance of a surprise move, the yen immediately weakened, with USD/JPY peaking just under 137, before larger global forces took over, in the form of lower US rates.  These drove a strong recovery in the yen, with a gain of 1% Friday night seeing USD/JPY finish the week around 135.

UK GDP rose 0.3% m/m in January, a positive surprise that followed weak growth over Q4, raising the chance that the economy might have avoided a technical recession. PM Sunak told reporters that “the underlying fundamentals of the economy are strong”, something that most analysts would probably disagree with, including us.

Stronger than expected Canadian employment growth left the unemployment rate at a cycle low of 5.0%, against expectations for a small lift. Further strong data would challenge the BoC’s case for a pause in the tightening cycle, although the plunge in US short rates over the past two sessions has seen the market reduce the chance of any further BoC hikes this year to next to nothing. China credit growth was much stronger than expected in February, supported by the PBoC’s encouragement to banks to boost loans.

While lower US Treasury yields spilled over into other markets, the fall in US rates was greater, seeing broad-based USD weakness Friday night despite weaker risk appetite. However, currency movements were modest compared to the action seen in rates markets and equities. We noted the strong gain in the yen. This was closely followed by GBP, ending the week at 1.2030. EUR saw a more modest recovery to 1.0640.

The NZD outperformed AUD and CAD for no fundamental reason, closing the week just over 0.6130 after meeting some resistance around 0.6175. When risk appetite plunges, closing open positions can become the predominant force over fundamentals, so the moves of Friday night might signal the market was shorter the NZD than the other commodity currencies. The AUD finished on a soft note closing at 0.6580 and this saw NZD/AUD back above 0.93.

Domestic rates showed notable falls on Friday, with the tailwind from falling US Treasury yields. NZGBs fell 9bps, with slightly smaller falls for the ultra-long bonds. Swap rates were 11-12bps lower. Since the NZ close the Australian 10-year bond future is down 13bps in yield terms and the 3-year bond is down 15bps , setting the scene for lower NZ rates across the curve on the open.

NZ Q4 activity indicators released were much weaker than expected, resulting in downgrades to the GDP estimate that will be released this Thursday, with our estimate in line with the consensus looking for a 0.2% q/q contraction, well below the RBNZ’s published estimate of +0.7% q/q. The calendar this week begins on a quiet note with NZ PSI and food price indicators and little else to note.

Globally, the key release this week will be the US CPI on Tuesday night. The ECB meets and where a 50bps hike has been clearly guided. Elsewhere, US PPI and retail sales, China monthly activity data and the Australian employment report will all be closely watched.