Weaker than expected US core PCE deflator drives US Treasuries down 8-11bps. Spillover to European yields. Banks borrow less in aggregate from the Fed, further sign that the most acute phase of liquidity crisis is over

Last week ended on a positive note, with some market-friendly US inflation data driving US Treasury yields 8-11bps lower alongside more evidence that the most acute phase of the bank liquidity crisis was likely over. The S&P500 rose 1.4%, capping off a strong month and quarter.  The USD was stronger, perhaps reflecting month-end portfolio flows.  The NZD closed the week just over 0.6250.

Friday was packed full of economic data releases, some of them market-moving. In the afternoon, China PMI data were stronger than expected, particularly for the non-manufacturing sector, with a historically high figure of 58.2, reflecting a strong post zero-COVID bounce-back in economic activity. This sent the USD lower and commodity currencies higher, the NZD making a run towards, but not breaking, 0.63 and the AUD towards, but not breaking, 0.6740. It wasn’t long before the USD turned around and overnight month-end flows dominated, seeing the USD close the day stronger.  The NZD closed the week just over 0.6250 and the AUD at 0.6685.

CAD bucked the trend and managed a stronger close into the end of the week after data showed Canada GDP running much stronger than the Bank of Canada expected, with a 0.5% m/m lift in January and Statistics Canada estimating a 0.3% m/m lift in February.  Even a flat March would leave growth for Q1 at an annualised pace of 2.8%, compared to the BoC’s projection of just 0.5%. Further economic strength would test the BoC’s tolerance for leaving rates unchanged after opting to pause at its last meeting.

The rates market was impacted by some market-friendly US inflation data. The US core PCE deflator was slightly weaker than expected in February, at 0.3% m/m and 4.6% y/y, following the downwardly revised 0.5% m/m gain in January. The key services component excluding housing and energy services also eased to 0.3% m/m. The data were consistent with moderating inflation pressure, albeit the Fed wants to see a few more months of weaker data to be more comfortable with the inflation backdrop. Boston Fed President Collins spoke after the release and said “we still have more work to do and more to see to know that inflation is really on a sustained downward path”. Real personal spending fell 0.1% m/m in February after the strong upwardly revised 1.5% lift in January, seeing spending for Q1 overall on track for a strong rebound after recent quarters.

The weaker inflation data drove US Treasuries lower, the 2-year rate ending the day down 9bps at 4.03% and the 10-year rate down 8bps at 3.47%, the belly of the curve seeing an even greater fall, with the 5-year rate down 11bps. This spilled over into European rates, with German bunds showing the same pattern with rates down 6-9bps. The stronger USD saw EUR and GBP weaker into month-end, closing at 1.0840 and 1.2330 respectively, while JPY was well supported due to the lower global rates backdrop, seeing USD/JPY ending flat for the day at 132.80.

Euro area CPI inflation fell by more than expected to 6.9% y/y but the core figure was in line at 5.7% y/y, a fresh record high. It is the currently the core figure that is more important to the ECB in its policy deliberations, and strong inflation plays to the view of more hikes to come including a 25bps hike next month. Speaking after the figures, GC member de Galhau commented “…although we have completed most of our rate-hiking journey, we may possibly still have a little way to go…after that, we need to stay the course for as long as necessary”.

Given the recent focus on the US banking system fragility, the weekly data by the Fed have become more important releases to watch. Fed data showed $88.2b in outstanding borrowing from the Fed’s traditional discount window, down from $110.2 the previous week and $152.9b during the week of peak-distress. Outstanding borrowings at the Fed’s new emergency Bank Term Fund Programme rose from $53.7b to $64.4 over the week. The data suggested that the acute phase of the bank liquidity crisis was over, but the economic impact of tighter lending conditions remains ahead.

Commercial bank deposits fell by $126b in the week ending March 22. Deposits for small banks rose $6b after the massive $196b outflow the previous week, and large banks saw an outflow of $90b (although this could reflect a re-categorising of some of SVB’s balance sheet from a large bank to a small FDI bridge bank). In separately released data, market money funds have seen $300b of inflows in the three weeks to March 29, taking a fair chunk of the money leaving the banking system and these large flows pose an ongoing risk to the banking system.

Oil prices closed slightly higher on Friday, taking its weekly gain to 6.4% for Brent crude to just under USD80 per barrel on higher risk appetite. During the weekend, OPEC+ announced a surprise oil production cut of more than 1 million barrels per day which will set the scene for higher prices when oil resumes trading today.

In domestic news, NZ consumer confidence remained depressed with the ANZ index remaining near its record low. The rates market saw little movement across the NZGB and swaps curves out to 10-years into month-end. Since the NZ close, the Australian 3 and 10-year bond futures are down 7-8bps in yield terms, which should see lower NZ rates on the open.

With calmer conditions in markets with less concern on financial stability, the economic calendar will come back into focus this week. In the day ahead the key release will be the US ISM manufacturing index, with the consensus expecting it to remain in contractionary territory at 47.5.  Domestically there will be some interest in tomorrow’s QSBO and a 25bps hike is well priced for the RBNZ MPR on Wednesday. The RBA decision is a closer call, with economists divided between a pause and a 25bps hike, with market pricing heavily weighted to the former. At the end of the week, the US employment report will be important for US monetary policy expectations, and ahead of that the ISM Services release will also be of some interest.