Weaker US ADP employment and services ISM data push US Treasury yields lower. RBNZ shocks with a 50bps hike. NZ curve flattens; market sees a good chance of easier policy in the second half, when the economy is likely to be deeper in recession

US rates fell after soft ADP employment and ISM services prints. The USD strengthened, with safe-haven flows offsetting concerns about a weaker economy. The RBNZ shocked the market with larger 50bps hike, but the NZD is back down to its pre-statement level after spiking higher. The NZ curve flattened, with longer term NZGB yields lower on the day.

US economic data were softer than expected.  ADP private payrolls rose by 145k, below all surveyed estimates. The ISM services index fell by about 4pts to 51.2, with a more than 10pts drop in new orders to 52.2, and employment and prices paid indices were also lower, the latter down for the fifth straight month and giving a clear steer on weaker inflationary pressure in the sector. The data capture the initial economic impact of the bank failures and more downside can be expected, with the large fall in new orders notable.

US Treasury yields fell after the reports. While the chances of a 25bps hike at the Fed’s May meeting remained finely balanced (11bps priced), there was a more decisive pricing of easier policy over the second half of the year that dragged the 2-year rate down 6bps to 3.77%, after spiking down to as low as 3.64%. The 10-year rate is down 5bps to 3.29% after reaching a fresh seven-month low of 3.26%.

By contrast, German factory orders rose by a much stronger than expected 4.8% m/m in February, the third successive increase, a sign of a healthier manufacturing sector. The report noted the move was driven by large-scale orders for vehicles and a significant increase in domestic demand.

The S&P500 is down 0.3% with the economically sensitive sectors underperforming.  The KBW banking index is down 1%, with Western Alliance Bancorp down around 11%. The bank was down almost 20% at one stage after a filing excluded information on deposits and investors assumed the worst. The loss was pared after company reported deposits fell by “only” 11% in the first quarter, with net outflows falling sharply but “returning to normalised levels by March 17”. The Nasdaq is down over 1%.

While we have recently seen the USD weaken on softer US data and lower rates, this time the risk-off factor has dominated, and the USD has strengthened on safe haven flows.  While the USD shows broad gains, the gain in dollar indices for the day is a modest 0.3%. A stronger yen has played a part in that, supported by the lower global rates backdrop. USD/JPY has fallen towards 131, EUR fell back to around 1.09 and GBP has fallen to 1.2460.

For the NZD, the RBNZ’s policy update has been a factor in its performance. The RBNZ kept the pace of hikes at 50bps, taking the OCR to 5.25%, against a strong market consensus for a smaller 25bps hike and with the OIS market priced at +28bps. Following the recent fall in swap rates, the Bank appeared keen to prevent lending rates doing the same, and thereby opted for the larger hike, with the committee not yet confident that the level of rates was sufficient to bring inflation back into the 1-3% target range.

Despite the chance that the economy might already be in recession, the commentary on the economy read hawkish, with talk of demand continuing to outpace supply, the “strong” labour market, and near-term inflationary pressures having increased, boosted by recent severe weather events.

The Statement didn’t give any clarity on the RBNZ’s next move, with its comment that the extent of the expected moderation in domestic demand, core inflation and inflation expectations “will determine the direction of future monetary policy”.  While a strict read of that comment raised the question of whether the next move could be an easing, reading the totality of the minutes certainly didn’t imply that and the market consensus quickly shifted to the Bank’s February projection of a 5.5% peak OCR, which would be achieved by a 25bps hike next month.

The reaction in the rates market was modest despite the shock value of the Statement, with many disbelieving of the RBNZ’s view. Higher rates were led by the short-end and with significant curve flattening. The 2-year swap rate ended the day up 10bps to 5.12% but forward swaps like 1y1y were barely higher, suggesting little buy-in from the market on the Bank’s updated view that interest rates needed to be higher than what had already been priced. Mid-curve swaps were little changed, while the 10-year rate fell 2bps to 4.18%. The market sees a good chance of easier policy in the second half, when the economy is likely to be deeper in recession, with more than a full rate cut priced by November.

NZGBs continued to outperform, with rates from 6 years out lower on the day and the 10-year rate down 6bps to 4.01%. The mid-month maturity of 2023 bonds and large coupon payments will see a large jump up in index duration for NZGBs, supporting the market.

The spike up in the NZD to just under 0.6380 looked one-dimensional.  After all, a deeper recession, an increased chance of a policy overshoot and expectations of some policy reversal, are ostensibly NZD-negative. Overnight, the NZD has pared its gain to be back at the prevailing pre-Statement level around 0.6315.

NZD crosses are mostly higher on the day, with modest gains, apart from NZD/JPY weaker at 82.75.  NZD/AUD pushed up to as high as 0.9445 but has traded just below 0.94 this morning. RBA Governor Lowe gave a speech just after RBNZ update, where he explicitly noted a bias to tighten further, with the outlook determined by the flow of data. He added that it was way too early to be talking about interest rate cuts.

In the day ahead, the RBA’s Financial Stability Review might be of vague interest, while mainly second-tier global data are released apart from Canada’s employment report. While markets are closed on Easter Friday, the US employment report will be released so the market response will have to wait until Monday. A modest moderation in non-farm payrolls growth to 240k is expected, alongside a flat unemployment rate of 3.6% and a 0.3% m/m lift in average hourly earnings, seeing annual wage inflation drop to 4.3%.