US core retail sales not as weak as expected; 1 yr-ahead inflation expectations surge to 4.6%; Fed's Waller urges more tightening. USD rebounds on all that; US Treasury yields higher led by the front end

On Friday, stronger than expected US data drove US rates higher and broadly-based USD strength. Stronger than expected earnings results from big banks supported the move, and outperformance of Financials against a small fall in the S&P500. The NZD reversed all the previous day’s strength, falling 1.6% Friday night to close the week just over 0.62 and it was lower on all the key crosses.

On Friday there was a strong market reaction to US data releases, in particular retail sales. The headline figure fell by a greater than expected 1.0% in March adding to the 0.2% fall in February (slightly revised higher).  But the focus was on the core (ex-autos and gas) measure, which fell by only 0.3%, a smaller fall than the 0.6% drop expected. The data painted a picture of a stronger Q1 overall, with weakness in February and March not enough to counteract the surge in January, caused by warmer weather and changing seasonal patterns.  However, the monthly pattern sets the scene for soft Q2 base effects.

Industrial production was stronger than expected at 0.4% m/m for Mar, but again weather-related effects inflated utilities production and manufacturing production contracted by 0.5%. Consumer sentiment rose 1½ points to 63.5, stronger than expected and sentiment showing no ill effects from the banking sector turmoil or a bounce-back in gas prices. The latter drove a sharp lift in year-ahead inflation expectations from 3.6% to 4.6%, unhelpful from a monetary policy perspective, while 5-10year ahead inflation expectations were steady at 2.9%.

Fed Governor Waller showed off his hawkish credentials in a speech saying, “because financial conditions have not significantly tightened, the labour market continues to be strong and quite tight, and inflation is far above target, so monetary policy needs to be tightened further”. Waller said he took no comfort from the CPI release earlier in the week, “I interpret these data as indicating that we haven’t made much progress on our inflation goal”. He repeated his view that monetary policy will need to remain tight “for a substantial period of time, and longer than markets anticipate”.

Less hawkish was Bostic, who said he favoured one more rate increase, followed by a pause.  Recall earlier in the week we heard from Goolsbee and Daly who both questioned whether further tightening would be necessary. The market wasn’t in a mood to take the dovish side of the argument, and rates rose sharply after the retail sales report and the move was sustained following the other economic releases. The 2-year Treasury yield closed up 13bps to 4.10% while the 10-year yield rose 7bps to 3.51%. Pricing for the May FOMC meeting nudged up to +20bps. European rates followed the move in Treasuries, with 10-year rates up in the order of 7-9bps.

The US earnings season kicked off with strong results from JP Morgan, Citigroup and Wells Fargo, the large banks being beneficiaries from the higher rates environment and banking sector turmoil, as they attracted deposits from the smaller banks. The microscope this week will be on the smaller regional banks and Charles Schwab, exposed to deposit outflows. The S&P500 fell 0.2%, with Financials up over 1%, going against the grain.

Fed data showed less stress in the banking system last week. Demand from banks for liquidity at the Fed’s facilities tracked lower for the fourth successive week.  Last week there was about $140b in outstanding borrowings from the traditional discount window and the newer Bank Term Funding Programme combined, down from $149b the previous week. A separate release showed a lift in both deposits and commercial bank lending for the week ending 5 April.

The USD reacted strongly to the retail sales report and subsequent data, showing a broadly based increase and the DXY index closing up 0.5% on the day to 101.55, after earlier nudging just below the February low during NZ trading hours, to 100.79, its lowest level in a year.

The NZD was the worst performer by far, for no obvious reason, and bearing in mind that risk appetite was higher. The VIX index closed at its low for the day at 17.07, just 1 tick above the February low and one has to go back to January 2022 to find the VIX at a lower level. The NZD closed the week just over 0.62, or a 1.6% drop over the Friday night session. There was another peek just below 0.62, before support kicked in at that level (yet again). The AUD fell by “only” 1.2% over the same period to close the week just over 0.67.  NZD/AUD continued to push lower, to just over 0.9250. The NZD was weaker on all the other key crosses, NZD/GBP at 0.50, NZD/EUR at 0.5650 and NZD/JPY just over 83.

The domestic rates market showed modestly higher yields across swaps and NZGBs, in the order of 3-5bps, largely a reflection of global forces. Early in the day, the manufacturing PMI fell 3.6pts to 48.1, so back in contraction territory. Meanwhile, net migration continues to surge, supported by the easing in border restrictions and a loosening of immigration rules. The figures are running well beyond what NZ experienced during prior boom phases in migration, although the data are prone to significant revisions.

The NZ PSI and food prices are released today. The latter will allow some firming up of Q1 CPI estimates, the key domestic release this week due on Thursday. The current market consensus at 1.5% implies downside risk to the RBNZ’s 1.8% q/q estimate.  Our estimates also suggest much lower non-tradeables inflation than the RBNZ projected.

Globally the focus will be on the US earnings season. Key economic releases this week include China activity data, including Q1 GDP (tomorrow), and global PMI data on Friday.