Fed hikes 25bps as expected; softens forward guidance on future tightening. Modest market reaction; market sees Fed done after 500bps of hikes. USD broadly weaker and US Treasury yields slightly lower

The widely anticipated 25bps hike by the Fed and softer guidance on possible future tightening has resulted in only a modest market reaction. The USD was softer ahead of the meeting and those broad losses have been sustained. This sees the NZD trading around 0.6240. Lower Treasury yields ahead of the meeting have been sustained, with the 10-year rate down 3bps on the day. Strong NZ labour market data supported some curve flattening yesterday and the market now seeing the May MPS as a decision between a 25bps or 50bps hike than 0 vs 25bps.

The Fed raised its policy target range 25bps to 5-5.25% and softened forward guidance on further possible rate hikes.  It replaced language on anticipating some additional policy firming with “in determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”  The characterisation of the economy was little changed, with “job gains have been robust”, “the unemployment rate has remained low” and “inflation remains elevated”.

So the Fed kept a tightening bias, but opened the door to pausing the rate hike cycle after its 500bps of hikes to date.  Fed Chair Powell said that the Fed will make decisions meeting by meeting, based on the incoming data. Ahead of the next meeting we’ll get two more employment and CPI reports.

There was a kneejerk fall in rates and the USD immediately after the announcement but that reversed and essentially the moves seen pre-Fed have been sustained as we go to print. US Treasury yields show small falls for the day and the USD is broadly weaker, with dollar indices down 0.5%. The market sees a small chance of the Fed tightening again in June, but a strong consensus view is that the Fed is now done.  The market still anticipates that the Fed will be reversing course in the second half of the year, with over 50bps of cuts priced.

The NZD was trading around 0.6240 ahead of the Fed and as we go to print is still around that level. It is mixed on the crosses, with NZD/AUD pushing up to 0.9330, flat against EUR at 0.5640 and with modest falls against GBP and JPY. US equities are modestly higher. Of note, regional bank stocks recovered some of the previous day’s losses, with the index up around 2%.

Coming ahead of the Fed meeting, US data didn’t move the market. ADP private payrolls rose by 296k in Apr to a nine-month high, close to double market expectations, with gains in leisure and hospitality accounting for more than half of the increase. The strong pick-up in employment conflicts with other labour market measures which show a cooling market.  The figure has undershot the key non-farm payrolls figure for six of the past eight months, so the strong gain may simply just reflect some catch-up.

The ISM services index was in line with expectations at 51.9, suggesting a modest pace of expansion for the services sector. The underlying series were mixed, with a fall in business activity and a lift in new orders of roughly equal magnitude, slight slippage in the employment index to 50.8 and prices paid little changed at 59.6, still tracking below its 5-year average.

Yesterday, NZ labour market data were mixed. The key message we took was that very strong net migration was allowing firms to fill positions, resulting in strong employment growth.  But the large increase in the labour force kept the unemployment rate unchanged at 3.4%. It conveyed a stronger labour market than expected, but the key private sector labour cost index rose by “only” 0.9% q/q, two-tenths less than expected. Still, that figure needs to be closer to 0.5% for the RBNZ to achieve its inflation target and the annual lift was 4.5% y/y, a fresh high for the cycle.

The market focused on the more hawkish features of the report, pushing up rates across the curve. Pricing for the May MPS rose 5bps, taking it to 5.525%, implying a full 25bps and, for the first time since the shocking 50bps hike in early April, a small chance of a follow-up 50bps hike. After being marked as low as 5.07% as global forces sent rates lower on the open, the 2-year swap rate closed up 5bps for the day at 5.16%. There was significant curve flattening, with the 10-year rate down 3bps to 4.19%, seeing the 2s10s spread close around minus 98bps, a similar scale of inversion seen during the GFC.

NZGBs traded heavy compared to swap, ahead of the tender today, with the 10-year rate little changed at 4.13% and a 3bps lift in rates for the ultra-long bonds.

In the day ahead, focus turns to the ECB tonight, where a 25bps hike is widely expected and fully priced, alongside guidance of higher rates to come. There are a number of second-tier global economic releases, with US jobless claims the pick of the bunch.