US Treasury yields higher after more positive vibes on US debt ceiling negotiations, a drop in initial jobless claims. NZ Budget conveys picture of loose fiscal policy, with large cash deficit, rising debt levels. S&P fires warning shot on credit rating

US Treasury yields continue to rise, with a trio of upward forces overnight.  The USD showed broadly based gains, seeing a weaker NZD. NZ rates shot higher yesterday after the Budget conveyed a continuation of easy fiscal policy, driving government debt higher and raising the chance of additional policy tightening from the RBNZ.

There have been further positive vibes to come out of the US debt ceiling negotiations, with House Speaker McCarthy saying that an agreement in principle could be reached as soon as this weekend, which could set up a House vote next week. The increased confidence has been backed up others, including White House representatives. However, these comments might all be just part of the political process and there is no evidence yet that the two sides are close.

US initial jobless claims fell a larger than expected 22k last week to 242k. The signal from the data has got messy recently after reports that Massachusetts accounted for nearly half of the previous week’s increase due to fraud, and figures for Kentucky might also include fraudulent claims. Excluding Massachusetts from the figures reverses the upward trend of recent weeks. Still, there are other leading indicators suggesting a softening labour market.

In other second-tier data, the Philadelphia Fed manufacturing index bounced a higher-than-expected 20pts in May to minus 10.4 whilst remaining at a historically low level. And US existing home sales fell 3.4% m/m in April.

Some hawkish comments by Dallas Fed President Logan got the market’s attention after she suggested that current data don’t yet justify a pause in the rate hike cycle. She said “the data in coming weeks could yet show that it is appropriate to skip a meeting…as of today, though, we aren’t there yet”. Market pricing moved to a 40% chance of a rate hike next month, well up from the near zero chance the market gave a week ago. 

The combination of the prospect of a debt ceiling agreement, drop in initial jobless claims and Logan’s comments have conspired to drive US Treasury yields higher across the board, in the order of 8-12bps with a flattening bias. This sees the 10-year rate at 3.65% and now up 27bps over the past five trading sessions. Rising rates haven’t perturbed the equity market, with the S&P500 showing a modest rise, adding to the 1.2% gain seen yesterday.

With the risk of a government debt default seemingly receding, the USD is stronger across the board, with the DXY index up 0.7% on the day, and the key majors we follow are all consistently down between 0.4-0.8% from this time yesterday, so there’s not much to say about the crosses. The NZD has found some support just over the 0.62 mark while the AUD has found some support just over 0.66.

NZD/AUD is little changed from the level prevailing pre the NZ Budget of around 0.94, so one can conclude that the Budget had no impact on the currency, despite the increased NZ rates backdrop (see below). The cross is slightly higher from the level prevailing ahead of the Australian employment report, which was weaker than expected. The report conveyed a modest softening in the labour market, with employment down 4k and the unemployment rate up two-tenths to 3.7%. The data supported the consensus view that the RBA can probably pause in June, but doesn’t rule out future rate hikes.

The NZ Budget showed a significant deterioration in the fiscal accounts compared to the half-year update, reflecting a weaker economy generating a shortfall in tax revenue, mixed in with higher spending. The accounts show larger underlying operating deficits of 1.8% of GDP for the current fiscal year and next year, while rising capex adds to the pressure on rising debt. As an arguably truer measure of the loose fiscal position, the accounts show a cash deficit (core Crown residual cash) of 7.4% of GDP in FY22, estimated to be 5.7% in current FY23 and the deficit rising to 6.5% in FY24. Net debt is projected to rise by over $20b in FY24. 

S&P fired a warning shot, noting that NZ must deliver stronger fiscal metrics than peers because of the external vulnerabilities, adding “downward pressure on the sovereign rating could eventuate if external metrics remain weak”. Twin deficits of 6.5% of GDP on the fiscal side and 9% for the current account is not a good position for a small country like NZ to be in.

Easy fiscal policy is set to work against the RBNZ’s endeavours to weaken domestic demand, adding to the chance of a higher peak OCR rate, and BNZ Economics added in an additional 25bps to its projections, now seeing two 25bps hikes taking the OCR to 5.75% in July. Domestic rates were higher across the board, with OIS pricing for August up 10bps to 5.79%, taking its gain for the week so far to 28bps.  With next week’s meeting priced at 5.55%, the market sees a 20% probability of another 50bps hike, rather than the RBNZ settling for 25bps.  The swap curve showed further flattening pressure, with the 2-year rate up 17bps on the day to 5.29% and the 10-year rate up 10bps to 4.34%.

NZGBs cheapened relative to swap, as the market digested news of the significant upward revision to the government’s bond tender programme – up by $4b to $34b for FY24, or $20b in aggregate for the four-year projection. Over the coming year, the market will be tested in terms of its ability to absorb elevated supply. To ease the pressure on the programme, NZDM will ramp up T-bills and Euro-Commercial Paper borrowings from $4.5b to $9b, and indicated some more flexibility in the tender process to better align supply and demand. Short-dated NZGBs rose 18-19bps, the 5-year rate rose 15bps and the 10-year rate rose 10bps. Australia’s 10-year bond future is up 11bps in yield terms since the NZ close, so expect significant upward pressure on rates from the open.

In the day ahead, Japan’s CPI is the pick of the bunch, expected to show core inflation continue to accelerate to fresh multi-decade highs. Second-tier releases include NZ trade, UK consumer confidence and Canadian retail sales. US Fed speakers include NY President Williams, Chair Powell and former Chair Bernanke.