Little progress on US debt ceiling negotiations. A number of China concerns in the spotlight, and a big upside miss for UK CPI inflation. AUD hits a fresh low for the year but NZD/AUD still down 1.3% to 93.3 AUc

Risk appetite weakened overnight on a number of concerns. Lack of progress on debt ceiling negotiations and a much stronger than expected UK CPI inflation haven’t helped, seeing short-end gilt yields trade significantly higher. Global equities are much weaker, US Treasury rates are little changed and the USD is broadly stronger. The combination of global forces and a much more dovish RBNZ policy outlook than expected have driven the NZD significantly lower to 0.61.

A wall of worry is facing markets today, with little progress on US debt ceiling negotiations, China’s headwinds in the spotlight, UK CPI data shocking to the upside and technical factors such as the clear rejection of the 4200 level on the S&P500. That index is down 0.8%, following a 1.8% plunge in the Euro Stoxx 600 index and China’s CSI300 index closing down 1.4%, only slightly above its low for the year.

The political impasse over US debt ceiling negotiations continues and US Treasury Secretary Yellen is giving daily reminders to the negotiators that the government could run out of cash as soon as 1 June. As far as we can tell the two sides are still far apart and the best-case scenario looks like a last-minute extension to the debt ceiling that kicks the can down the road for a few months. Yields on T-bills maturing 1 June surged past 7% on fears that there won’t be enough cash on the day to redeem.

China has been getting more focus of late, after the run of weaker than expected data through May, suggesting weaker growth momentum following the initial boost proceeding its reopening after abandoning its zero-COVID policy. And on that note, a fresh wave of COVID looks to be sweeping the country.  Debt concerns have also returned with local government financing vehicles facing pressure – an after-hours last-minute payment by one LGFV saw it narrowly avoiding becoming the first one to default. One might also add US-China geopolitical risks to the worries overhanging China.

UK CPI inflation data for April were a significant 0.5-0.6% percentage points ahead of market expectations, with the headline rate only dropping to 8.7% and the core rate lifting to 6.8%. This was the month that was meant to showcase weaker inflationary pressure as higher energy costs last year dropped out of the annual calculation, but instead the release simply highlighted just how sticky inflation was in the UK, adding to the chance of tighter monetary policy despite the sluggish growth backdrop.

Speaking after the release, BoE Governor Bailey denied that the UK was suffering from a wage-price spiral but he noted the “stickiness” of inflation. Another full rate hike was priced into the curve for this year, with the chance that the BoE might step up to a 50bps hike at the next meeting. The curve prices in another 90bps or so of hikes that would take Bank rate between 5.25-5.5% later this year. The UK gilt rose 23bps to 4.33% and the 10-year rate rose 6bps to 4.21% after trading as high as 4.37% on the open.

Germany’s IFO survey was weaker than expected, with the business outlook deteriorating for the first time since October, with IFO’s President noting that “the mood in the German economy has taken a significant hit”.

Higher UK rates spilled over into US Treasuries in early trading. While the US 2-year rate traded a 15bps range, the net result has been little change. The 10-year Treasury rate has traded between 3.66-3.74% and is currently barely higher at 3.71%.

Fed Governor Waller, who sits at the more hawkish end of the spectrum, said that he didn’t support stopping rate hikes until “we get clear evidence” that inflation is moving down towards 2%, adding “but whether we should hike or skip at the June meeting will depend on how the data come in over the next three weeks”. The FOMC minutes of the May meeting showed a divided committee over whether further interest rate increases would be necessary, but a clear majority seeing the end of the tightening cycle – “some” officials saw additional tightening as likely warranted while “several” thought it may be time to stop hiking.

In currency markets, the risk off vibe has driven broadly-based strength in the USD, although the DXY index is only up 0.3%, given muted movements in EUR, being only a touch weaker at 1.0760. Higher UK inflation and rates only had a passing positive impact on GBP and it is down 0.3% on the day to 1.2375, probably on fear that much tighter UK monetary policy can only be bad for the growth outlook.

The NZD has seen a significant fall, with the sharp loss seen after the dovish RBNZ update (see below) added to overnight by global forces. This sees the NZD down 2.3% from this time yesterday to just over 0.61, finding some support at 0.6095, just above the March low of 0.6085.  A shake-out of long positions heading into the meeting has likely exacerbated the move. The AUD moved down in sympathy but weak sentiment around China has been a contributing factor and the AUD is down about 1% to 0.6540, after trading at fresh low for the year of 0.6530.  The NZD is much weaker on all the key crosses, including a 1.3% fall in NZD/AUD to 0.9330.

The RBNZ’s 25bps hike to 5.5% was widely anticipated but what surprised the market was the RBNZ’s outlook, which was consistent with the end of the tightening cycle being reached – the MPC now “confident” that policy was restrictive enough to meet its inflation objective. The Bank wasn’t particularly perturbed by possible inflation consequences of the expansionary Budget nor the recent steep lift in net migration, two factors which had prompted the market to consider that the RBNZ would likely revise up its projected peak in the OCR. Adding to the dovish overtones, two of the seven members voted to keep policy unchanged.

With the market anticipating a higher projected OCR peak, reaction was significant, with 2-year swap down 34bps to 5.21%, 5-year swap down 19bps and 10-year swap down 12bps. NZGBs showed similar falls. While these were meaty moves, rates simply fell to where they were a week ago. With rate cuts seen as highly unlikely over the next couple of meetings, the OIS market prices some chance of a further hike but, on the basis of the RBNZ’s messaging, we’d see a high hurdle for the Bank to hike again. In the course of time the debate will move to the timing and extent of the easing cycle. The Bank projects at least 200bps of easing from late 2024, but the market anticipates a much earlier start than that, with the first full rate cut priced by early next year.

Earlier in the day, NZ real retail sales plunged 1.4% q/q in Q1, following a downwardly revised 1.0% q/q fall in Q4, adding to the evidence that the economy likely entered recession in Q4. Consumer confidence at, or below, GFC levels from early last year gave plenty of advanced warning. While the recession has yet to be officially confirmed in GDP data, of note since the economy likely entered recession the RBNZ has hiked an additional 200bps. On that basis it is hard to be positive about NZ’s economic outlook for the rest of the year.

In the day ahead, there are only second tier global releases.