Soft US data support lower Treasury yields; plays to market disbelief of Fed's projection for more rate hikes. But US equities power on up. ECB hikes 25bps, revises up inflation forecasts, gives hawkish guidance; another hike in July "very likely"

It has been another action-packed session with plenty of market-moving news to digest. The ECB delivered the expected 25bps hike with some hawkish guidance, driving European rates and EUR higher. Markets remain disbelieving of yesterday’s Fed guidance of two more rate hikes and some soft US data overnight sees US rates lower and the USD broadly weaker. NZD/USD is safely back up through 0.62 but mixed on the crosses.

As expected, the ECB hiked by 25bps, taking the deposit rate to 3.5%, taking the cumulative tightening this cycle to 400bps. The accompanying language and forecasts resulted in a hawkish market reaction.  Core CPI forecasts were revised up by more than expected, up five-tenths for 2023 and 2024 to 5.1% and 3.0% respectively, and nudged up to 2.3% in 2025, suggesting above target inflation through the next 2½ years despite the significant tightening. Armed with higher inflation forecasts, ECB President Lagarde adopted a more vocally hawkish stance, labouring the point that the ECB has more to do and would “very likely” increase rates in July.

Market pricing added in slightly more to the forward track, with a 25bps hike next month more than fully priced and a very high chance of a follow-up up move in September now priced. German rates moved higher and flatter, with 2-year rate up 11bps on the day and the 10-year rate up 5bps, while the EUR has been one of the best performing currencies overnight, up 1.3% to 1.0950.

By contrast, US rates have fallen, with 2 and 10-year Treasury rates down 4-6bps, the former now back to its pre-FOMC level after yesterday’s “hawkish pause” by the Fed while the 10-year rate at 3.73% is above 5bps lower from the pre-FOMC level. The market isn’t buying in to the Fed’s view that at least two more hikes might be appropriate this year, with the OIS market little changed in pricing in a cumulative 20bps over the next two meetings, so less than a full hike.

Supporting that view, US data released overnight were consistent with a spluttering economy. Headline retail sales and the ex-auto and gas measure rose 0.3%/0.4% m/m in May respectively, both higher than expected, but the data release included downward revisions. Pantheon Macroeconomics notes that the negative carry-over effect of the revisions into Q2 means that if sales are unchanged in June then they’ll showed an annualised contraction of 0.9% for the quarter.

Other US data showed contracting industrial production, another weak Philly Fed business survey and higher than expected initial jobless claims, sustaining the prior week’s increase to 262k rather than reversing course as widely expected. The Empire manufacturing survey has been too volatile to make sense of recently, but for the record it bounced back to +6.6 in June after -15.1 for May.

US equities continue to power on up, adding over another 1%, with the S&P500 breaking up through 4400 and with signs of the rally broadening to sectors beyond IT. US recession might be just around the corner but equity investors are partying like its 1999.

The USD is broadly weaker, fully reversing the rally it saw after the FOMC meeting and falling beyond the pre-meeting level. The key USD indices are down 0.7-0.8% for the day. The NZD has returned to the high seen pre-FOMC, meeting some resistance just shy of 0.6240. NZD/AUD is weaker at 0.9060, following the combo of weak NZ GDP data and strong Australian employment data (see below). The NZD’s notable outperformance the previous night didn’t have any fundamental underpinnings and so it’s a case of slippage against most of the key crosses.  NZD/GBP is back below 0.49 and NZD/EUR is back below 0.57.

USD/JPY broke up to a 7-month high of 141.50 before broad USD weakness saw it move back down to 140.30. Still, the yen is on the soft side of the ledger and NZD/JPY trades up around 87.5. The BoJ meets today and is widely expected to maintain its ultra-easy policy settings, which stands in stark contrast to the global policy tightening in the rest of the G7.  There is always the chance of an outside surprise by the BoJ, but the general feeling is that the next meeting in July is more likely for any policy adjustment when a new set of inflation forecasts are published.

The overnight news added to the market-moving releases we saw during NZ trading hours yesterday. The PBoC lowered the rate on its 1-year loans by 10bps to 2.65%, following the same move for the 7-day reverse repo rate earlier in the week. The move came just ahead of another dose of weaker than expected China activity data for May, with the biggest miss coming for retail sales. There are increasing reports of China looking to provide more economic stimulus. Following recent Bloomberg reports on that topic, the WSJ’s lead article is a report that “Beijing is planning major steps to revive the country’s flagging economy, including the possibility of billions of dollars in new infrastructure spending, and looser rules to encourage property investors to buy more homes”.

Australian employment growth was much stronger than expected in May at +76k, driving the unemployment rate one tick lower to 3.6%. This saw the market price in an increasing chance of a July rate hike, with 15bps now priced and two full hikes priced by October.

NZ GDP contracted for the second consecutive quarter, with activity down 0.1% q/q, in line with the consensus, after the downwardly revised 0.7% fall in Q4. Historical revisions meant that annual growth of 2.2% was four-tenths below market expectations, with an even greater miss relative to the RBNZ’s above-market estimates. The soft GDP print will add to the RBNZ’s confidence that enough tightening has taken place to drive inflation lower.

The domestic rates market had a choppy session, with rates driven down after the weak NZ GDP print before being driven higher following the strong Australian employment data. In the mix was another strong government bond tender, particularly for the longer dated bonds. The 2-year swap rate was down nearly 8bps at its low before closing the day unchanged at 5.40% while the rest of the curve was down 1bp. NZGBs showed a small flattening bias with rates down 1-3bps, and NZ-Australian rate spreads continue to grind lower, converging on 50bps for the 10-year benchmark, well down from the high around 100bps a few months ago.

REINZ data supported evidence of an end to the housing market downturn, with signs of house sales activity pushing higher from their recent trough and the house price index showing stable prices over the past few months in seasonally adjusted terms.

In the day ahead, NZ manufacturing PMI and US consumer sentiment and inflation expectations data are released and, as noted, the BoJ meeting.