Risk sentiment soft again. Rates much lower across the UK, Europe, supporting lower US Treasury yields despite US housing starts unexpectedly surging 21.7% in May

The risk-off tone has continued into a second day supporting the USD, with weak sentiment on China driving a weaker yuan and some spillover into the NZD and AUD. Strong US housing starts and permits haven’t prevented US Treasury yields from falling against a backdrop of notable falls across Europe.

US housing starts unexpectedly surged 21.7% in May to their highest level in over a year while building permits also showed a much stronger than expected 5.2% gain. We’ve previously noted the dislocation in the US housing market, with the existing housing market dead as owners are reluctant to give up their low locked-in mortgage rates so any new buyers on the scene are “forced” into the new home market. This phenomenon will help support the US residential construction market even in the face of high mortgage rates.

The strong data only had a temporary impact on US Treasuries, with a risk-off market tone the dominating market driver. The 10-year rate opened the Asian session 6bps higher following the US long weekend, but it has been mainly downhill since then and it currently trades at 3.72%, down 10bps from the open and 7bps from the NZ close.

This move has been against a backdrop of much lower European yields, reversing by more than the lift seen over the previous session. German and French 10-year rates are down 11bps. There has been more ECB-speak with Governing Council members airing their personal views. Bank of France Governor Villeroy de Galhau remained on the dovish side of the spectrum, saying “we have done most of the path” in reference to the tightening cycle and suggesting an earlier fall in inflation to the 2% target than the official forecasts show. Reports from other GC members overnight weren’t as dovish.

UK gilts have seen an even larger move, with 2-10-year rates down 14-16bps, after their torrid run and the juicy yields on offer now enticing investors even ahead of two key risk events, UK CPI figures tonight and the BoE meeting later in the week.

Negative risk appetite can be traced to ongoing weak sentiment around China’s outlook. Chinese banks reduced their 1-year and 5-year loan prime rates by 10bps, in line with the PBoC’s rate reductions last week, although some in the market expected a slightly larger reduction in the 5-year rate which is the key benchmark for mortgages. USD/CNH is up, challenging the highs seen last week before the sharp reversal at the end of the week, and is back above 7.18.

The weaker yuan continues to be a headwind for NZD and AUD performance, and they are the two weakest currencies for the day of the key majors we follow. NZD is currently around 0.6160 while the AUD is at 0.6780. Some of the AUD’s underperformance can be traced to the RBA minutes released yesterday, which were viewed in a dovish light by the market. There was some focus on the comment that the decision to hike by 25bps was “finely balanced”. The market pared pricing for further hikes and the AUD weakened. This saw NZD/AUD trade over half a cent higher, breaking back above 0.91 overnight, but it has settled down to 0.9080.

The risk-off session accompanied by much lower global rates has helped support the yen and NZD/JPY has fallen to 87, extending the fall from the eight-year high at the end of last week to 1.7%. NZD/GBP is down to 0.4830, with the three-year low at the start of the month holding, while NZD/EUR is down to 0.5640.

The overnight GDT dairy auction showed no change for the price index and whole milk powder prices were also unchanged.

Equity markets are modestly weaker, with the S&P500 currently down 0.4% and the Euro Stoxx 600 index closed down 0.6%, with the Materials and Energy sectors at the bottom of the leaderboard for both markets, linked to the weak-China view. Oil prices are down 1-2% for the same reason. Some of the weaker equities, stronger bond market performance can be traced to early asset allocation moves ahead of month and quarter-end – the strong performance of equities over those periods leading to a reallocation of funds into the bond market.

The domestic rates market was whipped around by global forces, with higher yields on the open and subsequent falls in the wake of lower Australian yields, before heading back higher into the close. The net result was a 2-3bps lift across the bond and swaps curve. Australian 3-10-year bond futures are down 8bps in yield terms overnight, setting the scene for lower NZ rates on the open.

On the calendar tonight, UK CPI data are expected to remain strong, with the headline rate down to 8.4% and the core rate steady at 6.8%. Fed Chair Powell appears before lawmakers, facing a grilling on monetary policy, and where he will be reiterating the “hawkish pause” update last week.