Yield on the Fed sensitive US 2-year bond pierces 5%, logs fresh 16-yr high. White-hot ADP and strong ISM Services PMI adds to hawkish central bank narratives

By Stuart Talman, XE currency strategist

Risk sentiment has soured through Thursday as bond yields across the globe continue to ratchet higher on the narrative that major central banks are far from done - more monetary tightening required to cool demand to ultimately conquer persistently high inflation.

Risk assets lurch to the downside, most notably equity markets in the UK and Europe. The EURO STOXX 50, comprising 11 eurozone blue-chip companies from 11 countries fell almost 3%. Losses in the US have been less pronounced, the three major equity indices falling around 1 percent.

The year's fierce first half rally looks to be coming apart at the seams.

Pro-cyclical currencies are the laggards, although losses are by no means notable, the New Zealand and Australian dollar's each shedding around a third-of-a-percent. Importantly, both currencies have run into a technical brick wall, failing to push through respective convergence zones that contained the junction of the 100- and 200-day moving averages.

For the Kiwi, 0.6185 to 0.6200 presented as the key near-term resistance zone that needed to be cleared to confirm that NZD bulls could drive price action higher.

In choppy, see-sawing trade through the Asian afternoon and the European morning, NZDUSD looked primed to regain a foothold above 62 US cents, bid from near 0.6160 through 0.6210 before easing back to 0.6190. Another upside surge to within a pip or so of 0.6220 ended abruptly as a busy night of US data releases commenced with ADP Employment change.

Measuring the change in US non-farm private sector employment excluding the government sector, the headline ADP number reported that US companies added almost half-a-million jobs last month, easily beating the consensus estimate (497K vs 228K). The largest advance since February 2022, gains were broad based with the largest coming in service industries, notably leisure and hospitality.

The stunning result is exactly what the Fed does not desire.

It's also at odds with what is occurring in the real economy as growth continues to cool. US firms have been clear in recent surveys - hiring intentions have been dialled back as borrowing costs surge and demand softens. In addition, weekly jobless claims data continues to climb - a leading indicator of labour market stress.

The immediate reaction to the confoundingly white-hot ADP number:  US treasury yields, and the dollar ripped higher, US equities opened sharply lower. The yield on the Fed policy sensitive 2-year bond easily pierced through the 5% to mark fresh 16-year highs whilst the yield on the benchmark 10-year, traded through 4% for the first time since regional US banking stress emerged in early March.

Global bond yields have catapulted higher amidst a run of astoundingly resilient macroeconomic data, not only in the US but in other developed economies.  The UK aside, inflation data continues to pullback from cycle highs, yet the decline is far slower than central bank forecasts.

Heading into 2023, the base case was for the Fed and its peers to end their respective tightening cycles by mid-year with a short pause to be followed by rate cuts during 2H as recessionary forces significantly cool economic activity.

Instead, the most widely anticipated global recession in history has yet to materialise…..now expected to be a 2024 story.

Plunging from near 0.6220 to 0.6170 on the back of the ADP release, the Kiwi's nosedive extended following the release of Thursday's headline data point: the ISM Services PMI.

Also surprising to the upside, service sector activity for the US economy expanded at the fastest pace in four months, the index climbing from 50.3 the month prior to 53.9 (versus 51.0, expected). Its yet another data point that adds weight to the case for a Fed hike on 26 July and likely another on 20 September should the trend of upside data beats continue.

Core services inflation is the Fed's primary concern at present as unlike goods inflation, it is stickier and risks becoming entrenched. Both the ADP and ISM Services results will be a cause of concern for Jerome Powell and his FOMC colleagues.

Further NZD selling drove the Kiwi to an overnight low a couple of pips above 0.6130 before risk assets pared losses through the second half of US trade, NZDUSD improving back to 0.6160.

So, will risk assets remain under pressure into the week’s close?

The answer to that lies in this evening’s US employment report.

The headline non-farm payrolls number is expected to report 255K new jobs created through June, whilst the unemployment rate is projected to tick down from 3.7% to 3.6%. Average hourly earnings is expected at 0.3% MoM. Aside from February’s result, average hourly earnings have printed at 0.3% or 0.4% during the past 9 months.

A mix of strong headline jobs growth, a lower jobless rate and/or higher wages growth would be the catalyst for another wave of selling.

Its likely to be a lively end to the week!

A hot jobs report would push the Kiwi closer to key support at 61 US cents and sets the tone for a firmer dollar through July.

Stuart Talman is Director of Sales at XE. You can contact him here.