Rising investor risk aversion impacted global markets into the end of last week amid concerns about an escalation in the conflict between Israel and Hamas and the potential for it to spread more widely. Global equities fell – the MSCI world index ended down nearly 1% - and flows into safe haven assets picked up. The VIX measure of S&P implied volatility gained the most since March, US treasury yields decreased and the US dollar index moved higher.
In commodity markets, both oil and gold surged higher. Brent crude prices increased above $90 a barrel, a daily gain of more than 5%, on concerns over potential supply disruptions should the conflict widen. This reverses some of the large fall from 1-year highs above $97 at the beginning of October attributed to slower global growth and long market positioning by speculative accounts. Gold prices moved back above $1,900 an ounce and are now 6% above the October lows.
In the US, the Michigan consumer sentiment index fell to 63.0 in October, which was below the median estimate of 67.2, and the lowest level since May. This is the third straight fall and can largely be attributed to the rise in gas prices as well as the pullback in equities. However, consumer spending has remained healthy despite weaker sentiment in recent months.
Within the Michigan survey, Five-to-10-year inflation expectations increased 0.2% to 3.0%. This is a continuation of the 2.7-to-3.1% range where this indicator has oscillated since January 2021 which is above its pre-Covid average of 2.5%. The US Federal Reserve would like to see lower inflation expectations. This measure is sensitive to the current level of inflation and the recent decline should contribute to a retracement of longer-term expectations soon.
US treasury yields moved steadily lower on Friday amid safe haven demand which unwound some of the previous days large sell-off. 10-year yields declined to a low of 4.58%, down from a session high of 4.69%, before edging higher into the close. The front end underperformed in the rally with 2-year yields ending 1bp lower at 5.05%. The 2s/10s curve flattened to -44bp, down from a recent peak in October of -28bp. European government bond yields declined aligned with the move in treasuries with 10-year bunds down 5bps to 2.73%.
Fed Bank of Philadelphia President Patrick Harker said disinflation is under way. He said that economic and financial conditions are evolving as expected, that policy rates are restrictive, and that he favours holding interest rates where they are, barring a sharp change in data. After a busy week of commentary from Fed officials, futures market pricing suggests there is little chance a rate hike at the early November meeting. This compares with a near 30% probability of a 25bp hike a week ago.
Chinese consumer prices remained flat year-on-year in September while producer prices declined 2.5% amid lingering concerns about weak demand. Both measures were marginally below consensus estimates. Data this week on industrial production, retail sales as well as Q3 GDP will provide a clearer picture of the impact from the Government’s incremental stimulus measures. The PBOC is expected to leave the medium-term lending facility rate steady at 2.5% today.
The risk-off tone was reflected in currency markets. The US dollar gained as did other haven currencies such as the Swiss franc and the Japanese Yen. EUR/CHF fell almost 1% to the lowest level this year with the franc outperforming within G10 currencies. The Canadian dollar and Norwegian krone benefited from the large gain in oil prices.
The Australasian currencies extended losses overnight Friday. NZD/USD fell close to 0.5% and closed on the weekly lows near 0.5885. The 2023 lows reached in September at 0.5860 will form key near-term support. NZD/AUD ended marginally lower at 0.9345. The general election results in the weekend, which point to National and Act forming a coalition government, subject to the counting of special votes, is unlikely to materially impact the currency or rates markets to start the week.
NZ government bonds moved higher in yield in the local session on Friday with 10-year bonds closing up 9bps at 5.44%. The front end outperformed with the 2s/10s curve steepening to -20bp. There are close to NZ$750 million of coupon payments today and there will likely be some reinvestment flows taking place. Australian 3-year and 10-year bond futures are close to 5bps lower from the local close on Friday, and combined with the move in treasuries, suggest a downward bias in NZ yields on the open.
The Performance of Services Index for September is released today. The Performance of Manufacturing Index (PMI) fell further into contractionary territory on Friday and reached the lowest level of activity for a non-COVID affected month since May 2009. The key domestic data this week will be Q3 CPI data tomorrow.
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