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US Fed Chair Powell signals high rates for longer due to persistent inflation. 2-year US treasury yields reach 5%, the highest level since November. China set a weaker than expected daily yuan reference rate hurting commodity currencies

Currencies / analysis
US Fed Chair Powell signals high rates for longer due to persistent inflation. 2-year US treasury yields reach 5%, the highest level since November. China set a weaker than expected daily yuan reference rate hurting commodity currencies
Jerome Powell making a point

Global bond market remained under pressure. US treasuries yields made fresh highs for the year which constrained equity market performance. The S&P was marginally lower in early afternoon trade, with limited rebound from recent weakness, despite trading at one-month lows. The VIX gauge of US stock market volatility remained elevated reflecting the uncertain geopolitical backdrop. In currency markets, the US dollar was confined to a choppy range. Asian currencies were in focus after the PBOC set a weaker daily reference rate for the yuan and the yen was volatile amid intervention concerns.

Fed Chair Powell, who was speaking on a panel in Washington, said recent data shows a ‘lack of further progress on inflation’. He also commented it will take longer to gain confidence on inflation and it is appropriate to let policy take further time to work. His comments align with recent Fed speakers who observed that, while there has been considerable progress in lowering inflation, the task of sustainably restoring 2% inflation is not done yet.

US 2-year treasury yields, which had been steadily moving higher, reached 5% after Powell’s comments. This is the highest level since November, as the market reflects rates remaining higher for longer, due to robust activity and persistent inflation. The market is pricing less than 40bps of Fed rate cuts for this year. Housing market and industrial production, which was in line with consensus estimates, had limited impact. 10-year treasuries increased 6bps to 4.66%.

China Q1 GDP beat expectations with a 5.3% y/y expansion. Separately monthly activity data for March were mixed. March industrial production and retail sales undershot median forecasts while fixed asset investment expanded faster than expected. Consumption remains soft with limited evidence of a shift in reliance away from investment as a source of growth. Policymakers are attempting to support domestic demand as the economy grapples with a property crisis.

The PBOC set a weaker daily reference rate, after a period of stability, suggesting there is some flexibility for the Yuan to depreciate in line with regional currencies in response to the stronger US dollar. After the weaker fix, Bloomberg reported that Chinese state banks sold USD/CNY to limit dollar gains. The weaker yuan and general soft risk tone weighed on the Asian currencies including the NZD.

UK unemployment rose to 4.2%, a six-month high, in the three months to February. This was up from 3.9% in the previous 3-month period and higher than the 4% median estimate. One thing to note is the UK Office for National Statistics continues to warn of increased volatility in its data due to smaller survey samples. Meanwhile wages grew at a 6.0% annual rate in March, faster than expected.

The US dollar was broadly stable in offshore trade. The dollar index traded to the session highs as 2-year treasuries yields reached 5%. The yen remained weak with USD/JPY approaching 155. Intra-session volatility was high – USD/JPY dropped close to a big-figure in a matter of seconds before rebounding - with traders on edge given potential for intervention. The Canadian dollar weakened after core inflation measures came in softer than expected. NZD/USD was range bound overnight. The NZD was unable to recover meaningfully from the yuan driven weakness yesterday and remains close to the lows for the year.

NZ fixed income yields moved higher in the local session yesterday reflecting moves in offshore markets with 10-year NZGBs matching the move in Australia. 10-year NZGBs increased 8bps to 4.89%, levels just below the 2024 high reached in mid-February. Swaps matched the moves in bonds and the 2y10y curve steepened 3bps to -39bps. Australian 10-year bond futures are 3bps higher in yield overnight, suggesting an upward bias for NZ yields on the open.

In the day ahead, Q1 CPI is the key domestic release. After the March inflation partials were released on Friday, we have revised down our forecast for Q1 headline CPI to 0.6% q/q and 3.9% on an annual basis. While this is above the RBNZ forecasts (0.4% q/q and 3.8% y/y), the Bank noted recent price increases are mostly due to volatile components at the April Monetary Policy Review. UK CPI data for March is expected to fall further, aided by base effects.

[chart;daily exchange rates]

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This is a true "between a rock and a hard place" for the RBNZ. 

NZ economy stalling and the US booming. If they drop our rate to try get things going again the already weak NZD will drop like a stone, if they don't things will stall further locally.

If I was a betting man I'd think Adrian will give us a 0.25 decrease in the next review or so, but only to give a bit of confidence, don't expect any large drops this year while the US party continues.