Fed Governor Waller tempered expectations for a September hike. US equities rallied. The US dollar weakened broadly, while the yen led gains on firmer expectations of BoJ tightening

US equity markets gained while US treasury yields declined after Fed Governor Waller struck a balanced tone on the monetary policy outlook ahead of next week’s August inflation data. The S&P 500 rose more than 1% in a broad-based rally, with almost all sectors higher on the day. The US dollar weakened against G10 currencies, with the yen the largest mover, extending recent gains after the hawkish comments from a Bank of Japan board member. Brent crude was steady near US$95 per barrel.

Governor Waller said his next decision on interest rates will be “heavily influenced” by August inflation data due next week. He said would consider a rate hike if inflation comes in hot but is willing to support holding the policy rate at its current level if there is continued progress toward the 2% goal. Waller expects the August inflation data to come in at a “reasonable” level and said recent data suggest some signs of disinflation, with price pressures showing signs of improvement.

The ISM services index rose to 55.4 in August, its highest level since February and above the consensus estimate. The survey points to resilient services activity, although its relationship with consumer spending on services has been less reliable in recent years. New orders increased to 60.9, the strongest reading in more than three years, while the prices paid index rose to 72.6, also a multi-year high. Employment remains subdued at 47.8. Separately, initial jobless claims were little changed at 206k.

The market pared expectations for Fed tightening after Waller’s comments and was little moved by the subsequent economic data. Around 13bp of tightening is priced for the September FOMC, down from 16bp ahead of Waller’s speech. The shift supported a modest rally in US Treasuries, led by shorter maturities, contributing to a steeper curve. The 10-year yield is 2bp lower at 4.75%. European bonds also gained with 10-year gilt yields falling 10bp to 5.13%, having traded to a multi-decade high earlier this this week.

The US dollar moved steadily lower in offshore trading, while the yen extended its sharp rally. USD/JPY fell below 155.50 as markets priced a greater chance of tightening at the next Bank of Japan meeting and investors remained cautious about the risk of further official action. The yen had started strengthening early Thursday after a BoJ board member raised the possibility of larger or back-to-back rate hikes. Overnight index swaps now fully price a 25bp hike at the 18 September meeting.

Outside the yen’s large gain, moves across G10 currencies were relatively modest, though consistently firmer against the US dollar. NZD/USD traded up towards 0.5890, extending its recovery from the post-RBNZ slump. The NZD was little changed on most key crosses. NZD/JPY was the clear exception, falling below 91.50 after opening the week above 94.50.

NZ rates consolidated in the local session yesterday after the previous day’s post-MPS rally. Two-year rates rose 2bp to 3.71%, while the curve flattened marginally, with 10-year rates edging 1bp lower to 4.48%. The weekly NZGB tender drew solid demand, with NZ$1.9b of bids for the NZ$450m offered. Both lines were more than four times covered, with the cross-market underperformance perhaps supporting demand. Ten-year NZGB yields ended unchanged at 4.79%.

US labour market data this evening should clarify whether July’s conflicting payrolls and unemployment signals were noise or genuine weakening. A soft August 55k payrolls print is expected, with unemployment stable at 4.1%, but Fed Chair Warsh’s Jackson Hole view that the labour market is close to full employment means weak payrolls growth could limit the dovish read-through for rates markets. CPI data week will likely be more decisive for September pricing. Labour market data is also scheduled in Canada.

Stuart Ritson is a senior Markets Strategist at BNZ Markets.