Carnage in global bond markets; rates surge to fresh multi-decade highs. Higher oil prices, prospect of US diesel export ban, strong US and European PMI data all in the mix overnight. Equity markets weaker, but unremarkable falls

Risk sentiment has soured, with the most dramatic moves occurring in global rates markets as yields surge to fresh multi-decade highs. Higher oil prices, rising speculation that the US will ban diesel exports, and strong PMI reports have all added to the mix. Global equities are weaker and the USD is broadly stronger. The AUD has been the weakest of the majors, while the NZD has fallen to its lowest level in nearly three months, trading towards 0.5660.

The bear market in global bonds intensified overnight, with some chunky moves across the board. US Treasury yields are up 11-17bps across the curve, with the 5-year rate bearing the brunt of the sell-off, breaking above 5% for the first time since 2007 and currently up 17bps for the day. The 10-year rate traded at an overnight high of 5.13% and is currently up 16bps at 5.12%. The 30-year rate has traded as high as 5.41%. European rates have seen similar moves, with the belly of the curve showing the largest increases. The French-German 10-year spread has reached 110bps for the first time since the European debt crisis in 2012.

Investors are concerned about the prospect of higher inflation, against a backdrop of rising energy costs, mounting pressure on fiscal accounts from higher interest costs, and strong PMI reports overnight that added to the upward pressure on rates.

Trump described talks with Iran as very good and said there was a “lot of momentum” for a deal. However, Iran’s President Pezeshkian told the UN that Iran would not allow freedom of navigation through the Strait of Hormuz while sanctions and a US naval blockade remained in place. Through mediators, Iran presented the US with a formal list of conditions for restarting negotiations, including ending the naval blockade, releasing frozen assets, and accepting a Hormuz shipping route agreed with Oman. Brent crude is up over 4% for the day and trading with a USD103 handle.

Of greater concern to energy markets is speculation that the US will soon ban diesel exports. Politico reported sources indicating a planned 90-day export ban, with implementation targeted by the end of the week. Such a ban would have legal ramifications, given long-term supply contracts with overseas buyers. However, US Energy Secretary Wright said the Trump administration is working with refiners to voluntarily curb exports of US diesel as an alternative to an outright ban.

An export ban, or even reduced US exports, would have global ramifications, including making it more difficult and expensive for NZ to acquire diesel. Europe is also exposed, and the market now prices in four full rate hikes by the ECB through July next year. Pricing for a sequential Fed rate hike at the next meeting in late October has edged up to 18bps. Fed Governor Barr said further interest rate increases are likely needed to bring inflation down to target, echoing Chicago Fed President Goolsbee’s hawkish comments earlier this week.

Adding to the sense that financial conditions remain too easy despite higher rates, the US composite PMI surged 2.4pts to a more than five-year high of 58.4, against expectations of a dip from an already elevated level. Both the manufacturing and services components were strong. The data were accompanied by a lift in the employment index and the input price index to four-year highs. The report noted “some of the most severe supply chain bottlenecks seen in the near-two-decade survey history if the pandemic is excluded, with companies also reporting increasing problems finding suitable staff. Backlogs of work are consequently rising sharply.” The index level was consistent with growth running at an annualised rate of 5% and upward inflation pressure.

The European PMI survey was also strong, with output rising at its fastest pace in more than three years and solid expansion across both the manufacturing and services sectors. Inflationary pressures intensified in September, with both input costs and output prices increasing at their fastest rates in four months. By comparison, the UK survey was not as strong, with the key services PMI slipping to a three-month low of 51.7 and output growth consistent with the economy expanding at a quarterly pace of 0.1%.

Higher global rates have weighed on equity markets, although not as much as might have been expected given the scale of the bond market sell-off, perhaps reflecting some comfort from the strength in the PMIs. The S&P 500 is currently down 0.7%, while the Nasdaq index is down over 1% from yesterday’s record high. The Euro Stoxx 600 index closed down just 0.4%.

Against the backdrop of weaker risk sentiment, the USD is broadly stronger, with dollar indices up around ½% for the day. The AUD has been the weakest performer overnight, perhaps reflecting its exposure to higher diesel prices, and has fallen 0.9% to 0.7040. The NZD faced another day of selling pressure through local trading hours, with the move lower extending overnight and finding some support just above 0.5660. The year-to-date low just above 0.5625 will be watched as a potential support level.

CAD has been one of the better performers, reflecting its positive exposure to oil prices and seeing NZD/CAD fall below 0.80. NZD/AUD has recovered overnight to 0.8060, but the NZD is generally weaker on the other crosses.

NZ rates headed lower yesterday, riding on the coattails of lower Australian yields. Swap rates fell 3-5bps, led by the short end, while NZGB yields were also down 3-5bps. This should all be reversed today, and more, given the overnight sell-off. The Australian 10-year bond future is up 14bps in yield terms, which will set the tone when the market opens.

In the day ahead, Australian labour market data will be closely watched ahead of the expected hike next week, with the market expecting modest employment growth and the unemployment rate to remain unchanged at 4.5%. There are only second-tier global economic releases tonight, alongside more Fed speakers. There will also be some focus on the forthcoming meeting between Presidents Trump and Xi. We expect a warm embrace between the two leaders but are not holding out much hope for any significant developments.

Jason Wong is the senior Markets Strategist at BNZ Markets.