There are a lot of developments to cover overnight, with US CPI and the FOMC minutes released and the ECB meeting taking place. The net effect has been lower bond yields, modestly higher equity markets, and a slightly weaker USD, suggesting the primary driver of market movements was the lower than expected US core CPI data.
US core CPI was slightly lower than expected, coming in at 0.1% in March (0.148% unrounded) and taking the year-on-year rate down to 2%. Core inflation was impacted by a sizable 1.9% fall in the volatile apparel category, likely related to a methodological change from the Statistics department, while falls in used car prices also weighed. In contrast, the heavily-weighted shelter categories (rent and owners’ equivalent rent) were strong. While the CPI data was likely affected be some one-off factors, it added to the perception that inflation in the US is contained and the Fed will not need to raise rates again this cycle.
US CPI was released at the same time as ECB Draghi commenced his press conference (see more below), and the two factors contributed to pushing global rates lower. The 10 year Treasury yield fell from 2.51% pre-CPI to 2.46% while the 10 year bund yield fell from 0% to -0.03%. The S&P500 is up 0.4% on the day.
The 10 year Treasury yield has retraced marginally over the past hour, after the release of the FOMC minutes, to sit at 2.475%. The minutes to the March meeting, in which FOMC officials lowered their interest rate projections, painted a generally constructive outlook for the economy, with most members "indicated that they did not expect the recent weakness in spending to persist beyond the first quarter.” That said, the minutes highlighted the significant uncertainties to that outlook and, as such, a “patient” approach to interest rates was appropriate. The Fed is in wait-and-see mode to see how these uncertainties resolve. There was a small reduction in Fed rate cut pricing after the minutes.
The USD has had a volatile session, and is now sitting lower on the day (by around 0.1% on the various USD indices). Likewise, the EUR has whipsawed back and forth overnight, falling from 1.1280 to 1.1230 during ECB President Draghi’s press conference, before bouncing right back to those levels over the past few hours amidst broad-based USD weakening.
At the ECB meeting, Draghi gave a more downbeat assessment of the Euro Area economy, saying that recent weakness in the economy had been “somewhat longer lasting” and that it was likely to extend into the rest of the year. The ECB reiterated that the balance of risks were to the downside. There were no policy change measures at this meeting, and the ECB keep its forward guidance, which states that rates will be on hold “at least through the end of 2019”, unchanged. However, Draghi said the ECB would evaluate measures to mitigate the effects of negative interest rates on the banking system (such as a tiering system) before the June meeting, which is seen by some as a prerequisite for extending forward guidance beyond the current “end of 2019” date. How much impact the ECB would generate from extending forward guidance into 2020, when the market prices the first (10bp) hike for late 2020, is pretty debatable, although it will be a focus for the next meeting in June, when the ECB will refresh its economic forecasts. At this stage, the ECB appears to be considering incremental policy adjustments, like an extension to forward guidance, rather than ‘big bang’ policy options, like a resumption of QE (which would require the ECB to change its self-imposed constraints, such as allowing it to own more than 33% of a single country’s government bonds).
The AUD has outperformed over the past 24 hours after RBA Deputy Governor Debelle failed to provide the dovish outlook that the market was hoping for. The AUD is up 0.7% to 0.7170, its highest level since late February. Debelle suggested that the Bank was still puzzling over the disconnect between the strong signs from Australia’s labour market and reported weakness in GDP growth in H2 2018 and the early months of 2019. Further, during Q&A, Debelle stated the heavily scrutinised tweak to the last paragraph of the post-meeting statement this month reflected that the Bank was grappling with this tension and uncertainty. A subsequent MNI article played down the chances of an imminent rate cut. In response, the market pared back the chance of a May cut to around 12%, down from 25% prior to the speech. Our NAB colleagues argue that the RBA remains on alert that it may need to reduce interest rates, but it will likely require a few more months’ data, barring an exceptionally low Q1 outcome for core CPI.
The NZD has largely mirrored the path of the AUD over the past 24 hours, but is up a lesser 0.25% to 0.6765. The NZD/AUD cross has continued to move lower, and is now at 0.9430, its lowest level since mid-January.
There was a mild reaction in the NZ swap market to the comments from Debelle, with the 2 year swap increasing 1.5bps to 1.675% and the market paring back its probability of a May rate cut to 33%. In contrast, NZGB yields increased sharply, by between 4 to 5bps across the curve. So far this month, the 10y NZ swap has risen 10bps to 2.67% while the 10 year NZGB has increased 25bps, with the scale of NZGB underperformance suggestive of heavy selling pressure in bonds.
In the session ahead, we await the EU’s decision on what Brexit extension to offer Theresa May. EU leaders are meeting at an emergency summit in Brussels as we speak. Fed Vice Chair Clarida is also speaking.
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