Global rates jump higher - US 10-year rate above 1.40% for first time since July. Equity markets rebound further. USD falls amidst improving risk appetite

Global bond yields have had a sharp move higher overnight, with the US 10-year rate jumping 11bps, to above 1.40%, its highest level in over two months.  Driving the moves higher in global rates has been more hawkish messaging from central banks, including the FOMC yesterday and the Bank of England overnight, which opened the door to a rate hike before the end of the year.  Equity markets have been unperturbed.  The S&P500 is up almost 1.5%, helped by some easing of concerns around the Evergrande situation.  Currencies have traded with a risk-on pattern, seeing the USD and JPY lower and the NZD back to 0.7075.

At its monetary policy meeting overnight, the Bank of England appeared to open the door to an interest rate hike before the end of the year, even if that occurred before the scheduled end to its QE bond buying programme.  The key line was that “any future initial tightening of monetary policy should be implemented by an increase in Bank Rate, even if that tightening became appropriate before the end of the existing UK government bond asset purchase programme”.  The BoE added that recent developments, principally on the inflation side, had “strengthened the case” for the “modest tightening ” projected at its August meeting, although uncertainty remained high.  The market moved to price a 15bp rate increase by February and over 50bps of tightening by the end of next year.  UK bond rates were up by a uniform 11bps from 2 to 10-year maturities, with the 10-year rate closing at its highest level since mid-2019, at 0.91%.

The US Treasury market also appears to have woken up to the hawkish messages from yesterday’s FOMC meeting, notably the upward shift in the ‘dot plot’, which showed 9 of 18 officials thought a 2022 rate hike would likely be appropriate, and Fed Chair Powell’s indication that tapering will likely be completed by the middle of next year.  The US 10-year rate broke above 1.40% overnight for the first time since mid-July, with the yield curve reversing yesterday’s flattening move in the wake of the Fed meeting.  The 10-year German rate also increased 7bps, to a 2½ month high of -0.26%.

Meanwhile, Norway’s central bank, the Norges Bank, became the first developed market central bank to raise interest rates in the post-Covid era, lifting its cash rate from 0% to 0.25% overnight, as expected, amidst a “normalizing economy”.  The Norges Bank added that a further rate increase in December was “most likely” while its updated projections incorporated the cash rate getting to around 1.25% by the end of next year.

Equity markets have been resilient to the more hawkish messaging from central banks and upward jolt to bond yields.  Following on from yesterday’s 1% increase, the S&P500 has added 1.4% overnight, led by the Energy and Financials sectors, the latter benefiting from the steepening of the yield curve (perceived as supportive of bank net interest margins).  In addition to what appears to be a return to the ‘buy the dip’ mentality in equities, some easing of concern around the Evergrande situation (see below) has supported market sentiment.  The S&P500 is now less than 2% from its all-time high, set earlier this month.  Likewise, commodities have been buoyant, with brent crude oil futures rising more than 1%, and closing at an almost 3 year high, while Singapore-listed iron ore futures have stabilised above $110.

Evergrande’s share price jumped 18% yesterday while its 2022 USD bond price increased over $3, to a still deeply distressed price of $32.70.  (Before getting too excited about Evergrande’s share price bounce, it is only back to where it was a week ago.)  Helping sentiment, Bloomberg reported that regulators had instructed Evergrande to avoid a near-term default on its USD bonds, although there’s still no word on whether it made payment on its US$83.5m coupon due yesterday, which has a one-month grace period before an event of default occurs. Meanwhile, Dow Jones reported the authorities had told local governments to “get ready for the possible storm ”, with state intervention only to take place at the last minute, if it can’t manage its way out of the situation in an orderly way.

Currency markets have moved in a risk-on fashion overnight.  The BBDXY USD index is down a chunky 0.4%, more than reversing its post-FOMC appreciation, on improving risk appetite.  The JPY (-0.4%) is the only currency to fall against the USD over the past 24 hours, with USD/JPY back above 110 amidst higher US Treasury yields.

Commodity currencies have led the charge, with the NOK up 1.1%, the NZD and CAD around 1% higher and the AUD up by 0.8% from this time yesterday.  The NZD is back to 0.7075, almost a full cent higher than where it was trading yesterday afternoon. While it is still early days, the currency market reaction to the more hawkish-than-expected Fed meeting is playing out very differently to that in June, which led to a sustained period of USD strength (and has seen the NZD trade well below our short-term fair value estimate since).

Economic data overnight hasn’t been market moving, with investors focused on central banks and the evolving Evergrande situation.  The ‘flash’ European PMIs showed declines in both manufacturing and services activity, albeit with ongoing supply-side disruption being one of the factors (more so for manufacturing).  Even after their falls in September, the European PMIs remain at high levels on a historical basis and consistent with well above-trend growth in the region.

In the domestic rates market, swap rates were down slightly yesterday, by 1-2bps, although we will see a meaningful move higher today based on overnight global moves (the yield on the Australian 10-year bond future is 10bps higher than it was when the NZ market closed yesterday).  In the local bond market, yesterday’s government bond tender saw exceptionally strong demand for the shorter maturity bond, the May-2024, which came 5bps through secondary market levels at the time and had a bid-to-cover ratio above 5x.  Shorter maturity bond yields fell 6-7bps while the 10-year yield fell 4bps, to 1.89%.  Strong offshore demand for New Zealand bonds is no surprise given the significant yield pick-up compared to other developed markets.

There isn’t much on the agenda in the session ahead.  There might be some comments from Fed Chair Powell and Vice Chair Clarida, although the message is unlikely to be much different from Thursday’s FOMC meeting.