Friday, June 24, 2022

NZ-US rate spreads continue to ease

In continuation of this year’s trends, global rates continue to rise, putting pressure on equity markets, especially tech stocks. The US 10-year rate has hit a 2-year high, about 1.86%, with the market now holding a small chance at a 50 bps hike in the Fed rate in March. The NASDAQ continues to struggle, down more than 2%. The USD has benefited from a pickup in higher rates and risk aversion, taking the NZD below 0.68.

The sell-off in the global bond market continued overnight with further rise in US and European rates. The US 2-year rate broke above 1% in Tokyo yesterday after resuming trading after a long weekend (currently 1.04%), while the 10-year rate has risen to 1.86%. Again, there was no clear trigger or catalyst for the move, but rates seem to be following the typical historical pattern of rising Fed growth earlier in the cycle. The market is now pricing in more than four Fed hikes this year (about a 15% chance of a 5th hike), as well as a small possibility of a 50 bps Fed hike at the March meeting (about 5%). Meanwhile, the UK 10-year bond rate hit a 21/2-year high and Germany’s 10-year bond yield neared the 0% mark, up 1 bps on the day.

A further rise in oil prices may have played a part in the rate hike, adding to the already heightened inflationary pressures. Brent crude oil hit its highest level since 2014 yesterday, just above $88 a barrel, setting its year-over-year increase of 12%. The market appears to have become more confident in the demand outlook, with O’Micron appearing far less lethal than Delta, while holding off supply growth from OPEC+. Meanwhile, supply disruptions in Libya and drone strikes near oil facilities in the UAE have heightened supply fears. Goldman Sachs raised its forecast overnight, now calling for oil prices to hit $100 a barrel next year.

Equity markets have remained under pressure amid continuous hike in global rates. Interest rate-sensitive tech stocks continue to outperform, with the NASDAQ down more than 2% overnight, reducing its year-over-year performance to -5.8%. The S&P500 is down 1.7%, with a surprising leading drop in the financial sector. Banks are generally viewed as beneficiaries of higher rates and a steeper curve, but this has been overshadowed by disappointing overnight earnings from Goldman Sachs, especially in terms of trading revenue. Goldman’s stock price is down more than 8% after JPM’s similarly disappointing results last week.

Against the backdrop of higher US rates and weak equity markets, the USD is broadly strong. BBDXY is up 0.5% on the day and is now flat year-on-year. A puzzle earlier this year was easing weakness in the USD with increased expectations of a Fed rate hike and increased risk aversion, both of which would generally be expected to help the USD appreciate. Heavy USD long positions could be part of the explanation, although price action over the past few days suggests that the correlation is not yet completely broken.

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The EUR is down 0.75% to 1.1325, while the NZD and AUD are both up around 0.6% over the past 24 hours, with the NZD falling to around 0.6750 near its lowest level for the year. A strong global dairy trade auction overnight, the overall price index up 4.6% and the price of whole milk powder up 5.6% at a 7-month high of $4,082, did not provide much support to the NZD.

The JPY has outperformed overnight (widely unchanged on the day despite a stronger USD), the pickup in risk aversion appears to be outweighed by the impact of higher US rates. In yesterday’s policy update, the BoJ raised its inflation forecast slightly and upgraded its risk assessment of the inflation outlook to “balanced” for the first time since 2014. Governor Kuroda dismissed speculation of an early end to his provocative settings, saying that “Raising rates is unthinkable,

Overnight the economic data has been mixed and not the major driver of the markets. The New York Fed’s Empire Manufacturing Survey was very weak, with its headline index falling to its lowest level since mid-2020. The Omicron wave in January may have dampened optimism, but forward-looking measures were more positive, with the capital expenditure index reaching its highest level since 2006. Similar positivity about the future was observed in the German ZEW survey, which reported rapid growth. Expectations. In the UK, payroll employment rose by 184k stronger than expected in December, while the unemployment rate dipped to 4.1%, indicating a tighter UK labor market.

China reported two more new Omicron cases in Beijing, with a separate case from Delta. Markets are concerned about the potential repercussions for growth (and the global supply chain) if China needs to widen its sanctions to eliminate Omicron in the weeks before the Winter Olympics. On a more optimistic note, African researchers reported that vaccinated people who caught Omicron were much less likely to be infected with Delta afterward, suggesting the researchers could mean that COVID-19 is less disruptive.

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A day after cutting its two policy rates by 10bps, the PBOC deputy governor confirmed that the PBOC is now in an easing cycle, saying that “Widen the monetary policy toolbox, maintain a stable overall money supply and avoid credit collapse”, The CNY rose to a three-and-a-half-year high yesterday, despite China’s global easing of monetary policy adoption, although it has given back its gains overnight.

Turning to local development, yesterday’s QSBO business survey highlighted acute inflationary pressures and skills shortages currently in the economy. Net 52% of businesses reported that they raised prices in the fourth quarter, with 65% saying they intend to do so in the quarter, pointing to the risk that CPI inflation will be higher and/or later than we currently see. higher than expected (we’ve penciled in the annual inflation peak for Q4/Q1 at 5.7%). Meanwhile, employment intentions remained very strong, pointing to a further decline in the unemployment rate with border closures and firms reporting extreme difficulty finding labor. Trading conditions, which drive activity levels, were lower in the fourth quarter, suggesting a cautious outlook on near-term GDP. Meanwhile, REINZ housing data showed a modest 0.5% seasonally adjusted decline (+21.5% y/y) in home prices in December as the housing market shows further signs of losing momentum.

NZ rates continue to outperform other markets, particularly the US. The NZ 10-year swap rate fell by 4bps to 2.77% yesterday, despite US rates pushing their moves higher. The 10-year spread in swaps has come down nearly 20bps year-on-year to 87bps. The spread compression this year primarily reflects the more bullish rhetoric coming out of the Fed, but also, to an extent, the fact that the NZ market entered 2022 with a much tighter tightening of the curve than the US.

Ahead of next week’s Bank of Canada policy meeting, the Canadian CPI, released tonight, expects headline inflation to hit a new cycle high of 4.8% y/y. The market now has a nearly 70% chance of a rate hike by the Bank of Canada next week, which will become the fourth developed market central bank after RBNZ, BOE and Norges Bank to raise rates after COVID. The UK CPI, also released tonight, expects headline inflation to reach 5.2% y/y.

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Nation World News Desk
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