Equity markets rally strongly on Friday. Big upside surprise to German CPI sees European rates rise and push up UST 10yr. Significant offshore NZGB buying today and some buying of the NZD likely

Equity markets closed last week on a positive note, with a strong earnings report from Apple (a relief after recent disappointing results from other big tech firms) contributing to a 2.5% rally in the S&P500.  Global rates rebounded to end the week, helped by much stronger-than-expected European country-level CPI data, a reminder that central banks still have work to do get inflation under control.  The US 10-year rate ended the week back above 4% while German rates reversed their post-ECB meeting falls.  The improvement in risk appetite didn’t help the NZD and AUD on Friday, but the NZD still managed to close the week above 0.58.  NZ government bond yields experienced further sizeable falls on Friday with the market bracing for large offshore inflows into the bond market this afternoon, with NZGBs set to join the WGBI index.  WGBI inclusion may also provide a short-term boost to the NZD over the next 24 hours.

After a miserable couple of months for equity markets, October has been much more positive.  The S&P500 was up 2.5% on Friday and the NASDAQ 2.9%, taking their gains on the month to 8.8% and 5% respectively.  The S&P500 is now almost 12% off its recent lows.  Investors continue to debate whether this is merely a ‘bear market rally’, i.e. a correction from oversold levels, or whether the lows of the cycle have already been seen.  The fundamental outlook still looks challenging given the aggressive and synchronised nature of this global tightening cycle, notwithstanding recent talk that central banks might soon dial down the pace of rate hikes, and the potential for the global economy to slide into recession next year.

Helping market sentiment on Friday was a positive earnings report from Apple, which saw its share price jump almost 8% after beating analyst expectations for earnings and revenue.  The Apple results were a relief after some recent high-profile misses from other big tech names, including Meta (which crumbled 25% on Thursday night) and Amazon, which fell around 7% on Friday after producing disappointing revenue guidance for Q4.  It has been an ‘okay’ earnings season so far, with 71% of the S&P500 companies that have reported having beaten earnings expectations, below the 5-year average of 77%.

A key exception to the generally positive tone in equity markets remains China, with the CSI300 index falling 5.4% last week and the Hang Seng slumping over 8%, as investors digested President Xi’s reshuffle of his Politburo leadership team, with the consensus being that any shift to the country’s zero-Covid policy is now some way off.

While much of the talk last week was around how major central banks (Fed, ECB, BoC) might soon (or have already) dial back the pace of rate hikes, European country-level CPI data on Friday was a reminder that the inflation challenge is not over yet.  German headline CPI hit an annual rate of 11.6% in October, blowing economist expectations of 10.9% out of the water, while Italy (11.9% vs. 9.5% exp.) and France (7.1% vs. 6.5% exp.) also saw big upside surprises. Bloomberg reported that German annual inflation was now at its highest level since the early 1950s. The data sent economists scurrying to revise up their Euro area CPI forecasts (due out tonight), now expected to increase to 10.3% y/y, rather than fall back below 10% as previously thought.

The European inflation data set off a big increase in European bond rates.  The German 10-year rate increased 14bps, to 2.10%, all but reversing its falls the previous session after the ECB meeting, which was seen as less hawkish than expected (the ECB removed reference to raising rates “over the next several meetings ”, seen as a sign it was becoming more cautious about the need for further aggressive tightening).  The market is now pricing around a 50% chance of another 75bps rate hike from the ECB in December.  The US 10-year rate increased 9bps on Friday, closing the week back above the 4% mark.  The US 10-year rate was still 20bps lower on the week, as the market factored in the signalling from WSJ ‘Fed whisperer’ Timiraos, who wrote earlier in the week that the Fed was considering downshifting to a 50bps hike in December.

In other economic data, US personal spending was stronger than expected in September, rising 0.6%, with households continuing to rundown their large stockpile of savings accumulated through the pandemic (estimated to still be in the region of $1.4tn).  The Employment Cost Index showed private sector wages (ex-incentive payments) grew 1.2% in Q3, a modest step-down from the pace of the previous two quarters but still incompatible (too high) with the Fed achieving its 2% inflation target. Pending home sales continue to crater, now down 35% from their peak in October 2021, as the housing market continues to adjust to the surge in US mortgage rates (now above 7%, their highest level since 2000).  In Europe, Germany’s economy unexpectedly grew 0.3% in Q2, in contrast to expectations it would contract.

Going against the grain of global central bank tightening, the BoJ remains an outlier with its ultra-accommodative monetary policy stance.  As expected, the BoJ kept its Yield Curve Control and other policy settings unchanged on Friday.  In the press conference, Kuroda pushed back against expectations for a shift towards tightening any time soon, pointing to the BoJ’s forecasts for inflation to fall back below 2% over the next two years and saying, “at the moment we don’t see a rate hike coming or an exit from policy .”  The JPY was the weakest of the G10 currencies on Friday, with USD/JPY up almost 1% to 147.60. Despite Kuroda expressing confidence in the BoJ’s inflation forecasts, the market is much less sure.  Given the increase in underlying inflation over the past six months, investors think the BoJ will ultimately be forced into a policy U-turn over the next year.

The strong rally in equity markets on Friday didn’t do much to help the NZD and AUD, which were down 0.6% and 0.9% respectively, the NZD ending the week just above 0.58.  Still, it was a good week overall for both currencies (+1.2% and +0.5%), with the emerging narrative that central banks might be past the point of ‘peak hawkishness’ leading to firmer risk appetite and a broadly weaker USD.  The BBDXY index was down 0.8% last week.

Turning to domestic developments, monthly filled jobs increased 0.35% in September (1% over Q3 as a whole), foreshadowing what is likely to be strong employment growth in this week’s HLFS data.  We have pencilled in a 0.4% increase in employment in Q3 and a 0.2% fall in the unemployment rate, to what would be an all-time low of 3.1%, although the HLFS data can be notoriously volatile.  An unemployment rate starting with a “2” is not out of the question.

NZ rates were lower again on Friday, capping off a big week of falls right across the curve.  Swap rates were down 5-8bps on Friday and 33-37bps over the week, although we should see some reversal today given the rebound in global rates on Friday night.  The market significantly pared back RBNZ OCR expectations last week on growing expectations offshore central banks might soon scale back the pace of tightening, with expectations of the terminal OCR falling from a high of around 5.50% to around 5.10%.

New Zealand government bonds officially join the FTSE-Russell World Government Bond Index (WGBI), the major global government benchmark used by international investors, tomorrow.  The index is rebalanced, to include NZGBs, at the market close tonight, so we should see a flurry of bond buying from offshore investors which use this benchmark over the next few days.  We have previously estimated there could be $2b of offshore inflows into the NZGB market in November.  NZGB yields continue to perform very well, the 10-year yield falling another 8bps on Friday, with market participants wary of getting caught out by the expected deluge of demand.  WGBI entry should also be a short-term positive for the NZD over the next 24 hours, as those passive funds which have unhedged benchmarks will need to buy the currency.

It’s another big week offshore ahead. The Fed is expected to raise its cash rate by another 75bps on Thursday morning, taking it to 3.75%-4%. Most of the interest will centre on Powell’s comments in the press conference, particularly whether he suggests a step-down to a 50bps hike in December is the committee’s base case.  The RBA is expected to raise its cash rate by 25bps tomorrow, although markets see an outside chance (~20%) of a 50bps move given the recent large upside surprise to CPI.  The Bank of England is expected to raise its cash rate by 75bps on Thursday night, to 3%.  There is also plenty of top-tier US economic data out, with payrolls on Friday (+190k expected) and both the ISM surveys released. We should see new highs in European headline and core inflation tonight, as foreshadowed by the country-level CPI reports from Friday night.