A stronger-than-expected US PPI release on Friday set the stage for a further rebound in global rates, with the US 10-year rate rising 10bps to 3.58%. US equity markets were lower amid the higher rates backdrop while currency moves were relatively subdued in comparison. The NZD ended the week above the 0.64 mark. It’s a huge week ahead, including US CPI data and the Fed, ECB and BoE meetings, all with the potential to generate significant volatility. Domestically, NZ GDP data and the Half-Year Economic and Fiscal Update (HYEFU) take place this week too.
US PPI data isn’t usually a major market mover. However, investors were more focused on its release on Friday because, unusually, it was released ahead of the all-important CPI data this time. Both headline and core PPI were stronger than expected, with annual core PPI inflation moderating from 6.8% y/y to 6.2%, much higher than the 5.9% consensus. Core PPI is now some way below its 9.7% y/y peak from March but the higher-than-expected reading for November got the market’s nerves running that CPI could surprise on the upside this week (data released tomorrow night).
US bond yields experienced a big move higher after the PPI data, with the US 10-year rate increasing from just above 3.45% to 3.58%. The rebound in rates was led by the long end of the curve this time, possibly reflecting upcoming 10-year and 30-year supply early this week. The US 2-year rate was 4bps higher on the session, closing the week at 4.34%. Global rates were higher in sympathy, with German and UK 10-year rates 11bps and 9bps higher respectively.
Equities came under downward pressure after the PPI data, with the S&P500 and NASDAQ both falling 0.7%. After their recent strong run higher, on growing optimism that US inflation has peaked, the Fed is nearing the end of its tightening cycle, and Chinese growth should improve post the removal of Covid restrictions, last week saw a sizeable pullback in US equity markets, with the S&P500 off 3.4% and the NASDAQ 4%. Chinese equities continue to perform strongly though, the CSI300 index gaining 1% on Friday and almost 5% on the week, with the market welcoming the shift away from the zero-Covid policy and signs of more support for the beleaguered property sector.
In other economic data, the University of Michigan consumer confidence index rebounded to 59.1 in December, above market expectations but still very low levels on a historical basis. The rally in equities in November and fall in retail gas prices (-8% on the month) explain the rebound in sentiment. Consumers’ 1-year ahead inflation expectations fell to 4.6% lower, likely also reflecting lower gas prices, while 5-10yr inflation expectations remained stable at 3%.
Currency moves were relatively muted in comparison to the rates market. The DXY index was flat on the day, leaving it near its lowest level in five months. The CNY was a star performer last week, as China further loosened Covid restrictions, appreciating 1.4% on the week, with USD/CNY closing the week below the 7.0 mark for the first time since mid-September. The NZD and AUD outperformed Friday (+0.4%-0.5%) but both were broadly flat on the week, consolidating after their recent sharp moves higher. Likewise, it was a week of consolidation for the EUR, which ended the week above 1.05.
In China, the FT reported the authorities had loosened Covid testing and quarantine rules for transport workers, a move which might help ease supply chain bottlenecks (although some disruption is almost guaranteed in the short term as Covid spreads more widely). Separately, one of China’s leading health officials was quoted in Xinhua, a state media outlet, over the weekend as saying the death rate from Omicron was comparable to the flu, the latest effort among government officials and the media to shift the narrative away from fear of the Virus.
Turning to domestic developments, we finalised our pick for Q3 GDP, which is released later this week, after the release of more activity indicators on Friday. We’re now looking for a 1.3% q/q increase in GDP for the quarter (1.0% previously), albeit with larger-than-usual uncertainty around the result. Given the noisy and historic nature of the GDP data we suspect it won’t have major implications for the RBNZ. The key data the market will look at to judge whether the RBNZ will hike by 75bps at the February MPS (as its MPS projections indicate) will be CPI and labour market statistics in the New Year.
NZ rates drifted higher on Friday despite generally lower offshore rates during the local trading session. The NZ 2-year swap rate nudged 3bps higher while 5 and 10-year rates were up 4bps, the yield curve steepening marginally from its heavily inverted levels (the 2y5y swap curve is at its most inverted level since at least the early 1990s, at -72bps). The NZGB 10-year yield was 3bps higher on the session, at 4.06%, a stark underperformance compared to the 7bps fall in the Australian 10-year bond yield on the session. The 10-year NZ-AU bond spread is at 76bps, its widest levels this year, reflecting the divergent approaches to monetary policy between the RBNZ and the RBA and possibly some market nerves ahead of this week’s NZDM bond programme update (we’d expect some increase to forecast bond issuance, in part due to the government taking over Kainga Ora’s $2-3b annual funding requirement).
It should be a relatively quiet session up ahead before the fireworks kick off later this week. The all-important US CPI data are released tomorrow night, with the market looking for another 0.3% m/m reading for core inflation. Last month’s downside surprise to core inflation sparked a wave of optimism that US inflation might have peaked, leading to a pullback in Fed rate expectations and contributing to the surge in risk assets. The CPI release comes one day ahead of the December FOMC meeting at which the Fed is almost universally expected to raise its cash rate by 50bps, a step down from the recent 75bps-per-meeting pace. This would take the upper end of the target range to 4.50%. While a 50bps hike is all but a done deal, the market reaction will likely hinge on the updated interest rate projections contained in the ‘dot plot’ and Powell’s comments in the press conference. Powell recently suggested the Fed might lift its interest rate forecasts, which previously showed a peak of 4.625%, “somewhat higher” at this meeting (consensus is for a forecast peak in the region of 5%, similar to market pricing).
The ECB meeting comes on Thursday night, where the consensus among economists and market participants is that, like the Fed, it will step down to a 50bps hike, taking the deposit rate to 2%. The market is pricing an outside chance (~20%) of another 75bps hike. The market will be watching for any guidance on how much more tightening the ECB thinks might be required and any details around quantitative tightening (‘QT’) which is expected to kick off in the first half of next year. The Bank of England is also expected to raise rates 50bps next week, which would take its cash rate to 3.50%. The European PMIs (Friday night) and Australian employment data (Thursday afternoon) round off what is a huge week for markets.
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