Equities and bond yields lower overnight; markets remain volatile. Powell reiterates that Fed will kick off tightening cycle this month with a 25bps hike. Commodity prices generally stronger, although oil falls on speculation of an Iran nuclear deal

Markets remain volatile and focused on the Russia-Ukraine war.  US equities and bond yields are lower overnight, partially reversing their big moves higher yesterday, while the EUR hit a fresh 18-month low.  Wheat, corn and aluminium prices continue to push higher on supply fears although oil is slightly lower overnight on speculation of an imminent Iran nuclear deal.  The NZD remains torn between the tailwind of higher commodity prices and the headwind of weaker risk appetite.

Russia continues to make slow progress in its war against Ukraine.  Russian troops have reportedly gained control of the Southern Ukrainian city of Kherson and encircled Mariupol.  But the column of military vehicles en route to Kyiv has been repeatedly held up.  The three largest cities, including Kyiv, remain under Ukrainian control.  After speaking with Putin, French President Macron warned “the worst is still to come” in Ukraine with Russia intending to take “full control” of the country by whatever means necessary.

The EU said it was looking to remove Russia’s Most Favoured Nation status at the WTO, which would see Russian exports hit with tariffs.  Russian exports have already been disrupted by sanctions on Russian entities.

Commodity prices remain in the spotlight given the potential for supply disruptions.  Spot Brent crude oil hit almost $128 per barrel overnight although it has since given back those gains amidst speculation an Iranian nuclear deal could be close, which would help release Iranian supply to the market.  Brent crude is now down around 2% on the session.   Likewise, European natural gas futures hit an all time high of €200 before falling back to €160.  Aluminium prices hit a record high and nickel an 11-year high.  Wheat futures surged 15%, taking their gains this week alone to almost 40%, while corn futures jumped another 3%.

After yesterday’s strong rally, equity markets have pulled back overnight.  The S&P500 is down around 0.1%, with defensive sectors such as utilities and consumer staples outperforming.   The surge in oil prices and prospect of an extended Fed tightening cycle, both of which increase the risk of recession down the line, are weighing on equities.  European indices were sharply lower, by 2-4%.

In case anyone didn’t get the message yesterday, Fed Chair Powell reiterated that he would be recommending a 25bps rate hike this month, adding that “we are prepared to raise by more than that” in subsequent meetings if inflation remains elevated.  Powell said the Fed would announce its quantitative tightening (QT) plans at the upcoming meeting.  He signalled that QT would be a graduated process involving ‘caps’, like the previous period of QT in 2018 and 2019, whereby the Fed lets larger monthly amounts of bonds roll off its balance sheet over time.

Short-end US rates have been reasonably stable overnight with the market continuing to fully-price a 25bps Fed rate hike this month and six hikes in total this year.  But longer-term US rates have followed equity markets lower.  The US 10-year rate is down 2bps from yesterday, at around 1.86%.

In currencies, the EUR has hit a fresh 18-month low overnight, with the market wary of spill overs to the European economy (and ECB outlook) from Russian sanctions and the energy price shock.   The EUR is down 0.5% to around 1.1060.  Commodity currencies remain caught between the tailwind of strong commodity prices and the headwind of weaker risk appetite.  The NZD and AUD are up by 0.2% and 0.5% respectively from this time yesterday.  The NZD continues to hover just below 0.68.

A day after the Bank of Canada kicked off its tightening cycle with a 25bps hike, Governor Macklem signalled that it was appropriate to start “moving to a more normal setting for interest rates”.  Macklem didn’t say when quantitative tightening (‘QT’) would start but said its balance sheet would “shrink relatively quickly” when the Bank starts letting its bond holdings roll off.

In Germany, the Debt Management Office said sanctions were creating a scarcity of certain bonds, which had suddenly become ‘locked up’ and difficult to source. Repo rates on some bonds have reportedly traded as low as -5%, implying counterparties were willing to lend cash at deeply negative interest rates to borrow these hard-to-find bonds.  In response, the German DMO said it would increase the volume of a 2024 maturity bond by €8.5b, to be made available for counterparties to borrow.  Meanwhile, cross-currency basis swap spreads continue to normalise after their plunge at the start of the week on fears that Russian sanctions could disrupt funding markets.

In contrast to the upside surprise to the ISM Manufacturing index earlier in the week, the ISM Services index fell to a 12-month low of 56.6 in February, well below expectations of 61.1.  The index showed a modest worsening in supply chain issues, with increases in order backlogs and supplier delivery times, despite the sharp fall in Omicron cases during the month.  Meanwhile, the employment subcomponent fell below 50, its weakest level since August 2020.  More encouragingly, weekly initial jobless claims fell back to near recent lows, indicating a low level of layoffs amidst the tight job market.  In Europe, following yesterday’s upside surprise to inflation data, European unemployment rate fell to a fresh record low of 6.8%.

The domestic rates market was again volatile yesterday, following the big rebound in global rates the previous night.  The swap curve was 4-5bps higher, more than reversing the previous day’s falls.  Both 5-year and 10-year swap rates made new cycle highs, closing at 3.03% and 3.07% respectively.  There was steepening pressure on the bond curve, with a soft tender of 30-year bonds contributing to an 8bps increase at the ultra-long end.

The nonfarm payrolls report should take centre stage tonight.  The market is looking for a 415k job gain in February and a 0.1% fall in the unemployment rate, to 3.9%.  Wage growth is expected to remain strong, at 0.5% m/m.