US Treasury rates have rebounded overnight, with the 10-year rate increasing 12bps, while the USD has appreciated to a fresh 20-year high on a DXY basis. Recession fears still linger, but a stronger-than-expected ISM Services survey has, at least temporarily, helped lift market sentiment. US equities are modestly higher, following decent-sized gains in Europe. The NZD has fallen back to around 0.6150 amidst a broadly stronger USD. NZ rates experienced big falls yesterday, with the market further paring back expectations for RBNZ tightening.
Market sentiment appears to have stabilised over the past 24 hours, even though recession concerns clearly haven’t gone away. Helping the mood, the ISM Services index surprised to the upside, coming in at 55.3 compared to last month’s 55.9 reading and economists’ expectations for 54. That said, this is still the lowest level of the index since mid-2020, consistent with decelerating services sector activity this year, while the employment sub-index fell into contractionary territory, at 47.4. Meanwhile the JOLTS report revealed a still-extremely tight labour market with around 1.9 job openings for every unemployed worker. Fed Chair Powell has repeatedly cited this ratio, which is near record high levels, as an indicator of the tight US labour market.
The FOMC minutes, released a short while ago, were unsurprisingly hawkish. The Fed appears set on hiking the policy rate by either 50bps or 75bps at the upcoming meeting later this month (the market prices an 80% chance of a 75bps hike) while a restrictive policy stance was seen as warranted given the strength of inflation and tightness in the labour market. Highlighting where Fed officials saw the balance of risks at present, the minutes flagged the possibility of an “even more restrictive stance” if elevated inflation pressures were to persist. While markets have quickly moved to price in Fed rate cuts in 2023, there was no sign in the minutes that the Fed is thinking of wavering from its strategy, even with a growth slowdown in train and equity markets in ‘bear market’ territory; getting inflation back to target is the key policy priority. To that point, participants “recognized that policy firming could slow the pace of economic growth for a time, but they saw the return of inflation to 2% as critical to achieving maximum employment on a sustained basis.”
After briefly falling below 2.75% overnight, its lowest level since late May, the US 10-year rate has rebounded strongly, to 2.92%, 12bps higher on the day, with most of that move occurring after the release of the ISM data. Day-to-day volatility remains extremely high. The yield curve remains under flattening pressure, with the 2y10y curve dipping back into inversion territory for the third time in the past three months. Historically, an inversion of the 2y10y yield curve has been a reliable recession indicator for the US, albeit typically with at least a 12-month lead time. Going against the grain of global bond market movements, European rates were slightly lower overnight.
US equities are showing modest gains, of around 0.8% for the S&P500 and NASDAQ, consistent with a slightly better tone to risk sentiment. But with recession concerns unlikely to ease any time soon and central banks showing no let-up in their tightening ambitions, it’s hard to see a sustained rally in equity markets. Earlier, the EuroStoxx 600 index increased 1.7%, albeit from 18-month lows.
In FX markets, the EUR remains under significant pressure as the region grapples with an unfolding energy crisis. The currency is down around 0.8% over the past 24 hours, following on from the previous day’s heavy fall, taking it to a fresh 20-year low of around 1.0180 this morning and bringing parity into closer view. European natural gas futures rose around 6% overnight, taking them to their highest close since March, and markets worry that Russia will further cut gas supplies to the continent, raising the risk of electricity rationing at some stage. The counterpart to EUR weakness has been USD strength, with the DXY index up 0.5% to a 20-year high and the broader BBDXY index hitting its highest level since the depths of the crisis in March 2020.
The GBP has performed relatively well over the past 24 hours, down just 0.1%, despite mounting pressure on Boris Johnson to resign after his latest scandal. Helping the GBP have been hawkish comments from BoE officials, with Chief Economist Pill saying he was willing to “adopt a faster pace of tightening” in August, albeit dependent on the data between now and then, and Deputy Governor Cunliffe saying the Bank “will do whatever is necessary” to contain inflation.
The NZD and AUD are modestly lower overnight amidst broad-based USD strength, the NZD falling back to around 0.6150, near two-year lows.
A day after they slumped almost 10%, oil prices have fallen again overnight, by around 2% for Brent futures. Industrial commodities remain firmly in a downtrend too, nickel and copper prices falling by 3.5% and 2% respectively overnight, the latter now 30% off its March highs. The recent fall in oil prices, alongside that of a broader range of commodities (ex-natural gas), signals growing concerns around the demand outlook amidst increasing talk of recession risk.
NZ rates experienced another huge move yesterday as the market played catch-up to the overnight falls in global rates markets. The 2-year swap rate fell 13bps, to 3.76%, its lowest level since the May MPS, with the market further trimming expectations of the peak in the OCR to around 3.80%. Only a few weeks ago, the market was pricing a peak in the OCR of 4.75%. Longer-term rates were down by even more, with an 18bps fall in the 10-year swap rate taking it down to 3.80%. Government bonds underperformed swaps, with yields down ‘only’ 6 to 11bps, ahead of today’s $400m bond tender, double the volume offered last month. The enormous rates volatility is not isolated to New Zealand; the MOVE index of US Treasury volatility is trading at its highest level the GFC, except for a brief period in early-2020. We should see NZ rates open higher this morning, reflecting the turnaround in the US Treasury market overnight.
The market’s immediate focus is on the nonfarm payrolls report on Friday night. In the session ahead Fed Governor Waller, St Louis Fed President Bullard and ECB Chief Economist Lane are all speaking while the minutes to the last ECB meeting, at which it foreshadowed a start to the tightening cycle this month, are also released. Initial jobless claims, which have been gently trending higher over recent months, are also out tonight.
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