US equities push higher again while US 10-year pushes up above 3%. Putin says EU gas flows will restart at 20% capacity

Italian politics have come back into the limelight overnight, with Draghi’s government on the verge of collapse after the major coalition parties withdrew their support.  Italian bonds have sold off and the EUR has come under pressure but there haven’t been any major spill overs to broader markets.  Indeed, US equities are higher on the day while the US 10-year rate has pushed up to 3.04%.  The NZD is broadly unchanged over the past 24 hours, despite the fall in the EUR.  It’s a potentially pivotal 24 hours ahead.  The ECB is set to hike rates for the first time in over ten years (the market evenly split between a 25bps hike and a 50bps move) and it is expected to formally announce its anti-fragmentation tool to support peripheral bond markets, like Italy’s, although the devil will be in the detail for the market. Putin has suggested gas flows will resume through the Nord Stream 1 pipeline tonight on schedule, albeit still at heavily reduced volumes.

Italian political ructions have taken centre stage overnight, with the government on the verge of collapse after the main coalition partners, the right-wing League and Forza Italia parties and the left-wing Five Star party, abstained in a confidence vote a short time ago. Earlier, Draghi had given markets hope, saying he was willing to continue as PM if the mishmash of coalition parties signed up to his reform agenda. But it appears the main parties would rather early elections, likely in September or October. Political uncertainty is not new in Italy, with the country having had 69 governments since 1945.

After earlier falling below 200bps, after Draghi indicated his willingness to stay on as PM, the Italy-Germany 10-year bond spread has exploded higher as early elections loom.  The 10-year spread closed at around 213bps and futures indicate it is now closer to 230bps, near recent multi-year highs.  Likewise, futures on Italy’s equity market are off more than 4%.  After a strong run over the past few days, the political uncertainty has seen the EUR has come under pressure overnight, down 0.5% to back below 1.02.

The political turmoil in Italy means tonight’s ECB meeting takes on even greater importance, particularly the details around its proposed anti-fragmentation tool, designed to support vulnerable peripheral government bond markets, like Italy’s.  The ECB faces a difficult situation, because it doesn’t want to backstop irresponsible governments, but it does want to prevent a self-reinforcing spiral in peripheral bond yields and limit any potential contagion to other countries. If the ECB ‘underdelivers’ on its anti-fragmentation tool, it is likely to put even more pressure on Italian bonds (and the EUR) and will also likely constrain market expectations of future rate hikes.  As for the ECB’s rate decision itself, the market is roughly evenly split between a 25bps hike and a 50bps move.

Also ahead tonight, the Nord Stream 1 gas pipeline is due to come back online after its annual maintenance shutdown. Putin indicated overnight that gas flows will resume as planned, however at reduced volumes, possibly 20% of the pipeline’s capacity. Gazprom has blamed technical issues around a broken turbine for the restricted gas flows, but most suspect Putin wants to keep the pressure on Europe, by not providing enough supply for countries to refill storage facilities ahead of winter. As reported in the media the previous day, the EU proposed a 15% voluntary cut in gas consumption until March to reduce the risk of power rationing over winter, as the region prepares for Russian supply disruptions.

The political shenanigans in Italy haven’t had any major spill overs to broader markets outside Europe, with US equities pushing higher again (S&P500 +0.6%, NASDAQ +1.5%) and the US 10-year Treasury yield pushing up to 3.04%, now slightly higher on the day.  Helping the tone towards tech stocks, Netflix’s earnings results yesterday were better than feared, with 970k subscribers leaving the service, around half as much as the market was expected, helping its share price to increase over 6% overnight. This comes ahead of earnings reports from some of the other big names over the next week, including Tesla after the bell this morning.

After Apple was reported earlier this week to be planning to slow hiring and spending in some parts of its business next year, Google said it would pause all hiring for two weeks as it reviews its headcount.  This follows news last week that Google was aiming to slow hiring over the rest of the year.  Google joins several other high profile tech firms that have recently announced hiring freezes or layoffs, including Tesla and Meta, and adds to the sense that the US labour market, while exceptionally tight, is losing momentum.  US equities dipped on the Google headlines but have since recovered.

UK headline inflation continues to rise, hitting 9.4% in June, slightly higher than expected.  The Bank of England expects headline inflation to reach 11% later this year after energy companies increase prices.  There wasn’t much reaction in either the GBP or UK rates, with the inflation numbers coming close to expectations and investors more focused on developments in Europe over the next 48 hours. The GBP is down around 0.2%, to 1.1970, overnight.

Meanwhile, bucking the trend of upside global inflation surprises, Canada’s headline CPI came in much lower than expected, at 8.1% y/y (8.4% exp.), still its highest level in almost 40 years.  The average of the Bank of Canada’s three core inflation measures pushed up to 5% y/y, close to market expectations.  The market reaction was short lived, with an initial fall in Canadian short-term rates quickly reversed and the CAD recovering most of its initial sell-off, now little changed on the day.

The NZD has outperformed overnight, despite the weakening in the EUR.  The NZD pushed up to around 0.6270 yesterday afternoon, its highest level in almost a month, before easing back to around 0.6230 this morning, little changed over the past 24 hours.  There haven’t been any major spill overs from the Italian political uncertainty to broader risk appetite, and by extension the NZD, at this stage.

RBA Governor Lowe’s speech yesterday contained few new insights, except that the central bank sees the neutral cash rate being “at least” 2.5%.  The key near-term influence on RBA expectations will be the Australian CPI next week.  A stronger-than-expected result, especially considering the sharp fall in the unemployment result last month, will likely see the market shift in favour of a 75bps hike next month (currently ~30% priced in).

Despite China’s economy coming under pressure from Covid flareups and associated restriction, Premier Li signalled that the authorities had no intention to turn on the taps with large-scale stimulus.  Xinhua reported Li as saying “China won’t roll out massive stimulus, issue an excessive amount of money or overdraw the future for an overly high growth target”, adding the policy response will remain targeted.  Market concerns around China’s weak growth trajectory – linked to its zero-Covid approach – have been part of the growing narrative around global recession risk.

The domestic rates market saw further curve steepening yesterday, led by another big lift in longer-term rates (10-year swap +9bps to 4.03%).  The 2y10y swap curve, which ended last week at -26bps, is back to -13bps, still inverted (and still suggesting the market thinks the RBNZ will overdo it with its tightening cycle), just less so.  Market expectations of the peak in the OCR have been relatively stable, at just above 4.1%.

It is shaping up to be an action-packed next 24 hours, with the ECB meeting taking place, the supposed restart to gas flows through the Nord Stream 1 pipeline, and likely further developments in Italian politics, with Draghi’s future as PM hanging in the balance.  The BoJ meeting also takes place tonight, with no expectations of any policy shift, the BoJ remaining an outlier among central banks in maintaining its ultra-accommodative stance.