Risk appetite higher - Pelosi leaves Taiwan, good US earnings reports and US ISM services index shows a surprising lift. US Treasuries curve inverts further, supported by more hawkish Fed-speak

US equities have been supported by stronger earnings reports while more hawkish Fed-speak and surprising strength in the ISM services index have pushed up Treasury yields, albeit more at short end than long end. Currency movements have been modest, but with the yen coming under pressure for a second day on higher risk appetite. A lift in NZ’s unemployment rate saw only a temporary fall in the NZD, which is now flat for the day, although NZ rates went against global forces and fell.

House Speak Pelosi has left Taiwan after vowing US support for the island in the face of China threats.  Other than some military operations over coming days surrounding the island, and some belligerent comments, China’s response has been restrained – so far.  Yesterday there were reports that China halted natural sand exports to Taiwan, an input for the construction industry, and would stop some food imports from Taiwan. Pelosi’s visit will be long remembered by China, but the market has now moved on.

So back to watching economic stuff and on that note, the US ISM services index surprisingly improved 1.4pts to a three-month high of 56.7, against expectations of a near 2pt drop.  Prior data showing a chunky fall in the PMI services index, a more volatile survey with less history, provided some poor guidance. New orders rose to just under 60 and there were signs of easing supply-side pressures and the prices paid index fell 8pts to 72.3 – overall a goldilocks report with improved activity and signalling weaker inflationary pressure.

The data caused US Treasury yields to shoot higher but only temporary. Still, the 2-year rate is up 7bps for the day to 3.12%, while the 10-year rate is up less than 1bp at 2.76%, after peaking just under 2.85%. This puts the 2s10s curve deeper into negative territory at minus 36bps, leaving those predicting a forthcoming economic recession more confident, despite the ISM indicator. There has been more Fed-speak from an array of FOMC members, and they are all on the same page showing some determination to keep lifting rates to bring inflation down to target.  US equities continue to recover, with the S&P500 index up 1.7% and the Nasdaq up 2.6% as we go to print, supported by some strong earnings reports and the ISM report.

Oil prices are down about 4% with Brent crude trading with a USD96 handle after EIA data showed rising inventories of US crude. OPEC announced a lift in supply of 100,000 barrels, a smaller increase than they have been proceeding with over recent months.

Currency markets show mainly modest movements, although higher risk appetite sees notable overnight weakness in CHF and JPY. USD/JPY is up about 1% overnight to over 134. EUR and GBP are slightly weaker while the commodity currencies are slightly stronger overnight.

Yesterday, the NZD fell in the aftermath of weaker than expected data in the Household Labour Force Survey, down some 40 pips to 0.6213 before recovering during the afternoon – the market seemingly focused on weak employment and the small lift in the unemployment rate rather than the strong wages data from the two other labour market surveys released. The currency trades at 0.6260, showing little change from this time yesterday. NZD cross movements are modest, apart from a 0.6% lift in NZD/JPY to 84.

On the detail of the labour market reports, NZ employment was weak for the third consecutive quarter, essentially flat for nine months, and this drove the unemployment rate up a tick to 3.3% compared to market expectations of a tick down or two. With the ongoing difficulty in finding labour, this reflected more of a supply than demand issue, a problem not easily rectified from the supply side but solved by raising interest rates by enough to send demand for labour careening lower.

On that note, the strength of wage inflation should keep the heat on the RBNZ to continue to raise rates. The 1.3% q/q run rate of the Labour Cost Index is more than double the 0.5% rate that is consistent with the Bank achieving the 2% inflation target mid-point. On an annual basis, average ordinary time hourly earnings rose 6.4%. While labour market data are lagging indicators, there was nothing in the data to make the RBNZ comfortable about the inflation outlook.

But paying more attention to the activity side than the wages side, the rates market reacted with a sharp fall in yields after offshore factors had earlier pushed them much higher. The OIS market now sees a 50bps hike locked in for the next meeting, and further priced out the chance of a larger move. On the day, swap rates fell 2-3bps across the curve, a remarkable performance considering they were up 9bps before the data, liquidity conditions no doubt a factor in the seemingly over-cooked market response. The 5-year NZGB yield was flat for the day, while the 10-year rate closed 2bps higher, still a significant outperformance against offshore moves.

Tonight will see the Bank of England’s policy meeting, where over two-thirds of economists surveyed by Bloomberg project a 50bps hike in the policy rate to 1.75%, while the rest are picking a smaller 25bps move. The market is more aligned to a 50bps hike (75% chance). The lack of conviction either way reflects the split committee and zig-zagging guidance of late. Some sort of market reaction looks inevitable.