Another shockingly high UK CPI release has set the tone for markets overnight, driving a big increase in global bond yields and weighing on equity markets. The USD is generally stronger against a backdrop of higher rates and weaker risk sentiment, although it has pared some of its gains since the release of the FOMC minutes, which expressed some concern about the risk of the Fed overtightening. The RBNZ delivered a 50bps OCR yesterday, as expected, and nudged up its forecast OCR track to show a peak of 4.1%. There was little market reaction in either NZ rates or the NZD, although the NZD has fallen away overnight, to now below 0.63, amidst the stronger USD.
UK inflation data was much stronger than expected in July, with annual inflation cracking double digits, headline CPI inflation hitting 10.1% in July (9.8% expected). The 0.6% monthly increase in inflation, an unusually large increase for July, was driven by, among other things, higher food, airfare, and packaged holiday prices. But core inflation (which strips out food and energy price movements) was also significantly stronger than expected, at 6.2% y/y. Things are set to get worse from here, with the BoE forecasting a peak in annual headline inflation above 13% later this year, alongside five consecutive quarters of negative economic growth starting in Q4. and Citi overnight saying it expected inflation to hit 15% in Q1. Conservative leadership frontrunner Liz Truss’s idea of tax cuts to help with the cost-of-living crisis is probably only going to matter matters worse on inflation.
After a brief reprieve from inflation concerns after last week’s downside surprise to US CPI, the UK inflation data refocused attention on the challenge central banks face getting inflation back to target. UK rates blasted higher, with the 2-year rate increasing a huge 24bps and the 10-year rate up 16bps, to 2.28%. The market is now pricing around a 30% chance of a 75bps BoE hike next month and a cumulative 200bps by March next year. There were significant spill overs to other bond markets, with the US 10-year rate increasing 9bps, to 2.89%, and the German 10-year rate rising 11bps, to back above 1%.
US rates and the USD have come off their highs in the past hour after the release of the FOMC minutes, which the market has viewed as somewhat less hawkish than expected. While members expressed concern around the risk that elevated inflation could become “entrenched” in expectations, markets honed in on the comment that “many” members saw a risk the Fed could overtighten, given the long lags from monetary policy to the economy. The US 2-year rate has dropped 7bps from its day’s highs, now only 3bps higher, at 3.29%, while the BBDXY USD index has fallen around 0.3% since the minutes were released. Meanwhile, there was some push back against market pricing of rate cuts next year, the minutes noting that “some ” members thought it would be appropriate to keep the cash rate at “a sufficiently restrictive level… for some time to ensure that inflation was firmly on a path back to 2 percent.”
The big sell-off in the bond market has put renewed downward pressure on equities, the S&P500 down around 0.4% overnight and the NASDAQ 0.8%, although both are well off their intraday lows. Equities rallied strongly last week, with the downside surprise to US CPI creating some emerging talk that the global economy might still have a shot at a ‘soft landing’. The UK inflation data overnight was a reminder that there is still some way to go before central banks can declare mission accomplished on their tightening cycles and consequently recession fears are likely to persist.
The USD is generally stronger overnight against a backdrop of higher rates globally and weaker risk sentiment, the BBDXY index up by around 0.2%. Risk sensitive currencies, including the NZD and AUD, have underperformed, the AUD down more than 1% from this time yesterday and the NZD 0.8% lower, now trading back below the 0.63 mark. The big upside surprise to UK CPI hasn’t provided much support to the GBP, which is down 0.2% overnight.
Despite persistent recession concerns, US retail sales showed the US consumer remains in good health, for now at least. Core retail sales, ex auto and gas, were much stronger than expected, increasing 0.7% in July, with consumers seemingly spending the windfall from lower gas prices at pump on other consumer goods and services. Upward revisions to prior months’ data, especially the ‘control group’ data which feeds into GDP, added to the sense consumer spending was still holding up relatively well. US households are still sitting on around US $2 trillion in excess savings accumulated during the pandemic.
US retailer Target’s CEO shared those sentiments at its earnings report overnight, saying “we continue to see a very healthy US consumer.” Target’s earnings were well below expectations as the firm cut prices last quarter to clear excess inventories that had built up on its shelves, seeing its share price fall around 3% overnight.
Turning to the RBNZ MPS yesterday, the Bank raised the OCR by 50bps, as universally expected by markets and economists, taking it to 3%. The RBNZ slightly lifted its forecast OCR track, now projecting a peak in the cash rate of 4.1% next year (previously 3.95%) and signalling a high chance of 50bps hikes at each of the next two meetings, in October and November. The tone of the statement was unsurprisingly hawkish, with the RBNZ emphasising that core inflation was still much too high and the labour market too tight.
After an initial spike higher in the hour or two after the MPS was released, the NZD and NZ rates both settled back down close to where they were before the statement (the NZD has since fallen away overnight). The market appeared to see the increase in the OCR track, from a little below 4% to a little above, as largely symbolic, while the RBNZ’s hawkish messaging was broadly in-line with expectations. The 2-year swap rate ended unchanged on the day, at 3.93%, a far cry from the last three MPS releases which have seen an average 16bps move on the day. Market pricing of the peak in the OCR is broadly consistent with the RBNZ, at around 4%. The market sees a high chance of another 50bps hike in October and around a 50% chance of the same in November. The BNZ Research team changed its OCR forecast after the MPS and now sees a peak in the OCR of 4% by November.
The NZD/AUD cross is slightly higher over the past 24 hours, up from around 0.9030 to 0.9060, although this mainly reflects the downside surprise to the Australian wage price index yesterday rather than the RBNZ MPS. Despite the softer than expected reading for wages in Q2, leading indicators point to a significant lift in Australian wage pressure ahead, especially considering a much greater proportion of the labour force typically receive a pay rise in Q3, in the new financial year.
We’re likely to hear more from the RBNZ over the next few days. RBNZ Governor Orr attends the Finance and Expenditure Select Committee this morning and Orr and his deputies usually engage in media interviews in the days that follow an MPS. This afternoon sees the release of the Australian employment report, with the market looking for the unemployment rate to remain at an all-time low of 3.5%. After the plunge in the Empire manufacturing index earlier this week, the market will be watching the Philadelphia Fed business survey tonight alongside jobless claims data.
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.