USD strength yesterday sees many new FX milestones but a reversal overnight on higher risk appetite also notable. Oil down over 5% to 7-month low

There has been plenty of news and price action over the past 24 hours.  Broad USD strength saw new FX milestones, including the NZD dipping below 0.60 yesterday, but a swing in the USD overnight has seen a reversal of those moves. Global rates are much lower, with the UK 2-year rate plunging 18bps, the biggest mover on the day on fresh UK news. Lower rates are supporting US equities even as the market moves closer to pricing in a 75bps hike later this month.

There has been so much going on in the past 24 hours it is hard to think where to start and what to leave out in this daily summary. Yesterday’s FX moves can’t be ignored, with USD strength driving the NZD down to 0.5997, its lowest level in over two years. We have been expecting a sub-0.60 print for some time on the back of growing global recession risks and the market gradually embracing this view.  While the USD has staged a U-turn overnight that sees the NZD recover to 0.6060, we don’t rule out the NZD making fresh lows over coming months and our prevailing projections have been consistent with the trading range extending down to as low as 0.57-0.58.

The yen plunged further and USD/JPY turned around just shy of 145, a fresh 24-year high. On its way up through 143 there were further warnings from Japanese government officials about the rapid decline of the yen, with Chief Cabinet Secretary Matsuno saying the government will continue to watch FX moves “with a high sense of urgency and take necessary responses if this sort of move continues” and Finance Minister Suzuki watching “with great interest”. These “open mouth” operations have been coming over the past 15% decline of the yen so it is hard to take them seriously and the market certainly didn’t.

Meanwhile the PBoC isn’t having much success in stemming the decline of the yuan.  It set the CNY reference rate on the strong side compared to estimates by a record margin but that didn’t prevent further depreciation. Chinese import and export growth figures were both below consensus estimates, with weaker growth consistent with slower global demand and a weak domestic economy.  USD/CNY traded just under 6.98 overnight, while USD/CNH reached just under 7.

Fresh lows have been printed for AUD (sub-0.67), EUR and GBP overnight before an improvement in risk sentiment has seen the USD knocked off its perch.  There has been plenty of UK news following the formation of the new government and the appearance of BoE folk addressing Parliament. All this has seen some big moves for gilts and Sterling. GBP fell to 1.1406, its lowest level since 1985, before bouncing back above 1.15. The 2-year gilt plunged 18bps as rate hikes get priced out, while the 10-year gilt fell 6bps.

Of note, the newly appointed Chancellor Kwarteng met with BoE Governor Bailey, where the Chancellor affirmed the government’s long-standing commitment to the BoE’s independence (calling that “sacrosanct”) and its monetary policy remit, removing the cloud hanging over the Bank under new PM Truss. BoE Governor Bailey said the Bank may revise plans to start selling gilts next month if it judges the market will struggle to digest the huge issuance needed to fund the government’s energy bill rescue scheme, estimated at £200b over the next 18 months. BoE officials noted that the energy package could cut inflation in the short term and this saw the market pare back rate hike expectations, although Chief Economist Pill noted that supporting household incomes would be an offsetting factor and will probably lead to slightly stronger inflation.

The Bank of Canada hiked its policy rate by 75bps to 3.25%, as expected, following the mega-100bps hike at its prior meeting. Forward guidance pointed to a further rise in the policy rate. After four successive rate hikes and 175bps over the past two meetings alone, the statement dropped reference to “front-loading” rate hikes and the market expects smaller hikes going forward.

Nick Timiraos of the WSJ, who is close to Fed officials, reported that the Fed appears to be on a path to raise interest rate by another 75bps this month in the wake of Chairman Jerome Powell’s public pledge to reduce inflation even if it increases unemployment.  He then cites all the hawkish reasons why, peppered with quotes, and fails to mention next week’s key CPI release as a possible reason for a smaller move. He simply says that “while inflation slowed a bit in July, underlying price pressures and wage growth suggest it could run above the Fed’s 2% target for some time.” The implication is that the Fed will hike 75bps regardless of next week’s inflation report. The market has increased pricing for the September meeting up 2bps to 70bps.

There has been plenty of Fed-speak overnight and Chair Powell speaks tonight. The hawkish messaging hasn’t changed, with vice-Chair Brainard noting that policy will need to raise rates to a restrictive level and keep them there for some time.

Despite the increased chance of a 75bps hike later this month, US Treasuries have rallied across the board, with the idea that more front-loaded hikes will get on top of the inflation problem and allow for lower rates down the track. There also seems to be the case of gyrations in European rates, as we’ve seen over recent weeks, spilling over into Treasuries. Key European 10-year rates are down in the order of 6-8bps and the US 10-year rate is currently down 9bps to 3.26%, reversing a chunk of the previous day’s rise. The yield curve has inverted further, with the 2-year rate down “only” 6bps.

Lower rates have supported US equities, with the S&P500 currently up 1.8%.  Lower oil prices have also been noted as possible support for equities and rates markets. Oil prices are down over 5%, with Brent crude below USD88 per barrel, its lowest level in seven months.  This reflects a combination of fears that a weak Chinese economy will crimp demand, and a poor technical picture as a “death cross” formed, with the 50-day moving average falling below the 200-day moving average. Also of note, European gas prices continue to retreat, down over 10% to EUR214/Mwh, ahead of the EU meeting at the end of the week to discuss new regulations to contain energy prices.

Global forces sent domestic rates higher yesterday and with a steepening bias. The 2-year swap rate rose 3bps to 4.33% while the 10-year rate rose 7bps to 4.26%.  NZGBs saw similar moves. Those moves should fully reverse today. Since the NZ close, the Australian 10-year bond future has fallen 10bps in yield terms, setting the scene for lower NZ rates on the open. Australian GDP data were in line with expectations, with a 0.9% lift in Q2.

In the day ahead there will be keen interest in RBA Governor Lowe’s speech this afternoon, where the market will be looking for clues on whether the Bank will step down from 50bps hikes to 25bps over future meetings. The key event tonight is the ECB’s meeting, where the debate will be on delivering either a 50bps or 75bps hike. Intense inflationary pressure favours the latter and that is what current market pricing favours. Fed Chair Powell will likely maintain a hawkish tone in his speech tonight.