Global rates continue to track higher, curves flatter. Market expectations for the peak in the Fed's cash rate now approaching 4.5%. Equity markets weaker as rate expectations gravitate higher

Global rates have tracked higher again overnight, the US 10-year rate approaching the 3.50% mark, with the upside surprise to US CPI earlier in the week continuing to reverberate.  The prospect of more monetary tightening continues to weigh on risk assets, with equity markets and industrial commodity prices down again.  USD/CNH broke above the psychologically important 7.0 level overnight.  There has been some spill over from weakness in the CNH to the NZD, which has made a fresh 2-year low.

Global rate expectations continue to gravitate higher, with investors coming around to the view that central banks will need to do more work with tightening to get inflation under control.  Market expectations for next week’s Fed meeting have been relatively stable, at around 80bps, implying a ~20% chance of a super-sized 100bps hike, but pricing for the peak in the cash rate continue to nudge higher, now up to almost 4.50%.  The US 2-year rate is 7bps higher overnight and has made fresh cycle highs of 3.87% while the 10-year rate is up 5bps, to 3.45%.  The deeply inverted US yield curve is consistent with the market expecting the Fed to take the cash rate to very ‘restrictive’ levels, setting the stage for a recession next year and eventually a policy reversal down the line.

US economic data overnight have been mixed, and not enough to dispel market participants of the notion that the Fed still has more work to do with rates and the economy is going to come under pressure.  US headline retail sales were stronger than expected in August, rising 0.3% on the month, although the result was flattered by a chunky increase in auto sales. The core (ex autos and gas) and control group measures were both much weaker than expected, the latter measure (which feeds into GDP) flat in August and revised down 0.4% the previous month.  The Atlanta Fed’s GDPNow tracking estimate for Q3 growth was shaved down a full percentage point, now suggesting an annualised growth rate of just 0.5% for the quarter.  A clear headwind for consumer spending going forward is higher mortgage rates, with Freddie Mac reporting the average 30-year mortgage rate has breached 6% for the first time since late 2008.

The Empire and Philly Fed surveys provided contrasting reads on the state of US manufacturing activity, the Empire rebounding back to -1.5 while the Philly Fed fell back to -9.9.  Both surveys remain at levels consistent with subdued activity in the manufacturing sector.  More encouragingly, there were further falls in the prices paid indices, suggesting the unclogging of supply chains and falls in commodity and transportation prices should contribute to lower headline inflation ahead.  Whether disinflation in goods prices is sufficient to offset sticky services sector inflation remains to be seen.  Elsewhere, initial jobless claims fell back to 215k, consistent with an extremely tight US labour market and ongoing wage pressure.

US equities and industrial commodity prices are lower overnight amidst the increase to central bank rate hike expectations and growing concerns around the growth outlook.  The S&P500 is down 0.9%, the NASDAQ 1.2% lower while the EuroStoxx 600 was down for the third day running, off 0.7%.  Copper, often seen as a barometer of global growth given its wide use across different industries, was down around 1% overnight, leaving it almost 30% below its peak earlier in the year.  Oil prices are almost 4% lower, with the US DoE saying it didn’t have a price level in mind for refilling the Strategic Petroleum Reserves, contrary to reports earlier in the week that it would look to replenish stocks below $80 per barrel.

There hasn’t been much movement in the major currencies overnight, the EUR drifting back up towards parity while USD/JPY has stabilised around 143.50, a day after the BoJ was reportedly checking FX rates, a warning that FX intervention is under active consideration.

The most notable move in the FX market has been USD/CNH, which finally broke above 7.0 overnight and has since consolidated above that mark.  The PBOC has been leaning against the depreciation in the yuan through its daily fixing and by tweaking foreign currency reserve requirements, but it has only helped to slow, rather than prevent, the decline in the currency.  Monetary policy divergence between the Fed and the PBOC, with the latter having cautiously eased policy in recent months in response to the growth slowdown in China, has contributed to the trend higher in USD/CNY.  Note that that onshore renminbi, USD/CNY, closed marginally below the 7.0 level.

The weakness in the CNH and pullback in risk assets have weighed on the NZD and AUD, both around 0.6% lower over the past 24 hours.  The NZD has made a fresh 2½-year low and has pushed down to around 0.5970.  Likewise, the AUD is teetering above its lows for the year, trading just below the 0.67 mark this morning.

NZ Q2 GDP was stronger than market expectations, at 1.7% q/q, but only a fraction below the RBNZ’s 1.8% MPS pick.  A bounce back in growth was expected due to the loosening of Covid restrictions over the quarter and the reopening of the border.  That said, under the surface there was evidence of softer domestic demand, with private consumption falling 3.1% and business investment down 4%.  The GDP data remain very noisy and difficult to interpret given the complex mix of supply and demand factors impacting the economy at present.  We still see the RBNZ taking the OCR to 4% by November, with 50bps hikes at each of the next two meetings, with the risk that it might need to hike beyond that if inflation proves stickier than expected.  We’re also still expecting a shallow recession next year.

There was little reaction to the NZ GDP data, unsurprising given it is both dated and very noisy at present.  NZ short-end rates were modestly higher yesterday, the 2-year swap rate up 3bps with market expectations for the peak in the OCR sitting just below 4.40%.  In contrast, the 10-year government bond yield was down 4bps amidst the broader global curve flattening trend, also helped by strong demand at yesterday’s bond tender.

In Australia, the unemployment rate ticked up to 3.5% while employment growth was close to market expectations, at 34k.  Despite the (small) increase in the unemployment rate, the broader picture is one of an exceptionally tight labour market in Australia, as indicated by robust employment intentions in the NAB Business Survey and the extremely high levels of job ads, with much faster wage growth likely in the pipeline.  The market is pricing just over a 50% chance that the RBA hikes by 50bps again next month.

The market focus for the session ahead is the monthly release of Chinese activity data, with retail sales, industrial production and fixed asset investment all reported.  Chinese growth indicators have been softening this year under the weight of the property sector slowdown and on-again-off-again Covid restrictions.  The NZ Manufacturing PMI is also released this morning.