After another extremely volatile week, Friday saw some consolidation in global rates and currencies. Early session strength in the USD saw more milestones reached in the FX market, USD/CNY breaking 7.0, the GBP hitting its lowest level since 1985, and the NZD hitting a fresh 2½-year low, before a late turnaround saw the USD reverse most of these gains. Equities were lower again, capping off a week where the S&P500 fell almost 5%. NZ rates were sharply higher on Friday in thin trading conditions, the 2-year swap rate up 17bps off the back of higher global rates and as a local bank revised up its terminal OCR forecast. The local market is now pricing a peak in the OCR of around 4.50%. It’s a big week ahead with a trifecta of major central bank meetings taking place, the Fed, Bank of England, and Bank of Japan, so more volatility looks to be in store.
Asset class trends last week were defined by the big upside surprise to US CPI data which set off alarm bells among investors about the amount of monetary policy tightening likely to be required to get inflation under control. The CPI data set off another sharp repricing in Fed rate hike expectations (US 2-year rate +31bps last week), further broad-based strength in the USD (BBDXY +0.8% last week), big falls in equity markets (S&P500 -4.8%, NASDAQ -5.5%), and weakness in commodities (copper -1.2%, oil -1.6%), consistent with investors anticipating a larger monetary policy-induced slowdown in global growth.
Friday looked like it was heading the same way for much of the session, with all those trends extending. But things turned around in New York trading, helped by a lower inflation expectations reading from the University of Michigan consumer survey. The preliminary survey release saw 5-10yr inflation expectations drop to 2.8%, now their lowest level in more than 12 months, and consistent with the pullback in other survey-based measures of longer-term inflation expectations, such as the New York Fed’s 3-year ahead series (which is down to 2.75% from a high of 4.2% late last year). Anchored longer-term inflation expectations are critical if the Fed is to have any hope of getting inflation back to target without a major recession.
US rates and the USD fell after the University of Michigan survey data, the US 10-year rate closing unchanged on the day, at 3.45%, still near its highest level since 2011. After earlier being up as much as 0.4%, the BBDXY USD index ended up marginally lower on the day, albeit still near its highest level on record (since the index started in 2003). Profit-taking by investors (ahead of the major event risks this week - see below) was also likely behind the turnaround in US rates and the USD.
Friday saw several new milestones reached in the FX market. USD/CNY finally broke above the 7.0 level on Friday afternoon for the first time since late 2020. Stronger monthly Chinese activity data, across retail sales, industrial production, and fixed asset investment, were brushed off by the market, with investors still focused on the headwinds to Chinese growth from the ongoing slowdown in the property sector and China’s zero-Covid approach (although the lockdown of Chengdu was lifted over the weekend). The GBP hit its lowest level since 1985, falling to a low of just above 1.1350. And the AUD and NZD both hit fresh 2½-year lows during the London morning, the NZD trading down to almost 0.5940 at one point. However, the turnaround in the USD in the New York session saw these moves reverse, USD/CNY closing back below 7.0 and the NZD rebounding to 0.5990, 0.4% higher on the day.
On the week, it was the global growth-sensitive commodity currencies that underperformed, the NZD, AUD and CAD down 1.8%-2% and the NOK off a hefty 2.7%. The NZD and AUD typically don’t fare well during major global growth slowdowns or recessions. The weekly changes in the EUR and the JPY were much more modest, both down around 0.3%. Stepped up verbal intervention from Japanese officials last week helped limit the fall in the JPY despite higher US Treasury rates.
Equity markets were weaker again on Friday, not helped by a bleak earnings update from US package delivery company FedEx. FedEx shocked the market with much weaker earnings ($3.44 vs. $5.10 expected) and withdrew its full-year guidance, blaming worsening “macroeconomic trends…both internationally and in the US”. Its share price crumbled over 20%. The shift away from the pandemic trend of spending on goods towards spending on services is clearly at play here, but it’s fair to say the big earnings miss played to pre-existing fears that global growth is already slowing sharply, with recession a likely outcome next year. The S&P500 was lower 0.7% on Friday, having been down as much as 1.6% at one point, while the EuroStoxx 600 index was down 1.6% on Friday.
NZ rates were sharply higher on Friday, initially dragged up by offshore markets before ramping higher into the market close after a local bank changed its RBNZ call for a peak in the OCR of 4.75%. The 2-year swap rate was 17bps higher in thin trading conditions, hitting 4.49% and now on the cusp of its highest level since 2010. The market now prices the OCR to reach a peak of around 4.50% by mid next year. Curve flattening remains the dominant theme, with the market factoring in a higher expected peak in the OCR but ultimately more rate cuts beyond 2023. The 10-year swap rate was ‘only’ 9bps higher on Friday, seeing the 2y10y swap curve invert further, to -27bps. In domestic data, the Manufacturing PMI rebounded to an above average 54.9 in August, going against the grain of weaker global manufacturing data.
The week ahead is likely to be dominated by a trifecta of major central bank meetings - the Fed, Bank of England, and Bank of Japan – and the build up to these. The strong consensus is that the Fed will hike by 75bps for the third consecutive meeting on Thursday morning, taking the cash rate to 3.25%, although the market is pricing an outside chance (~20%) of a super-sized 100bps hike. Given the upside surprise to inflation and the still-extremely tight labour market, Fed officials are likely to lift their forecasts for the cash rate from what was a peak of 3.75% in June. According to a Bloomberg survey, economists expect the ‘dot plot’ to imply a Fed funds rate of 4% at the end of 2022, implying a cumulative 75bps of hikes at the November and December meetings, although the survey was largely concluded before the big inflation surprise last week. The market is now pricing the Fed cash rate to reach around 4.40% by mid next year.
The Bank of Japan meets on Thursday amidst the recent sharp fall in the JPY which has seen speculation mount that the Ministry of Finance could intervene in the currency market or the BoJ amend its Yield Curve Control policy to allow for more upward adjustment in Japan bond rates. The consensus is that this meeting comes too soon for any change to the Yield Curve Control framework, but the market is trading nervously, with the Japan 10-year yield sitting right on the 0.25% upper-limit. Any change to the Yield Curve Control framework, either widening the allowable range around the 0% 10-year yield target or switching the target bond to the 5-year maturity, would likely lead to another leg higher in global rates given Japan’s importance as a major investor across global bond markets. Japan CPI comes out tomorrow, with the chance that headline inflation could hit 3% y/y for the first time 2014 and underlying inflation clearly on an upswing (ex food and energy CPI has increased at a 3% annualised rate over the past six months), suggesting a change in BoJ policy is likely a matter of when, not if.
The Bank of England’s rescheduled meeting (delayed for a week due to the Queen’s passing) is more uncertain, with most economists looking for a 50bps hike but the market slightly leaning towards a 75bps move. The market will be tuned in to how the BoE sees the policy outlook being influenced by PM Truss’ energy price cap. Economists have slashed their near-term inflation forecasts and revised up their growth estimates since the announcement. The BoE is also expected to officially confirm its plans to start actively selling down its UK government bond holdings in the secondary market, despite bond issuance being set to ramp higher to finance the government’s pricey energy cap policy.
It should be a quiet session ahead with the UK, Canada and Japan markets all closed. The NZ PSI (the services PMI), which was sitting just in expansionary territory in July, is released this morning. The NAHB survey tonight should show further weakness in a US housing market coming under pressure from fast rising mortgage rates. ECB speakers are likely to keep up their hawkish rhetoric.
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1 Comments
"The market is now pricing the Fed cash rate to reach around 4.40% by mid next year."
I'm not sure if that will cut it when wage rises of 24% have been negotiated. Yes, that's over an extended time-frame, but the headline figure might trigger others to achieve the same or more.
Under that circumstance, even 5% might not be enough. So for our OCR calling it quits at 4.75%, I doubt that.
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