Annexation moves of Russian-held territories in Ukraine looks likely, which would escalate the war. Ongoing market nerves ahead of FOMC meeting tomorrow. These forces result in weaker risk sentiment and fresh highs for global rates

Risk sentiment has soured, with nerves ahead of the Fed’s policy announcement tomorrow and news that votes on annexation will be held in some Russian-held Ukraine territories, opening the door for an escalation in the war. Global rates have pushed up to fresh highs and Sweden’s Riksbank surprised the market with a jumbo 100bps hike. Safe-haven currencies have outperformed, and the NZD continues to fall to fresh lows, trading sub-0.59.

In news overnight, four regions in Russian-held territories in Ukraine will hold “sham” referendums 23-27 September on annexation, which the Russian government would support.  This would represent an escalation in the war, enabling the Kremlin to claim that attacks within those regions would amount to an attack on Russia, potentially giving Putin the formal legal basis to use all forms of self-defence, including chemical or nuclear weapons. In addition, Russia’s Parliament approved legislation that clears the way for military mobilisation.

This news comes alongside ongoing nerves ahead of the Fed’s policy announcement in less than 24 hours, which is keeping upside pressure on global rates. Adding to that mood, Sweden’s Riksbank surprised the market with a jumbo 100bps hike in its policy rate (75bps expected) to 1.75%, an aggressive move that signalled it thought it was behind the curve. The projections looked refreshingly honest, taking a leaf out of the BoE’s playbook, projecting an economic contraction of 0.7% next year, an 18% decline in house prices and inflation still remaining above target, just over 5%. The initial 0.8% plunge in EUR/SEK was quickly reversed after the market digested the move and the cross is actually up 0.7% on the day, with the market more focused on Sweden’s poor economic outlook than any support higher rates might provide to the currency.

The Riksbank’s surprise move hasn’t affected expectations for the Fed to deliver a 75bps hike (the market still seeing about a 20% chance of a surprise 100bps move) but it is a reminder of what central banks are capable of when they realise they need to get a move on. The ECB has been a clear laggard and Sweden’s move has spilled over into higher rates across Europe, with key 10-year European rates up in the order of 10-12bps and the UK up 15bps.

The US Treasuries curve shows a steepening bias, with the 10-year rate up 8bps to 3.57%, after earlier trading a fresh high of 3.60% and the 2-year rate up 2bps to 3.96%, after trading a fresh high of 3.99%. US housing market data were mixed, with housing starts rebounding 12.2% m/m in August, driven by the volatile multi-family units component, while building permits plunged 10% m/m. The latter is seen to be the more accurate assessment of where the US housing market is heading. Weaker risk sentiment and higher rates see the S&P500 currently down 1½%.

Canadian CPI data were softer than expected, with headline CPI down to 7.0% y/y in August (having peaked at 8.1% in June) and the average of the three core inflation pressures down to 5.2% y/y (from a peak of 5.4% in July). The data suggested the front-loaded hikes might be doing the job in reducing inflationary pressure and the market pared back expectations of further tightening ahead. Canadian rates fell against the grain of higher global rates, with the 2-year rate down 5bps and the 10-year rate down 4bps, while USD/CAD is up 0.9% on the day to 1.3370.

Japan continues to see rising inflation pressure, with the headline rate hitting 3.0% y/y, a three-decade high when changes to consumption taxes are excluded. The core rate which excludes fresh food and energy rose 1.6% y/y and has been running above 3% over the past six months. The data puts pressure on the BoJ to move away from its yield curve control policy, a change which could rock currency and bond markets, the only question is one of timing. While not widely expected at the BoJ’s meeting this week, an outside chance of a policy shift must surely be considered.

Against a backdrop of weaker risk appetite, the USD shows broad-based support, the DXY index back above 110, albeit trading below the high reached earlier this month.  SEK and CAD have been two of the worst performers overnight, for reasons noted above, with NZD followed closely behind, continuing its underperformance and moving below 0.59. AUD has pushed below 0.67 again, while NZD/AUD traded as low as 0.8799, taking it down to levels not seen since 2015. NZD crosses against EUR, GBP and JPY are all lower.

In the overnight GDT dairy auction the price index rose 2.0%, following the 4.9% increase in the previous event, providing additional confirmation of a positive turnaround in dairy prices, following a six month stretch of falling prices. Wholemilk powder prices rose 3.7% while skim milk powder fell 0.7%. Increased pricing will support market expectations for the FY2023 milk price, where futures closed yesterday at $9.85, towards the top end of Fonterra’s projected range of $8.50-$10.  Higher dairy prices is one positive force for the NZD against a backdrop of about 10 negative forces.

NZ rates headed lower yesterday, with the tailwind of lower Australian rates helping, seeing swap and NZGB yields down in the order of 4-6bps across the curve. That move should reverse today, with the Australian 10-year bond future up 8bps in yield terms since the NZ close.

The focus over the next 24 hours will be on the Fed’s policy statement, due 6am NZ time, which will include new projections, although the Chair Powell’s press conference from 6:30 often moves the market as well.  The market is well positioned for a 75bps hike alongside a hawkish update.