Equity markets fall heavily. Global rates higher overnight, although modest moves in the context of recent volatility. Fed and ECB officials continue to beat the hawkish drum

Yesterday’s relief rally in equities, after the BoE announced its emergency intervention at the long end of the UK bond market, didn’t last long.  The S&P500 is down almost 3% overnight and the NASDAQ almost 4%, with markets bracing for more hefty interest rate hikes ahead.  Global rates are higher, including in the UK where the bond yields have partially reversed their big falls from the previous night.  The GBP has had a better night though, up 1.7% to back above 1.10, helped by news the OBR would publish preliminary costings on the UK government’s fiscal plan later next week.  The NZD has managed to consolidate around the 0.57 mark overnight.

Markets remain extremely volatile, with focus still squarely centred on the UK.  In a positive development, the Office for Budget Responsibility (OBR) will publish its first ‘iteration’ of its fiscal forecast on October 7th with the full results now set to be produced by the end of the month, rather than the previously signalled deadline of November 23rd (the date the Budget is scheduled for).  The new government had chosen not to get the OBR to cost its free-spending ‘mini-budget’, making it appear as if it didn’t want the fiscal implications of its huge fiscal stimulus independently critiqued.  This was one factor that had damaged government credibility in the eyes of investors.

The GBP has recovered strongly overnight, with the news of the OBR’s earlier involvement helping to push it through the 1.10 level a few hours ago.  It is currently trading at around 1.1060, around 1.7% higher over the past 24 hours and now well off the 1.0350 panic lows seen on Monday.  Earlier, UK PM Truss gave no indication she was thinking of deviating from her expensive fiscal plan, despite the significant market volatility and the BoE’s recent intervention in the bond market.

Following their huge falls yesterday, after the BoE said it would purchase up to £65b of ultra-long end UK government bonds over a two-week period, UK gilt yields have pushed higher overnight.  Rates were up 12-13bps out to 10 years, with BoE Chief Economist Pill saying the Bank will deliver a “significant and necessary” monetary policy response to the fiscal package in November (again suggesting no desire for an intermeeting hike). The market is pricing a rate hike on the order of 150bps for that meeting.  After falling more than 100bps yesterday, the 30-year rate (where the BoE’s buying is concentrated) was only 3bps higher, providing some relief to the battered pension sector.

Global rates are higher, in sympathy with the UK, although the moves have been modest in the context of recent volatility.  The US 2-year rate is 5bps higher while the 10-year rate is up 3bps, at 3.76%.  Germany’s 10-year rate was 6bps higher overnight, at 2.17%.

There has been no let-up in the hawkish talk from the Fed.   Cleveland Fed President Mester said inflation was “unacceptably high ” and noted the Fed was still yet to reach a ‘neutral’ level of the real (i.e. inflation-adjusted) Fed funds rate, in her view.  She added the strong USD was helpful in dampening inflation, so market participants shouldn’t hold out any hope for a renewed Plaza Accord any time soon.  St Louis Fed President Bullard gave a thumbs up to the market reaction after the FOMC meeting, concurring with the significant repricing in interest rate hike expectations over the next year.  Consistent with the hawkish messaging coming out the Fed, the US labour market remains exceedingly tight, with initial jobless claims falling below 200k last week, their lowest level since April.

One upshot of the recent sharp increases in US Treasury yields is that US mortgage rates continue to head sharply higher, with Freddie Mac saying the average 30-year fixed rate had reached 6.7% last week, a more-than 40bps jump from the prior week and its highest level since 2007.  The sharp increase in mortgage rates has already led to an inevitable softening in the US housing market, with further adjustment likely on the way.

Ahead of the all-important European CPI release tonight, there have been mixed inflation readings from Spain and Germany.  German inflation was much higher than expected, hitting 10.9% y/y, due in part to the end of discounted transport fares.  Spanish CPI, in contrast, significantly undershot market expectations, at 9.3% y/y (10% exp.).  Against this high inflation backdrop, ECB officials continue to sound hawkish, Governing Council member Simkus adding his voice to the group that support a 75bps hike next month and Chief Economist Lane highlighting that the ECB cash rate was still some way below ‘neutral’.

Germany has announced a fiscal stimulus of its own overnight to support households and businesses from sky-high energy costs.  The €200b stimulus, around 5% of GDP, will go towards capping energy prices.  The fiscal support will be debt funded but, unlike the UK, Germany intends to recoup at least some of the cost through windfall taxes on energy producers.  And, unlike the UK, there has been limited market reaction.

Equity prices are down overnight, largely reversing the previous day’s rally.  The S&P500 is current down around 2.7%, leaving it on track for its lowest close since late-2020, while the NASDAQ is off a hefty 3.6%.  The significant decline in equities this year is consistent with the market expecting a (monetary policy-induced) major economic downturn next year. Also not helping sentiment, Russia plans to formally annex four regions in Eastern Ukraine tonight, raising the risk that Russia could deem fighting in the warring regions as an attack on its own territory, in turn escalating the war.

The GBP has been the standout mover in the currency market, but the EUR has also made gains overnight, up around 0.5% to just below 0.98.  USD/JPY continues to hover just below the 145 mark, with investors no doubt wary about the potential for further Japanese FX intervention.  The fall in equities has weighed on the commodity currency complex, with the NZD, AUD and CAD down between 0.6% and 0.9% from this time yesterday.  The NZD has traded either side of the 0.57 level overnight and trades this morning around 0.5685.

It was ‘more of the same’ in the ANZ business survey for September, with growth indicators struggling and inflation and cost pressures still uncomfortably high.  The Own Activity indicator nudged up, to -1.8, but remained at levels consistent with very subdued economic growth.  Pricing intentions edged lower, to +68, continuing their recent pullback from what was a high of +80 back in March. But they remain consistent with inflation well above the top of the RBNZ’s 1-3% target range, so no cause for comfort there.  And residential investment intentions slumped to a new all-time low of -76.5, reflecting the unhelpful combination of falling demand (and house prices) and still-elevated build costs.  There was nothing in the survey to move the needle for a market which remains much more focused on offshore developments at present.

NZ rates continued their recent wild ride, falling sharply yesterday in response to the UK-led fall in bond rates the previous night.  Swap rates were 9bps lower, at the 2-year point, and 13-14bps lower between 5 and 10 years.  Despite the pullback yesterday, swap rates have increased significantly during September, by 30-40bps, reflecting the dominant influence of global forces.  NZGB yields largely kept pace with swaps out to 10 years, but 20 and 30-year bonds underperformed (their yields falling only 7bps) after tepid demand at yesterday’s tender of $50m 2041 maturity bonds.

It’s a busy session ahead over the next 24 hours.  The ANZ consumer confidence index and building permits data are released this morning.  The Chinese PMIs are out this afternoon and are expected to show the manufacturing sector is still in contraction while services activity is expected to remain in positive territory (above 50).  The key release is the European CPI data, with the market looking for another punchy monthly reading (0.9% m/m), which would take the annual headline rate close to 10%. Core inflation is expected to reach almost 5% y/y, much too high for comfort for the ECB.   Fed Vice Chair Brainard and NY Fed President Williams, two of the heavy hitters on the FOMC, are speaking on financial stability overnight although there is always the chance of market-relevant comments on monetary policy.