Equity markets rally strongly for the second day running. RBA hikes rates by only 25bps, sparking big fall in Aussie rates and underperformance in the AUD. USD significantly weaker amidst recovery in risk appetite

Market moves in the first two days of October have been the mirror image of the previous month.  Equity markets have rallied strongly again overnight, the S&P500 up more than 2% for the second day running, as markets start to toy with the idea of an earlier end to the global tightening cycle.  The USD has fallen sharply, down more than 1% against both the EUR and GBP, amidst the improvement in risk appetite.  The AUD has been the big underperformer, down almost 1% following the RBA’s surprise decision to raise its cash rate by only 25bps yesterday, and this has weighed on the NZD, which has tracked broadly sideways over the past 24 hours, sitting this morning just above 0.57.  The RBNZ is set to hike the OCR by another 50bps this afternoon, with market attention likely to be centred on the Bank’s description of the policy outlook.  Tonight, OPEC+ is expected to announce a significant cut to oil supply (1-2m barrels per day) while markets will be closely watching the ISM Services index for any further signs of slowdown in economic activity.

In a surprise move yesterday, the RBA raised its cash rate by just 25bps, defying the broad consensus among economists and investors (~45bps was priced in for the meeting).  The RBA noted “the cash rate has been increased substantially in a short period of time”, adding that there was uncertainty around the global economy and how Australian households will respond to the recent sharp increase in mortgage rates.  It still said it "expects to increase interest rates further over the period ahead” but evidently the path forward will be in 25bps increments rather than 50bps moves now the cash rate is seen as closer to neutral.  The smaller-than-expected hike saw a big fall in Australian rates, the 3-year bond rate down 32bps on the session (having already been 15bps lower prior to the rate decision) as the market pared back terminal rate pricing for the RBA by around 50bps.  The market now prices ~100bps more hikes by the RBA, which would take the cash rate to a peak of around 3.60%.

Overnight, the JOLTS report showed a huge 10% fall in US job openings, the biggest monthly fall since April 2020.  Job openings used to be very much second tier data and not given much attention by the market, but Fed Chair Powell’s recent focus on the job openings-to-unemployed ratio has since elevated it to a key indicator.  This ratio fell from 1.97 (i.e. almost two job openings per unemployed person) to 1.67 in August, the first meaningful sign of some cracks in the labour market. To be clear, the absolute levels are still consistent with a very tight labour market and the data can be prone to significant revision, but the Fed will undoubtedly welcome the tentative signs of easing demand for labour.

The RBA’s surprise decision to hike its cash rate by 25bps yesterday, the big fall in US job openings, and yesterday’s downside surprise to the Manufacturing ISM survey have created a bit more debate around how more monetary policy tightening lies ahead and whether central banks might soon slow down the pace.  For now, Fed officials are sticking to the hawkish script, new Governor Jefferson saying overnight that the Fed was “resolute” in its commitment to getting inflation back to 2% and New York Fed President Williams yesterday saying the Fed still had “a significant ways to go ” with its rate hike cycle, although it would remain data dependent.  Meanwhile, ECB member Villeroy said he was in favour of raising rates aggressively at the two remaining meetings this year, to get the policy rate “below or close to” its neutral rate of 2%, but flagged “a more flexible and possibly slower” rate hike path next year.

US Treasury rates were significantly lower at one point overnight, the 2-year rate briefly falling back below 4% and the US 10-year rate hitting a low of 3.56%, but these moves have mostly reversed over the past few hours.  The 2-year rate is back to 4.11% while the 10-year rate is back above 3.60%, both only 1bp lower than yesterday’s close.  The market is pricing a terminal Fed funds rate just below 4.50%.  Europe and the UK both saw lower rates overnight, the UK 2-year rate falling another 10bps as the rebound in the GBP caused the market to scale back its expectations for a jumbo rate hike by the BoE in November (‘only’ 110bps now priced in for that meeting).

In a continuation of the ‘bad news is good news’ theme for equity markets, the large fall in US job openings has helped propel the S&P500 to another big gain, currently 2.7% higher on the day following yesterday’s 2.6% increase.  The interest rate-sensitive NASDAQ and the EuroStoxx 600 were up 3.1%.  Many investors are wary that the rebound in equities is simply a bog standard ‘bear market rally’ and the Fed, which has repeatedly said it doesn’t intend to repeat the mistakes of the 1970s and ease policy too early, will retain its hawkish stance.  On this view, the rally over the past few days is more a technical correction after the significant falls in September (-9.5% on the S&P500), exacerbated by extremely pessimistic sentiment and defensive positioning.  In other equity news, Elon Musk said he now intends to proceed with his deal to buy Twitter at $54.20.

Bloomberg reported that OPEC+ is considering cutting its oil production quotas by between 1-2 million barrels per day at its meeting tonight.  Oil prices increased sharply for the second session running, Brent crude up 3.4% overnight, also helped by the broader recovery in risk appetite.  Industrial commodity prices were also stronger overnight, with copper – often seen as a barometer of global growth – gaining 2.6%.

The recovery in risk appetite has seen a big decline in the USD, the BBDXY index falling 0.9% over the past 24 hours.  European currencies have led the way, with the oil-sensitive NOK up 1.6%, the EUR surging 1.5% to near parity again, and the GBP 1.2% higher.  The GBP is now around 2.3% above where it was before Chancellor Kwarteng’s shock mini-budget a week and a half ago, at 1.1460.  In an interview with LBC overnight, new UK PM didn’t rule out making other changes to her fiscal plan, including reversing course on ending the cap on banker bonuses.  USD/JPY has fallen only 0.3% overnight and remains above the 144 mark.

The AUD has been a significant outlier amidst the broad-based decline in the USD, falling 0.6% from this time yesterday to 0.6470.  The significant underperformance of the AUD, following the RBA’s surprise 25bps rate hike, has spilled over to the NZD, which has tracked broadly sideways over the past 24 hours despite the rebound in risk appetite.  The NZD trades this morning at around 0.5715.  The NZD/AUD cross, which reached a 9-year low last week, has rebounded to back above 0.88.

At the dairy auction overnight, the GDT price index fell back by 3.5%, a soft result likely influenced by the recent strength in the USD.  Whole milk powder fell -4% at the auction, leaving it 25% down from its peak in March.  The depreciation in the NZD will provide a helpful offset to the fall in global prices, with futures markets yesterday pricing a milk price just above $10 for the 2023 season, above the top end of Fonterra’s $8.50-$10 forecast range.

Yesterday’s QSBO survey highlighted the elevated risk of a recession in the NZ economy.  Expected trading conditions in the next three months fell to a net -14% from -11% the previous quarter.  Employment intentions remained strong, but there were signs of improvement in measures of skills shortages, which would be consistent with the unemployment rate tracking higher over the next few years.  Pricing intentions remained high, with a net 65% of firms intending to raise prices over the next quarter, but they are at least moving in the right direction for the RBNZ.  We don’t think the survey suggests the RBNZ needs to be any more aggressive with its rate hike path than what it has already signalled.

NZ rates were sharply lower yesterday, by 11-14bps across the swap curve, but those moves preceded the RBA’s rate decision, so we should expect a big move lower (and steeper) when trading opens this morning.

The RBNZ MPR takes place this afternoon with the market fully pricing a 50bps OCR hike, which would take the cash rate to 3.50%.  The market reaction is likely to hinge on the RBNZ’s characterisation of the policy outlook, particularly whether it states that its prior guidance for a peak in the OCR of 4%/4.25% still holds or whether it now expects a higher terminal cash rate.  While the RBNZ was clear in August that it expected to hike the OCR by 50bps at both the October and November meetings, given the RBA’s surprise step down in its pace of tightening yesterday, the market will no doubt be on the lookout for any signs that the RBNZ might consider a smaller rate hike in the coming meetings.

There is no press conference after this meeting although it has become customary for Governor Orr and his deputies to do the rounds with media in the days that follow.

The newly restructured ADP employment report and ISM Services index are released tonight.  After the downside surprise to the ISM Manufacturing index earlier in the week, there will likely be increased focus on the Services index tonight; the consensus is for a still very healthy reading of 56.