Stronger ISM Services index drives a big lift in global rates and the USD. US 10-year back above 3.75%, EUR back below 0.99. OPEC+ announced 2m barrels per day reduction to oil supply quotas

A stronger-than-expected ISM Services index overnight has helped drive a sharp increase in global rates and the USD overnight, reversing the moves from earlier in the week.  The US 10-year rate is 14bps higher and back above 3.75% while the EUR, which got within a whisker of hitting parity yesterday, is back below 0.99.  ‘Bad news is good news’ remains the prevailing theme in equity markets, with the S&P500 down around 0.5% overnight, slightly paring its gains over the past two days.  OPEC+ cut oil production quotas by 2m barrels per day, but oil prices are only modestly higher as the US said it would release more oil reserves from the SPR.  The RBNZ raised the OCR by 50bps yesterday, as expected.  There was a slightly hawkish tinge to the statement, given the RBNZ discussed a 75bps move, but the market reaction has been fleeting.   After hitting 0.58 in the wake of the RBNZ, the NZD is back to 0.5720 this morning.

After the weak ISM Manufacturing survey earlier this week, which had reawakened recession fears, there was greater than usual focus on the ISM Services index overnight. As it happened, the Services index was stronger than expected, falling marginally from 56.9 to 56.7, levels still consistent with strong growth in the services sector.  The key New Orders subcomponent remained at very healthy levels, above 60, while there was a notable increase in the Employment index, which rebounded back into expansionary territory, at 53.  The Prices Paid component fell again, but, at 68.7, it remains relatively high (the manufacturing equivalent is just 51.1), consistent with still-elevated inflationary pressures in the services sector.

As we noted earlier this week, it was uncertain whether the weakness in the Manufacturing ISM reflected the long-awaited rotation from consumer spending on goods back to services, or whether it hinted at a broader slowdown in economic activity.  The ISM Services index suggests the former interpretation, with services sector activity levels still holding at very healthy levels for now.  Market attention will now turn to the nonfarm payrolls report released tomorrow night.

Just as the downside surprise to the ISM Manufacturing index earlier in the week drove a big fall in rates and the USD, there’s been a big reversal of those moves overnight.  US rates are higher across the curve, with the 2-year rate lifting 7bps to 4.16% and the 10-year rate up 14bps, to 3.77%.  The 10-year rate is now essentially back to where it was on Monday, before the manufacturing data.  Near-term Fed rate expectations haven’t changed that much (70bps is still priced for next month’s meeting and a terminal rate a touch above 4.50%), but the market has pared back some of the rate cut pricing from mid next year. Likewise, the USD is up around 0.7%-1.1% in index terms overnight, reversing most of the previous day’s move.

Despite some murmurings around a possible ‘Fed pivot’ in the coming months, following the weak ISM Manufacturing and job openings data and the RBA’s surprise 25bps rate hike earlier in the week, Fed officials remain steadfastly hawkish.  San Francisco Fed President Daly told Bloomberg it would be “really challenging” to step down the pace of rate hikes while core inflation is rising, pointing to another 75bps hike next month.   On market pricing for rate cuts next year, Daly was blunt: “I don’t see that happening at all.”

In other news, OPEC+ announced a 2 million barrels per day reduction to oil supply quotas, the upper-end of the 1m-2m range flagged in the lead-up to the meeting.  Analysts believe the actual reduction in global oil supply will be closer to 1 million barrels per day because some countries are already producing well below their quotas so won’t be affected by the change.  In response, the US said it would release another 10m barrels from its Strategic Petroleum Reserve (SPR) in November, perhaps with the US midterm elections in mind.  Of course, with the US rapidly running down its oil reserves stockpile (Bloomberg estimates it will have released more than 200m barrels in 2022, likely leaving only 144m barrels in the SPR by the end of the year that can be used for emergencies), this approach can’t last forever.  Oil prices are modestly higher overnight, by around 1.5% on Brent crude ($93.50).

The ‘bad news is good news’ theme remains in play for equity markets, whereby stronger economic data is seen as likely to result in more Fed tightening, ultimately increasing medium-term recession risks.  The S&P500 was down as much as 1.8% overnight in the aftermath of the stronger ISM Services data, giving back some of its 5.7% rally over the previous two days, but it has had a smart recovery over the past few hours, now only 0.5% lower on the day.  The intraday rebound is suggestive of short covering by investors after the plunge in equities in September.

In other news, the Bank of England completed no QE bond purchases at the long end of the UK bond curve for the second day running, meaning it has now bought only £3.7b out of an allowable £30b to date. The BoE’s intervention at the long end of the UK bond market was justified on financial stability grounds, to prevent an implosion of the pension industry, although some market participants saw it as a potential U-turn away from quantitative tightening.  But the BoE’s revealed behaviour, and a statement overnight clarifying its purchase rules, suggests it wants its bond buying to be used only as a backstop for those investors that need to de-risk, rather than a tool to push down yields.  By the time the BoE’s emergency programme finishes at the end of next week, it will have bought significantly less than the £65b allowable limit, which should help placate those market participants worried that it is helping the government finance its expensive fiscal plan.  The UK 30-year rate was 16bps higher overnight, broadly in-line with global moves.

In a reversal of the moves over the past two days, the USD is significantly stronger overnight, the BBDXY index appreciating 0.7%.  The stronger-than-expected ISM Services index, and sharp upward move in US Treasury rates, has seen the EUR fall around 1%, to back below 0.99, while the GBP has given back some of its recent gains, down 1.3% to 1.1315.  USD/JPY remains much less volatile than the other majors and has cautiously pushed higher to 144.65, with investors likely wary of the potential for renewed Japanese FX intervention above 145.  The NZD and the AUD have been the two best performing currencies over the past 24 hours, both marginally higher against the USD compared to this time yesterday.

The NZD’s brief spike above 0.58 yesterday afternoon, after the release of the RBNZ statement, didn’t last long, and it is back to around 0.5725 this morning.  Likewise, the NZD/AUD cross, which is typically more sensitive to relative interest rate expectations than other cross rates, is only slightly higher compared to its pre-statement levels, at around 0.8830.

The RBNZ raised the OCR by 50bps at the MPR yesterday, as expected, taking the cash rate to 3.50%.  The statement emphasised that core inflation, both in NZ and offshore, was still too high and it was appropriate to continue tightening monetary policy “at pace”.

The main surprise was the revelation that the MPC had debated a 75bps hike, on the basis this might reduce the expected peak in the OCR, before settling on a 50bps move.  The discussion is intriguing since, logically, the higher the cash rate gets (and the closer it is to the likely terminal rate), the less compelling larger interest rate hikes become.  Indeed, the RBA was the first of the major central banks to step down the pace of its tightening cycle the previous day, when it raised its cash rate by 25bps to 2.60%.

There was no discussion on where the RBNZ now sees the likely peak in the OCR for the cycle.  There is still a lot of water to go under the bridge before the RBNZ’s next meeting in November, with CPI data released later this month and the key labour market reports in early November.  And, as recent events have illustrated, the global backdrop can change quickly too.  We are still expecting a 50bps hike from the RBNZ in November and a follow up 25bps hike to a 4.25% peak in the OCR in February.

NZ rates were already significantly lower before the RBNZ statement, reflecting the big falls in Australian rates after the RBA’s surprise 25bps hike the previous night.  There wasn’t much reaction to the news the RBNZ had debated a 75bps move, with rates continuing to grind lower over the remainder of the session.  By the close of trading, the 2-year swap rate had fallen 15bps, to 4.47%, while the 10-year rate was down 12bps, mirroring the steepening of the Australian curve after the RBA.  We should expect a big correction higher in domestic rates today following the global moves overnight.

There’s more central bank talk over the coming 24 hours, with Fed officials Bostic, Evans and Cook speaking and the minutes to the last ECB meeting released.  The market may well shift into a holding pattern ahead of the all-important nonfarm payrolls report tomorrow night.