Markets remain volatile but net result is a strong gain for US equities and US 10-year rate back above 4%. Market pricing of NZ OCR peak now above 5.3%

Markets have remained volatile, with a 2% swing in US equity futures and UK and US 10-year rates trading a 20bps and 10bps range respectively. Despite speculation to the contrary, the BoE announced it would commence QT (active gilt sales back to the market) from 1 Nov. The US 10 is back up through 4%. Yesterday’s strong NZ CPI triggered a large rise in domestic rates and supported the NZD. The currency has held its gains overnight.

The big news yesterday was NZ’s CPI showing a massive increase in Q3 of 2.2%, well above market expectations of 1.5%, seeing the annual increase nudge down only slightly to 7.2% y/y. Over half of the forecast error can be traced to a 20% surge in airline fares (which could well reverse sometime next year when more capacity comes on stream), but there were also signs of sticky underlying inflationary pressure.  All key annual core inflation measures lifted and ranged between 5.0% to 6.9%, including the RBNZ’s core sectoral factor model estimate, which rose to a record high of 5.4% y/y in data that dates back thirty years.

Given the RBNZ’s undeniable focus on bringing inflation down, the unusually large positive forecast error triggered a significant reaction in the rates market and economists ramped up their projected rate calls. One domestic bank revised twice within two hours, such was the flurry to meet the market’s repricing of the outlook. By the end of the day, all the major local trading bank economists were calling for a 75bps hike in November, no doubt influenced by the discussion at the October review that the RBNZ had debated whether to hike 50bps or 75bps at that meeting.  The OIS market priced in 72bps of hikes for November and a peak OCR of just over 5.3%.

The swaps curve flattened significantly with the 2-year rate closing up 14bps at 5.15% and the 10-year rate up 4bps to 4.81%.  Bond-swap spreads widened again, with the 10-year NZGB up only 2bps to 4.55%. The higher the cash rate goes, the deeper the economic recession NZ will face next year and the increased chance that an easing cycle will not long follow the tightening cycle – such is the case when inflation has got out of hand and the optics right now are that the RBNZ has to be seen to act tough to assert its inflation-fighting credentials, even if leading indicators point to a rapid decline in inflation through next year.

The NZD was supported by the news, with the higher rates backdrop providing a short-term fillip, but the move tempered by the fact that a likely deeper recession is ultimately bad news.  The NZD rose over a cent to almost as high as 0.5720 overnight, with further support from higher risk appetite as we note below, but it has since fallen back below 0.57. NZD crosses are all higher over the past 24 hours, with NZD/AUD settling just over 0.90.

Soon after the NZ close, the FT reported that the BoE was set to delay (again) the sale of billions of pounds of gilts bought under the QE programme, from the scheduled start of 31-October, due to the “very distressed” gilts market. This drove higher risk appetite but five hours later a BoE spokesperson said that the FT report was inaccurate and just over an hour ago the Bank confirmed the first gilt sale operation will take place 1 November. For Q4, the sales will be concentrated across gilts with a residual maturity between 3-20 years. Separately, the UK Treasury published a letter from BoE Deputy Cunliffe saying that the LDI funds which triggered the recent market distress had raised tens of billions of pounds in capital and are now on a more sustainable footing.

In line with recent volatility, trading in UK gilts has been choppy, with the 10-year rate trading between 3.90-4.10% and closing at 3.95%, ahead of the BoE’s announcement confirming QT sales. Trading in US Treasuries has also been choppy, trading a 3.96-4.06% range and currently flat around 4%.

US second-tier data were mixed. US industrial production rose 0.4% m/m in September, stronger than expected and seeing manufacturing capacity utilisation rise to 80%, matching the highest level in nearly two decades. High utilisation is usually associated with stronger inflationary pressure. The NAHB index of homebuilder sentiment fell for the tenth consecutive month, to 38, further signs that higher mortgage rates are a massive brake on housing market activity.  The index is a good leading indicator of new home sales, which are apt to plunge over coming months.

We noted the stronger NZD above and for other currencies, the AUD has traded in a choppy fashion but largely sideways centred around 0.63. Same goes for EUR, tracking sideways around 0.9850. GBP has traded a wide range of 1.1260-1.1410 and it currently sits just over 1.13, one of the worst performers overnight. As the political shenanigans move off the front pages, economic reality will bite. The key UK 2-year mortgage rate pushed up to a fresh 14-year high above 6.5%, to go along with a jump up in household energy bills this winter, the possibility of power cuts, some fiscal austerity under the new Chancellor and possibly ongoing volatility in rates markets.

The yen is on track to fall for the tenth consecutive day against the USD, as traders continue to test the appetite for official intervention and against a backdrop of ongoing upside pressure to global rates USD/JPY has traded as high as 149.38 and currently sits just below that.

In equity markets, the S&P500 was over 2% higher just after the open, with the gain pared back to barely positive, but recovering again as we go to print, up 1.4%. Goldman Sachs posted a stronger than expected profit, supported by its fixed income trading operations, and the 3% lift in its share price is currently the largest contributor to the gain for the Dow Jones index. It’s fair to say that the early read on the earnings season has been more positive than expected so far.

The overnight GDT dairy auction showed chunky falls in prices across all products offered, with the price index down 4.6%, the largest falls coming from whole milk powder (down 4.4%) and skim milk powder (down 6.9%). The falls were larger than expected, especially in light of Fonterra announcing that it was scaling back the WMP it would offer on the platform against a backdrop of lower milk production.

In the day ahead, UK and Canadian CPI data are released, both still expected to be at uncomfortably high inflation rates, the former at 10.0% y/y and the latter at 6.8% y/y, with monthly changes flattered by weaker gasoline prices. US building permits and housing starts round out the calendar.