Global rates continue to push relentlessly higher - US 10-year breaks above 4.20%. USD/JPY breaks above 150 for the first time since 1990 - market wary of further FX intervention from Japanese authorities

Market moves overnight have been a little more subdued by recent standards, but the relentless upward trend in global rates remains in force.  The US 10-year rate hit 4.20%, its highest level since 2008, while USD/JPY touched 150 for the first time since 1990.  Liz Truss finally resigned as UK Prime Minister but there hasn’t been much market impact, given her low-tax policy agenda had already effectively been ditched.  Currency moves have been relatively modest, the NZD trading just below 0.57 this morning.  Yesterday saw enormous volatility in NZ rates markets, but there were finally some signs that the washout of positions after the NZ CPI data might have run its course.

The train wreck that has been Liz Truss’s premiership came to an end overnight after she announced her resignation. In the battle of which would last longer, the iceberg lettuce won.  Another leadership contest will now be fought, although the Conservative party will restrict it to a maximum of three candidates, all of whom would need to gather the support of at least 100 MPs of the party. The new PM is expected to be decided by 28 October, after a vote of the party membership, so they will be in place before the medium-term fiscal plan announcement on 31 October.  Bookmakers have installed former Chancellor and Truss’s leadership rival Rishi Sunak as favourite to become the new PM, with Penny Mordaunt and Boris Johnson also seen as in contention.  Sunak consistently warned that Truss’s policy platform would exacerbate inflation and cause markets to take fright, predictions that have been accurately borne out.

There hasn’t been a lasting market reaction to the Truss resignation announcement, with her departure always seen as a matter of when, rather than if, and new Chancellor Hunt having already effectively cancelled most of her expensive tax cut proposals.  The GBP initially rallied on the news, trading up as high as almost 1.1340, but it has since given back those gains to now be largely unchanged on the day.  UK gilt yields initially fell but they too have reversed course over the past few hours, with the 10-year yield ending 3bps higher, at 3.90%.  Perhaps more importantly for the gilt market, the Bank of England confirmed that it would start selling down its holdings from 1 November, with eight auctions totalling £6b scheduled by the end of the year.

Besides the UK political shenanigans, there hasn’t been much market-moving news overnight.  The Philly Fed business survey improved marginally in October while US initial jobless claims were lower than expected, consistent with an extremely tight US labour market.  Fed officials Harker and Bullard talked up the need to act aggressively this year while suggesting further rate hikes in 2023 would depend on the data.  Bullard noted “in 2023 I think we’ll be closer to the point where we can run what I would call ordinary monetary policy…now you’re at the right level of the policy rate, you’re putting downward pressure on inflation, but you can adjust as the data come in in 2023.”

Global rates continue to push relentlessly higher against a backdrop of heightened inflation concerns and expectations for continued aggressive monetary policy tightening.  The US 10-year rate has broken above 4.20% in the past few hours, now 8bps higher on the day and at its highest level since 2008.  The market is now pricing a peak in the Fed cash rate above 5% by early next year.  In cycles over the past 30 years, the US 10-year rate has tended to peak around the time of the last (or penultimate) rate hike of the cycle, suggesting the trend higher in rates probably has scope to carry on for a little while yet.  The German 10-year rate was 3bps higher overnight while the implied rate on the Australian 10-year bond future has increased around 7bps since the NZ market closed.

The higher rates backdrop continues to exert upward pressure on USD/JPY, which hit the psychologically important 150 level overnight, the first time since 1990.  It is currently trading just above 150, although market participants remain wary of the potential for another bout of FX intervention from the Ministry of Finance.  Relatedly, the BoJ needed to step in yesterday to defend the 0.25% ceiling on the 10-year bond yield under its Yield Curve Control (YCC) policy.  With Japanese bond rates unable to adjust higher in response to rising US Treasury yields (because the BoJ is capping them under YCC), the release valve continues to be ongoing depreciation in the JPY.  Japanese FX intervention is only likely to slow, rather than prevent further yen depreciation while the BoJ retains its YCC policy and US Treasury yields continue to trend higher.

The relentless rise in global rates continues to put downward pressure on equity markets.  The S&P500 has given back gains of more than 1% and is now around 0.7% lower on the day. Disappointing revenue results from Tesla, which saw its share price fall 6% overnight, have weighed on the market. Tesla CEO Musk observed that “demand is a little harder than it would otherwise be”, suggesting some signs of slowdown in consumer spending on goods. Among other names reporting, IBM beat analyst expectations for earnings and revenue, seeing its share price jump 4% overnight.  So far, the earnings season has gone better than analysts had expected, providing a partial offset to rapidly rising bond yields.

Yesterday Bloomberg reported that China was considering reducing quarantine requirements for travellers to the country, potentially requiring 2 days hotel quarantine and 5 days self-isolation at home (from 7 days in a hotel and 3 days at home at present).  The proposal hasn’t been signed off by the party leadership and previous relaxation of quarantine rules haven’t been a precursor to any loosening in China’s zero-Covid approach.  Xi reiterated his support for the zero-Covid policy in his speech earlier this week.

Currency moves have been relatively restrained overnight.  The DXY index is down around 0.2%, having recovered from its lows of the day as equity markets peeled off their highs.  The NZD traded as high as 0.5740, a two-week high, but it has since pulled back to around 0.5680 as risk appetite has faltered.  Likewise, the AUD traded above 0.6350 a few hours ago but is back below 0.63 as we go to print, around 0.3% higher on the day.

The Australian labour market report was slightly weaker than expected, with employment increasing just 1k last month compared to market expectations for a 25k lift.  The unemployment rate stayed at an ultra-low 3.5%.  The market reaction was fleeting, with investors much more focused on the CPI release next week as the key driver for the RBA.  Our NAB colleagues are looking for another punchy quarterly reading for core inflation next week (1.6% q/q on the trimmed mean measure, slightly above the 1.5% consensus).  The market is still only attaching a small risk premium for a 50bps RBA hike next month, with around a 15% chance of such a move priced in.

Yesterday was another wild ride for the domestic rates market with significant volatility in both directions.  Rates initially picked up where the left off the previous day, blasting up to fresh multi-year highs in the morning, with swap rates as much as 14bps higher at one stage (the 10-year swap rate breaching 5% for the first time since 2014).  Rates then turned around sharply in the afternoon, eventually closing only 1-2bps higher.  Market pricing for a super-sized 100bps OCR hike next month was pared back from around a 35% chance to now around 10%.  The turnaround in NZ rates yesterday might suggest the washout of positions after the NZ CPI data might have run its course, although the market remains very volatile.

Government bonds performed relatively well, with yields down marginally on the day compared to a 12bps increase in Australia, helped by very strong demand for the longer bonds on offer at yesterday’s bond tender.  There is just one bond tender remaining ($400m next Thursday) before NZGBs join the WGBI index on 1 November. We’re expecting something in the region of $2b of offshore investor inflows into the local government bond market in the first month of index inclusion.

The Japanese CPI release is worth keeping an eye on this afternoon.  The ‘core-core’ measure of CPI (ex fresh food and energy, is expected to hit an annual rate of 1.8%, which would be a new 30-year high for this series (excluding changes in the consumption tax).  Inflation momentum is stronger than the annual rate implies, with the 6 monthly annualised core-core inflation rate running north of 3%, suggesting a BoJ policy shift is likely at some point over the coming year.