ECB raises rates by 75bps. Lower European rates spill over to other bond markets - US 10y back below 4%. NZD outperforms. Big falls in NZ bond rates as market gears up for WGBI bond index inclusion for NZGBs on 1 November

The emergent market narrative around central banks having passed the point of ‘peak hawkishness’ has gained further momentum overnight. The ECB raised rates 75bps, as expected, but markets interpreted the statement as suggesting the ECB is becoming more cautious about the need for further aggressive tightening.  European bond rates have fallen sharply, spilling over into other bond markets, and driving the US 10-year rate back below 4%.  The EUR has been the key mover in currency markets, down over 1% to back below parity, while the NZD has outperformed, pushing up to a 5-week high above 0.5850. Yesterday saw big falls in NZ bond rates, as the market starts to question the case for the RBNZ stepping up its rate hike pace next month and as it braces for what are expected to be large offshore inflows at month-end, when NZGBs join the WGBI bond index.

The ECB raised the deposit rate by 75bps at its meeting overnight, as expected, taking it to 1.50%, but the market interpreted the tone of the statement as less hawkish than September.  The ECB noted it had made “substantial progress in withdrawing monetary policy accommodation” and it removed reference to raising rates “over the next several meetings”, instead just saying it “expects to raise rates further ”.  While Lagarde later clarified that the less precise guidance around future rate hikes was because it was moving away from forward guidance, the market took it as an indication the ECB is becoming a little more cautious about the need for further aggressive tightening.  Lagarde added that growth risks were now “clearly on the downside” while inflation risks were “primarily on the upside”.

Following on from the recent WSJ article that suggested the Fed could step down its rate hike pace to 50bps in December and the surprise decision by the Bank of Canada the previous night to shift down to a 50bps hike, the market saw the ECB’s less overtly hawkish messaging as consistent with that trend away from ‘peak hawkishness’. The market thinks the ECB will step down to a 50bps hike in December (just a ~25% chance of a 75bps hike now priced in) and has revised down expectations of the terminal rate for the cycle to about 2.50%.  German 2-year and 10-year bond rates were 17bps and 15bps lower respectively overnight, with the 10-year rate now back below 2%.  The EUR is around 1% lower overnight, to back below parity, consistent with the market taking a dovish interpretation of the ECB’s signalling.

On QT, the ECB said it would determine the principles for running down its large bond holdings at the December meeting.  A subsequent Bloomberg article said the ECB isn’t planning to announce a start date for stopping reinvestments of its APP bond holdings at the December meeting, indicating it is cautious that QT could harm peripheral European bond markets, like Italy.  The market had expected the ECB would foreshadow a decision on QT at the December meeting, so the news on this front was also more dovish than expected.  In response, the Italy-Germany 10-year bond spread contracted 17bps, falling back to almost 200bps, its lowest level since mid-July.

Finally, the ECB is retrospectively changing the terms on its cheap long-term lending operations to banks (under TLTRO III), which is likely to encourage earlier repayment of these loans and faster ECB balance sheet normalisation.  Banks that had originally borrowed from the ECB at -0.75% during the pandemic (with the possibility of achieving a -1% borrowing rate) will now be charged the average ECB deposit rate over the period.  The change was in-line with pre-meeting expectations.

The falls in European rates have spilled over to other bond markets, driving a 5bps fall in the US 10-year rate to back below 4%.  The US 2-year rate is 7bps lower overnight, to 4.33%, as the narrative around central banks getting closer to the end of the tightening cycle gains traction.

US GDP wasn’t a market mover overnight, with the economy growing at a 2.6% annualised pace in Q3, close to market expectations of 2.4%.  This represents a bounce back after two consecutive quarters of negative growth, although temporary factors have recently been distorting the quarterly growth pattern (no one thinks the US economy was actually in recession in the first half of the year).  For Q3, personal consumption was stronger than expected, growing at an annualised 1.4% pace (1% expected) but the GDP result was flattered by a huge increase in net trade which is unlikely to be repeated in future quarters, given the strength of the USD. Residential investment plunged by 26.4% annualised over the quarter, consistent with the major slowdown in train in the housing market.  The underlying growth trend in the US is softening and markets remain wary of a likely recession next year.

Equity markets haven’t benefited as one might have expected from the plunge in global rates, the S&P500 0.2% lower overnight and the NASDAQ down over 1%.  A weak earnings report from Meta (formerly Facebook), which saw its share price crumble more than 20% overnight, has weighed on the NASDAQ.  Meta undershot analyst expectations for Q4 revenue, in part due to an expected 7% year-on-year revenue headwind from FX, while noting a weak advertising environment.  Tech heavyweights Amazon and Apple are reporting their earnings results after the bell this morning.

Outside the EUR (and satellite European currencies), FX market moves have been reasonably modest.  The NZD has outperformed, up around 0.5% over the past 24 hours to a five-week high above 0.5850.  The NZD/AUD cross has bounced back above 0.90.

The increased focus on major central banks stepping down the rate hike pace has spilled over to the NZ rates market.  NZ swap rates were 10bps-12bps lower across the curve yesterday, with the market reacting to the Bank of Canada’s surprise decision to hike by ‘just’ 50bps at the previous night’s meeting.  The market now has a ~70% chance of a 75bps RBNZ hike priced for next month whereas last week it was pricing a 35% chance of a mega-sized 100bps move. Still, the RBNZ would look like an outlier in stepping up to a 75bps hike in November when the global trend is going the other way. There wasn’t much new information from Governor Orr’s comments at the INFINZ conference, in keeping with the RBNZ’s policy of not providing a running commentary on economic and market developments in between meetings.

There was another big fall in NZ bond yields yesterday, as the market gears up for the imminent inclusion of NZGBs into the WGBI index on 1 November. Bond yields were 12bps to 19bps lower from 2-years out to 30-years, outperforming both swaps and offshore markets on the session.  Yesterday’s bond tender saw almost $1b of bids for the $150m 10-year bonds on offer, as well as strong demand for the 20-year bonds, with this being the last opportunity for the market to source primary market supply before WGBI inclusion.  We have previously estimated there could be around $2b of offshore inflows into NZGBs in November, mainly from ‘passive’ funds which use the WGBI as a benchmark.

The highlight of the session ahead is probably the BoJ’s monetary policy meeting later this afternoon.  The strong consensus is that the BoJ will keep its policy settings unchanged (i.e. retain the 25bps ceiling on the 10yr bond rate via YCC), however there is a chance Kuroda could signal a possible shift in the future if underlying inflation maintains its recent momentum. The Employment Cost Index, the most comprehensive measure of US wage growth, is released tonight.  The market is looking for 1.2% quarterly increase in the ECI, a much higher pace of wage growth than would be consistent with the Fed hitting its 2% inflation target.  German GDP data is expected to confirm the economy contracted 0.2% in Q3 as energy prices surged while annual German CPI is expected to remain at almost 11% y/y.  There are no speeches from Fed officials as they are in blackout before the meeting next Thursday night.