Investors waiting on US midterm election results and US CPI later this week. Global rates lower overnight while equities continue to recover

Risk appetite has continued to rebound overnight as investors await the results of the US midterm elections and the all-important US CPI data later this week. Global rates are lower, the US 10-year rate back to around 4.13%, helping to support a further lift in equities (S&P500 +1.3%) and a weaker USD.  The NZD has pushed up to almost 0.60.  Yesterday saw a large jump in 2-year ahead NZ inflation expectations, solidifying expectations for a 75bps RBNZ rate hike later this month.

Voting has started in the US midterm elections where betting markets and polls favour the Republicans retaking the House and (with somewhat less conviction) the Senate too, setting the stage for political gridlock over the next two years. Some investors are taking a glass half-full view of what would be a divided government.  With fiscal policy set to be constrained, it will likely put the onus on the Fed to respond in the event of a major future downturn, which investors think might be as soon as next year.  Likewise, Republicans will be able to veto any proposed corporate tax increases by Biden and the Democrats.  And while there are concerns we could see a repeat of the brinksmanship around lifting the debt ceiling in 2023, some analysts think the Democrats could use the lame duck session in December to pre-emptively raise the debt ceiling, which would be one less thing for the market to worry about next year.

The midterms shouldn’t be a major market mover, with investors fully expecting a divided government, and the key market focus is on the CPI report on Thursday night.  Markets are expecting a 0.5% monthly increase in US core inflation, a small step down on the previous month but, at 6% annualised, still much too high for comfort for the Fed.  Ahead of the CPI data, Manheim reported used car prices fell 2.2% in October, their fifth successive monthly drop, unwinding some of their post-pandemic surge higher.

There hasn’t been any major news overnight to drive markets, with little in the way of economic data and no Fed officials out speaking.  Equities have seen further gains, the S&P500 up 1.3% and the NASDAQ up 1.5%, with some commentators noting the historical tendency of equities to perform well under a divided government.  After its strong gains over recent days, on speculation   China will start to transition away from its zero-Covid policy over the coming year, the Hang Seng was broadly flat yesterday.

Global rates curves are lower and flatter overnight, reversing some of their recent sharp increases, as investors adjust positions ahead of the CPI release.  The US 10-year rate, which was trading around 4.22% at the time of the NZ market close, has fallen back to 4.13%.  Ahead of the CPI data, the market is pricing around a 35% chance of a 75bps Fed rate hike next month.  European 10-year bond rates were 6-10bps lower overnight even with ECB Vice President De Guindos saying the ECB would commence quantitative tightening (QT), by stopping reinvestments of its maturing bonds, “sooner or later, for sure in 2023.”

The USD is broadly weaker again overnight against a backdrop of improving risk sentiment and lower global rates.  The BBDXY index is down 0.5%, extending its fall over the past three trading sessions to 2.6%.  The falls in US Treasury yields, which have narrowed the US-Japan rate differential, have seen USD/JPY fall back to around 145.60, near its lowest level in a month.  The EUR is up 0.6%, pushing further above parity to around 1.0085.  The NZD and AUD have outperformed amidst the improvement in risk appetite, both up around 0.9% over the past 24 hours, the NZD now approaching the 0.60 mark for the first time in almost two months and the AUD breaking above 0.65.

Turning to local developments, the RBNZ’s Survey of Expectations showed a sizeable increase in the closely followed 2-year ahead inflation expectations series, jumping from 3.07% to a 30-year high of 3.62%.  While an increase in inflation expectations was to be expected, given the survey opened just seven days after the big upside surprise to NZ Q3 CPI data, the size of the move will no doubt be of some concern to the RBNZ.  Longer-term inflation expectations nudged higher, the 5-year ahead series increasing to 2.48%, close to its levels two quarters ago, and the 10-year ahead series moving up to 2.18%.  While the survey had only 33 respondents, meaning some might reasonably question its representativeness, the lack of alternative quality longer-term inflation expectations measures means the RBNZ survey does receive market attention.

The big increase in 2-year ahead inflation expectations, in combination with the tailwind from higher global rates during the local trading session, drove a significant increase in NZ rates yesterday.  Swap rates were 13-14bps higher across the curve, with market pricing for the terminal OCR again pushing up towards 5.50%.  The market is almost fully pricing a 75bps hike from the RBNZ later this month and around a 70% chance of a follow-up 75bps hike in February.  We should see some reversal in NZ rates today, with the implied yield on the Australian 10-year bond future around 7bps lower than where it was when the NZ market closed yesterday.  In other news, Adrian Orr was reappointed as Governor for a second five-year term.

There is not much on the agenda for the trading session ahead, with market attention likely to be focused on early results from the midterm elections.  China’s CPI and PPI are expected to show, in contrast to most countries, that inflation is still well under control.  NY Fed President John Williams is speaking tonight, the first of the heavy hitters on the FOMC to speak after the most recent statement.  Locally, electronic card transactions data are reported.