Market more sensitive to weaker than stronger data releases. Softer US PMIs and higher jobless claims push US rates and USD lower. NZ rates curve much higher and flatter on hawkish RBNZ signals

Higher risk appetite has extended, with another positive session on Wall Street, lower global rates and a weaker USD. Data releases were mixed, with the market giving more weight to signs of US economic weakness than the positive surprises. NZ rates rose sharply and the yield curve flattened significantly after the RBNZ delivered a record 75bps lift in the OCR to 4.25% and projected much higher rates to come, substantially more than the market had priced in. The NZD showed a modest gain post-MPS, constrained by the clear outlook for economic recession, with a move back above 0.62 overnight on USD weakness.

There has been a lot of global data to digest overnight with the weaker US data proving to be market moving.  PMI data were consistent with economic contraction across Europe and the UK in November, although the figures were generally not as weak as expected and at face value suggest a shallower recession than widely expected, although it is still early days.

By contrast, there were significant downside misses for the US PMIs, with the services index particularly weak at 46.1, below the levels recorded for Europe. US PMI data are more volatile than the preferred ISM indices, but they are still worth keeping a close eye on. Furthermore, jobless claims at 240k were higher than expected, with a distinct upward trend now in play over recent weeks. The continuing claims indicator has risen for six consecutive weeks and is on the threshold of signalling economic recession, an indicator which has had a 100% track record in signalling the eight recessions since 1970. Other US releases on durable goods orders, the final reading of consumer sentiment and new home sales were higher than expected.

The market reacted to the weak US data reports, with lower rates and the already weak USD extending losses. US Treasury yields are 2-3bps lower across the curve, although European rates are even lower, with Germany’s 10-year rate down 5bps and the UK 10-year rate down 13bps. We’ve previously noted the significant inverted US yield curve, but overnight Germany’s 2s10s curve became the most inverted since 1992, adding to range of economic indicators signalling economic recession.

The USD shows broad based losses with only CAD and CNY weaker. CAD’s performance has been weighed down by much lower oil prices and USD/CAD is up 0.2% to 1.34. Oil prices fell over 4% with Brent crude below USD85 per barrel as the EU’s price cap on Russian crude was proposed to be between USD65-70 per barrel, higher than expected.  A high price cap – noting that this is well above the country’s cost of production and as Russian crude trades around a $20 per barrel discount – would have minimal impact on trading, keeping Russia’s supplies flowing into the global market. An analyst from Bruegel, a Brussels-based think tank, said that any price cap above USD60 would not be certainly meaningful. Adding to the weaker sentiment in the market, were a large gain in US gasoline stockpiles and weaker demand.

The yuan weakened after reports of violent protests at Apple’s main IPhone plant in Zhengzhou did the rounds.  Social unrest is becoming more prevalent under varying COVID restrictions and there are inconsistencies over how local authorities are interpreting the government guidelines to contain the virus but without unnecessarily harming the economy. China’s State Council pledged support for the economy by measures including cutting banks’ reserve requirement ratio “at an appropriate time”, which some are picking could come as early as this week. USD/CNY is up 0.3% to 7.16.

GBP is the strongest of the key majors, up 1.3% overnight to 1.2040. The yen has strengthened over 1%, with USD/JPY back below 140. EUR has been a laggard only up 0.5% to 1.0370.  The NZD and AUD have made gains around 1% overnight, the NZD breaking comfortably above 0.62 and AUD back up through 0.67. For the NZD, higher risk appetite, driving a weaker USD, has had more impact than the hawkish RBNZ policy update, but NZD crosses are mostly higher. NZD/USD jumped 50 pips on the RBNZ announcement but soon faded, the support from higher NZ rates offset by expectations of some tough times ahead for the economy. NZD/AUD is up about 20 pips from the pre-MPS level to 0.9275.

As we noted yesterday, we thought the market was well positioned for a hawkish RBNZ policy update but the Bank still managed to deliver a significant hawkish surprise. The 75bps hike to 4.25% was well anticipated by most but, rather than being a toss-up between 50bps or 75bps, the Bank indicated it was more a decision between 75bps and 100bps, despite being well advanced in the tightening cycle. Furthermore, the projected OCR track was revised substantially higher, adding an additional 140bps of tightening from the August forecast to a peak OCR of 5.50%. In the press conference, Governor Orr said he was “very eager” to get to the OCR peak.

Driving the decision, the Bank was spooked by the recent large upside surprise to the CPI and that feeding into wages and inflation expectations. It is now looking to drive the economy into recession next year and it will take a 2½ percentage point lift in the unemployment rate to 5.7% to bring inflation back down to 2%.

The Bank’s message was clear, with absolute focus on the inflation target, to the detriment of economic activity.  It wasn’t happy with the pricing of an OCR only peaking as low as 5.15% – the prevailing rate in the week leading up to the MPS – the Bank wanted to see rates much higher than that. The market duly responded, with the OIS market now pricing the OCR close to 5.5% within the first half of next year, in line with the RBNZ’s view. A rolling maul of economists’ revisions to OCR forecasts followed, given the clear message by the RBNZ, with most seeing the Bank delivering on its projections.

The 2-year swap rate closed the day up 22bps to 5.28%, and the curve flattened significantly further, with 5-year year swap up 15bps and 10-year swap up just 6bps. The 2s10s spread hit minus 80bps, indicating that the RBNZ will get its wish of economic recession.  In the early stages of the GFC the spread reached a nadir of about minus 100bps. The RBNZ’s projection for a shallow recession next year looks optimistic, based on the current reading of the yield curve. The negative sloping yield curve gives the message that the market thinks monetary policy is tight and easier policy will soon follow tighter policy. OIS pricing shows the first full (25bps) easing priced by February 2024.

In the day ahead, soon after we go to print the FOMC will be releasing the minutes of the November meeting, where it changed the language around the policy outlook, softening its previous stance – taking into account the lags of monetary policy and the cumulative effect of the tightening to date in terms of its policy decisions going forward. Tonight, Sweden’s Riksbank is expected to hike its policy rate by 75bps to 2.5%, following the mammoth 100bps hike in September. The data calendar is light with Germany’s IFO business survey the key release.