US rates higher ahead of Powell, equities slightly lower. Optimism around an eventual end to the China zero-Covid policy continues to grow

Market moves have been relatively contained over the past 24 hours as investors wait on Fed Chair Powell’s speech at 7:30am this morning.  US equities are flat to slightly lower, US rates have pushed modestly higher, while the DXY is little changed.  Optimism around an eventual shift away from the zero-Covid policy in China continues to gather momentum, with Bloomberg reporting the health authorities are planning a fourth vaccine shot and state media appear to have subtlety shifted their messaging around Covid.  The CNH is around 0.7% stronger, which has dragged the NZD and AUD higher, while the Hang Seng was up more than 2% again yesterday, continuing its recent strong run.  NZ short-end rates were lower yesterday on the back of lower Australian rates and a dire ANZ Business Survey.

The market has been primarily focused on China this week, amid signs of a shift in its zero-Covid approach, but attention returns to the US today with Fed Chair Powell giving a speech on “The economy and labour market” shortly.  Powell is expected to rubber stamp a step down to a 50bps rate hike later this month but push back against any market thoughts of a dovish ‘pivot’ any time soon.  In the lead-up to Powell’s speech, market moves have been relatively modest.  The S&P500 is currently down 0.3%, the US 10-year rate is 3bps higher, at 3.77%, while the DXY USD index has increased around 0.1%.

In China, a day after the National Health Commission announced that it would encourage elderly people to get vaccinated, Bloomberg reported that the authorities were considering authorising a fourth Covid shot, with the elderly to be prioritised.  Such a move would be consistent with the market’s growing sense that China is making plans to move away from the zero-Covid policy next year. Separately, Bloomberg reported that Chinese state media appear to have shifted their messaging on Covid, with the People’s Daily telling people to be responsible for their own health and several media outlets running stories of people who have recovered from Covid.  A change in the official narrative, away from ‘fear’ of the virus, is likely to accompany an eventual shift towards living with Covid.  Chinese assets have continued their recent strong run amid growing optimism around the medium-term growth outlook, with USD/CNH falling 0.7% over the past 24 hours, to now below 7.10, and the Hang Seng rallying 2.2%, capping off a month in which it increased 26.6%.

The tailwind from a stronger CNH has seen the NZD and AUD outperform over the past 24 hours, the two currencies 0.5% and 0.3% higher respectively.  The NZD has pushed up to 0.6235 while the AUD has rebounded back above 0.67, despite a lower-than-expected monthly Australian CPI print yesterday (see below).  The EUR is now little changed on the day, at around 1.0320, while USD/JPY has pushed up to 139.35 (+0.7%) amid an increase in US Treasury rates.

There has been a deluge of economic data overnight.  The JOLTS data showed a fall in the ratio of job openings-to-unemployed to 1.71, its lowest since last November but still well above pre-Covid levels and consistent with an overheated job market.  This ratio has been one of Fed Chair Powell’s favourite metrics of labour market tightness. The revamped ADP employment report showed a net 127k job gain in November, well below the 200k consensus for payrolls, although this indicator has had a patchy track record predicting payrolls over recent months.  Meanwhile, the Chicago PMI was a shocker, plunging to 37.2 in November, recessionary levels.   While the Chicago PMI can be volatile month to month, it is another indicator pointing towards a sub-50 ISM Manufacturing survey tonight.  Finally, the core PCE deflator, the Fed’s preferred inflation measure, was revised slightly higher, to a 4.6% annualised rate in Q3, highlighting the Fed still has work to do to get inflation back to target.

US rates are higher overnight, with the market seemingly reacting to the modest upside surprise to US core PCE inflation and as investors prepositioned ahead of Powell’s speech, due at 7:30am this morning.  The US 2-year rate is 5bps higher overnight, to back above 4.50%, while the 10-year rate is 3bps higher, at 3.77%.

In Europe, headline inflation was well below expectations in November, a welcome downside surprise after a relentless run of higher-than-expected inflation prints.  Annual headline inflation fell 0.1% on the month, as foreshadowed by the Spanish and German inflation numbers the previous night, taking the annual rate down to a still-extremely-high 10% y/y. Importantly, however, core inflation remained at 5% y/y, well above the ECB’s 2% target.  The German 10-year rate was little moved overnight after the previous day’s 7bps fall.  The market is now in favour of a 50bps ECB hike next month, with a 75bps move seen as an outside chance (around 25%).

In Australia, the new monthly CPI series came in significantly below expectations, at 6.9% y/y in October.  Our NAB colleagues caution against reading too much into the data, noting this is not a full CPI (it only reflects up-to-date information on 62% of the basket), contains little new information on the all-important trends in market services inflation, and does not mean the peak in inflation is past.  Nonetheless, the market seized on the release by paring back RBA rate hike expectations, with just less than 20bps now priced in for next week’s meeting and a terminal rate of around 3.80% expected.

The ANZ Business Survey for November made for sobering reading, with the Own Activity index slumping to its lowest level since mid-2020, consistent with the impending recession the RBNZ is forecasting, while residential investment intentions collapsed to a staggering -90%.  The slump in residential investment intentions is consistent with a major downturn in the construction sector ahead which should, in time, help alleviate some of the intense inflationary pressures from the sector.  Notably, pricing intentions from the ANZ survey were sharply lower, calling into question the RBNZ’s recently revised near-term CPI inflation forecasts.  While the net 59% of firms reporting their intention to raise prices is still relatively high historically, it is now well off its highs (of 80%) and appears to be moving in the right direction for the RBNZ.  Finally, employment intentions turned negative for the first time since 2020, a tentative sign that some heat might be starting to come out of the labour market.

Separately, Westpac raised its mortgage rates yesterday to similar levels as ANZ, the key 1-year fixed mortgage rate now at 6.49%.  There is still a significant amount of tightening in the pipeline in NZ with the average fixed mortgage rate (as of September) just 3.78% and more than half of NZ fixed rate mortgages due to refix over the coming 12 months.

The pullback in Australian rates after the CPI miss yesterday spilled over to the NZ curve, driving the 2-year swap rate down 6bps, to 5.14%.  The curve finally appears to be coming under some steepening pressure, after the huge flattening move in recent months, with the 2y10y swap curve pushing back up to -75bps.

Besides Powell’s speech, the other main event in the session ahead is the ISM Manufacturing survey where market expectations are for the index to fall below into contractionary territory (49.7) for the first time since mid-2020.