Stronger services PMIs suggest economies are more robust than previously believed. And play to theme of tighter for longer monetary policy. Global rates much higher, UST10s peak just under 3.95%

Stronger services PMI data moved the market, with good news on the economy representing bad news on the monetary policy outlook. Global rates are notably higher, with the US 10-year rate peaking just under 3.95%, and equity markets are much weaker. The USD has outperformed against all bar GBP, given an outsized move on UK rates. The NZD is weaker, but key support at 0.62 has held.

The market has been trading nervously through February on the back of positive economic surprises that challenge the view of an imminent end to the monetary policy tightening cycle. Stronger flash PMI data for February added to the data releases that have now piled up, suggesting that economies are proving to be more robust than previously expected and this can only keep the heat on central banks to continue to hike rates.

PMI data for the services sector were notably stronger than expected across the Euro Area, UK and the US, rebounding further into expansionary. Manufacturing gauges were weaker across Europe and slightly stronger in the US, but still all in contractionary territory. With the services sector being a much larger and important part of the economy, composite gauges expanded. The data played to the theme that rate hikes weren’t seriously affecting economies and both the Euro area and UK economies might have truly avoided recession, with activity now swinging higher in Q1 from a weak base.

On inflation, the surveys continued to show high inflation pressure in the services sector, with the Euro area release suggesting “hints at persistent elevated price trends in the service sector, linked in part to higher wage growth” and the US release noting that the improved supply situation had taken price pressures out of manufacturing supply chains but “the upward driving force on inflation has now shifted to wages amid the tight labour market”.

The market moved swiftly to price in a further extension of the policy tightening cycle, with 2-year rates up 5bps for Germany, 8bps for the US and 16bps for the UK. Longer term rates are also much higher, 7bps for Germany, 11bps for the US and 14bps for the UK. The US 10-year rate peaked just under 3.95%, a fresh three-month high, and is currently at 3.92%. For the first time, the market fully prices in three full 25bps hikes from the Fed over coming meetings.

The larger move for UK rates reflects the larger surprise for the country’s services PMI, dealing a blow for those thinking that the BoE might be persuaded to pause at its next meeting, with almost a full 25bps hike now priced. This move has seen GBP outperform, up 0.8% overnight to 1.2120 against a backdrop of broader USD strength. 

The NZD is one of the weakest performers, down about 0.4% overnight to 0.6215, with key support at 0.62 holding. NZD/GBP is down over 1% to 0.5130. The AUD has also underperformed trading at 0.6860. While NZD/AUD has been range-bound around 0.9050, the NZD is modestly weaker on the other key crosses.

Higher rates have perturbed equity markets, with the S&P500 currently down over 1½% and the Nasdaq’s fall closer to 2%, both on track for a third consecutive weekly decline after factoring in a tighter for longer monetary policy backdrop. Walmart posted stronger than expected sales, a sign of cash-strapped consumers moving down the food chain to discount stores, so not necessarily a positive economic sign, and the company was downbeat on the outlook, saying there is much uncertainty and that customers are being more cautious about spending.

In other economic news, US existing home sales were weaker than expected, falling for a twelfth consecutive month, taking the peak to trough slump to 37%. Canadian CPI inflation data showed inflation easing to 5.9% y/y, 0.2pps weaker than expected. The average of the three core measures nudged down by 0.1% to 5.6% y/y. The data supported the Bank of Canada’s “pause” guidance on rate hikes at its last meeting.

The overnight GDT dairy auction showed a pullback in pricing from the previous strong one, with the price index down 1.5%, with the stronger USD over the past fortnight accounting for the move, so little change in NZD terms.  Whole milk and skim milk prices were down 2.0% and 2.4% respectively, offset to some extent by solid gains in butter (3.8%) and cheddar (1.5%).

In the domestic market, short end rates continued to push higher, reversing the fall seen last week in what looked like an over-reaction to the impact of the cyclone – the mood not helped by Finance Minister Robertson’s comments which came after Monday’s close that the RBNZ can “look through current events”. The move drove further curve flattening, with 2-year swap up 7bps to 5.20% and 10-year swap up 3bps to 4.50%.  NZGBs showed an even larger flattening bias, with the 2-year rate up 10bps and the 10-year rate up 4bps.

The domestic focus today will be on the RBNZ’s MPS, where there is a strong consensus that the OCR will be hiked by 50bps to 4.75% (market pricing at 4.71%). The impact of Cyclone Gabrielle is unlikely to be captured in the forecasts – there are still too many unknowns – so the messaging will be more important than the published figures. It would be premature for Governor Orr to declare that the war has been won against inflation, so we expect guidance towards further rate hikes, although the forward rate track is probably unlikely to be any higher than the previously published 5.5% OCR peak.

Ahead of that release, Australian wage data are expected to remain strong, keeping the pressure on the RBA to continue to hike rates, the Bank being a laggard in the tightening cycle compared to other dollar-bloc countries. Tonight sees the released of Germany’s IFO survey.