Weak US consumer confidence. Inflation expectations at 12-year high. US Dollar makes largest weekly gain since February. NZ yields lower and steeper following RBNZ inflation expectations survey

Major equity markets were little changed on Friday continuing the range bound conditions that have characterised May trading thus far. The recovery in the S&P from the peak of the banking stress in March has stalled below the key 4200 resistance level, which was the year-to-date highs for the index reached in February. However, US banking stocks remain under pressure with the closely watched index of regional banks ending the week close to the recent lows.

Investor risk appetite may be tested as negotiations to increase the US debt ceiling play out. Following on from US Treasury Secretary Yellen’s comments that the Federal Government could be heading for a default in early June, the Congressional Budget Office warned there is significant risk that the Government may not be able to meet all its obligations in the first two weeks of June if the debt ceiling is not raised. While an 11th hour deal will likely be reached, Treasury bills pricing reflects elevated risks.

The Michigan consumer confidence index fell to 57.7 from 63.5, well below the consensus of 63.0 with both current and expectations components falling. This likely reflects higher gas prices through April (which have now moderated) and lingering concerns about the banking stress. In addition, 5-10 years inflation expectations rose to a 12 year high of 3.2% and 1-year inflation expectations were little changed from April at 4.4%. Elevated inflation expectations are unlikely to be sustained and are at odds with market-based measure of break-even inflation, which are at the lowest levels since the start of 2021.

The latest commentary by US Federal Reserve officials highlighted inflation concerns. Chicago Fed President, Austan Goolsbee, said inflation is too high which followed comments by Fed Governor Michelle Bowman that it wasn’t clear if policy is restrictive enough and the central bank will likely need to raise interest rates further if price pressures don’t cool. Market based pricing for the June FOMC meeting overwhelmingly favours a pause in the hiking cycle before cuts later in the second half of the year. US yields moved higher on Friday evening but were little changed over the course of the week.

The UK economy grew 0.1% in Q1, matching expectations, and demonstrating resilience to higher interest rates and industrial action. Bank of England (BOE) chief economist, Huw Pill, said that inflation is at a ‘turning point’ and will turn sharply lower from energy related base effects. Slowing inflation combined with weakening domestic demand, in part driven by the transmission of higher rates through the economy, suggest that BOE officials may be getting closer to a pause in the hiking cycle.

Meanwhile in currency markets, the US Dollar made broad-based gains resulting in the best weekly performance since February. The Dollar benefited from the rebound in yields and market chat of persistent short covering of US Dollar positions. There is elevated positioning in some USD pairs. For example, speculative positions in EUR USD currency futures are 2 standard deviations above a 2 year mean as reported the Commodity Futures Trading Commission (CFTC) suggesting some pain if EUR USD downside gains further momentum.

The New Zealand Dollar was one of the weaker performers ending the week below 0.6200 and underperforming on the cross rates which saw the Trade Weighted Index fall close to 1.5% over the course of the week. Notably NZDAUD retraced from the 2023 highs near 0.9400 and relative fundamentals suggest there may be room for further declines on this pairing.

The domestic rates market ended the week with lower yields led by the front end following the release of the RBNZ inflation expectations data. 2-year inflation expectations fell to 2.79% from 3.30% in Q1. The downward momentum in expectations will give the RBNZ some comfort it is getting traction and is close to the peak in the official cash rate. The pressure on the local open will be for higher rates, aligned with the move in US and Australian yields on Friday night. In the week ahead the economic calendar is lite, and the focus will be on the Budget Economic and Fiscal Update (BEFU) on Thursday where the bond programme will be updated. With BEFU on Thursday, the weekly bond tender will take place on Friday.