US equity and government bonds came under pressure after solid labour market data reduced expectations about the extent the Federal Reserve will be able to ease monetary policy this year. Weak consumer sentiment and concerns about inflation also weighed on investor risk appetite. The S&P fell to the session lows and ultimately closed 1% lower, after it was reported President Trump intended to issue reciprocal tariffs this week, in a further escalation of his trade war. The US dollar gained against G10 currencies.
US payrolls rose by 143k in January, which was below the consensus estimate, but there was a large 100k upward revision to the previous two months. A drop in the unemployment rate to 4.0% from 4.1% in December and robust gains in earnings underscored the strength of America’s labour market. Average hourly earnings increased 0.5% in January, which took the annual rate to 4.1%, and exceeded expectations.
The Michigan consumer sentiment index dropped to 67.8, which was below the lowest estimate on the Bloomberg poll, and likely reflected concerns about tariffs. The expectations index fell to the lowest level since November 2023. Five-to-ten-year inflation expectations increased to 3.3% which is the highest since 2008.
The broader picture is one of labour market resilience and provides the Fed with few reasons to restart the easing cycle in the near term. This rise in longer term inflation expectations is another reason to proceed cautiously. The market is pricing 37bp of Fed rate cuts by December, down from 44bp ahead of the data.
The US labour market report contributed to a rise in treasury yields, which remained near the session highs, after the elevated inflation expectations in the Michigan report. The curve flattened at the margin. 2-year yields closed 8bp higher at 4.29% while 10-year increased 6bp to 4.49%.
German industrial production was below expectations in December. The weakness in German industry is likely to weigh on overall economic activity in 2025. Threatened tariff increases would weigh further on German manufacturing with the recent decline in the Ifo business climate index reflecting the deteriorating sentiment.
10-year German bunds closed unchanged at 2.37%. The European Central Bank released its report on the neutral policy rate. According to its analysis, the nominal rate which supports both full employment and stable inflation is between 1.75% and 2.25%, aligning with previous comments by President Lagarde.
The US dollar was broadly stronger in offshore trade with the dollar index gaining ~0.5% compared with the NZ close on Friday. The Canadian dollar outperformed within G10 currencies after Canada reported stronger than expected labour market data. The yen was ended little changed against the dollar.
The NZD ended the week near the offshore session lows against the dollar, having retraced back towards 0.5650. The major NZD cross rates were little changed relative to the NZ close, except for NZD/JPY, which was modestly weaker.
There were large moves in front end swap rates in the local session on Friday exacerbated by illiquid market conditions. 2-year swap rates closed 9bp higher at 3.46% amid position unwinding by speculative accounts. 10-year rates closed unchanged at 4.06%. The 9bp curve flattening was abnormal – there have only been a few days in the past 10 years when curve flattening has exceeded 10bp - particularly in the absence of economic data.
The government curve closed higher in yield and flatter. The May-2035 nominal line ended 2bp higher at 4.57%. New Zealand Debt Management are likely to launch a tap syndication of this line, perhaps as soon as today, after announcing the syndicate panel last week. Australian 10-year government bond futures are 4bp higher in yield terms since the local close on Friday, suggesting an upward bias, for NZ yields on the open.
It is a quiet start to the week with no domestic or international economic data of note. Further ahead, it is mainly second-tier data on the domestic calendar with card spending, the manufacturing PMI and inflation partials for January. The key international release is US CPI data. Fed Chair Powell is giving his semi-annual testimony to US lawmakers though his remarks are unlikely to deviate too much from the press conference following the January FOMC.
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