Friday brought an end to another tumultuous quarter, with US equities making fresh lows (S&P500 -1.5%) and commodity currencies tumbling again. The NZD was hammered on Friday, ending the week just below 0.56. In contrast, the GBP continued to recover and is now close to where it was before Chancellor Kwarteng’s mini-budget speech a week beforehand. European and UK rates were lower on Friday, despite European annual CPI hitting a new high of 10%, while US Treasury rates were higher, the 10-year rate ending the week just above 3.80%. Up ahead this week, the RBNZ and RBA are both expected to raise rates by 50bps, the US nonfarm payrolls report is released on Friday, while OPEC+ is expected to cut oil production.
September was another dismal one for equity markets, with all the major indices in the US and the Eurozone sustaining heavy losses (S&P500 -9.5%, NASDAQ -10.4%, EuroStoxx 600 -6.6%). The S&P500 was down another 1.5% on Friday, bringing its year-to-date loss to -25%, now well into ‘bear market’ territory. The slide in equity markets has occurred amidst the sharp repricing of central bank rate hike expectations which has, in turn, fuelled expectations for a global recession next year. Bear markets in the S&P500 are often, albeit not always, associated with recessions.
The key reason for the very aggressive pace of central bank tightening has been inflation. Worryingly, there has been no let up on that front yet. European headline inflation cracked double digits in August, exceeding the 9.7% consensus, as forewarned by the big upside surprise to German CPI the previous night. Core inflation was also higher than expected, hitting a new post-euro high of 4.8% y/y. For context, the previous high in annual core inflation, since the euro was established in 1999 but before this cycle, was just 2.5%. The market is pricing 70bps of rate hikes for the ECB’s next meeting in November. In the US, the core PCE deflator, the Fed’s preferred inflation measure, was stronger than expected too, at 4.9% y/y, while median PCE inflation, an alternative core inflation measure, hit a new 40-year high of 5.8% y/y, illustrating the strength of underlying inflation.
The European bond market brushed off the inflation surprise on Friday, with the German 10-year rate falling 7bps. But rates were higher in the US, by 9bps on the 2-year rate and 4bps on the 10-year, the latter ending the week at 3.83%. While the Bank of Japan was likely to have run down its large cash holdings at the Fed to finance its recent $20b FX intervention, Bloomberg reported there were signs that other central banks have recently liquidated bond holdings to prop up their currencies (a $38b decline in foreign official holdings of US Treasuries last week), which would have been another factor adding upward pressure to US rates.
The war in Ukraine is another headwind to risk sentiment that continues to linger in the background. News over the weekend that Ukraine had recaptured the city of Lyman, in one of the newly annexed regions of Eastern Ukraine, highlights the risk of retaliatory Russian military escalation.
Fed Vice Chair Brainard, the first of the heavy hitters on the FOMC to speak since the September meeting, sounded slightly less hawkish than some of her colleagues have recently. While saying that the Fed will need to keep policy at restrictive settings for “some time” and it is “committed to avoiding pulling back prematurely”, she also observed that monetary policy works with lags and “that risks may become more two sided at some point”. Market pricing of the terminal Fed funds rate is broadly in line with the most recent ‘dot plot’, at around 4.55%.
Commodity currencies were hit hard on Friday amidst the deterioration in risk sentiment. The AUD was down just over 1%, ending the week near 2½-year low at 0.64, while the NOK and CAD were off 1.3% and 0.7% respectively. The NZD was the weakest of the lot, down over 1.5% on Friday and 2.5% on the week, ending just below 0.56. While recent financial market turbulence looks set to remain for a while yet, we think the NZD now incorporates a lot of bad news and so we see the outlook as more balanced than what it was.
In contrast, the GBP put in another strong performance as it continued to recover from its plunge earlier in the week. The GBP was 1% higher on Friday, possibly aided by month-end rebalancing flows, leaving it back near the levels seen before Chancellor Kwarteng’s shock mini-budget two Fridays ago, at around 1.1170. After all the turmoil, the GBP ended the week as the strongest currency, up almost 3%, a far cry from the 1.0350 panic lows reached last Monday during thin Asian trading. The NZD/GBP cross had a wild week, briefly touching 0.55 during the turmoil on Monday before falling sharply over the remainder of the week, ending Friday at around 0.5015, its lowest level since February.
UK interest rates are still substantially higher since Kwarteng’s mini-budget speech, on the order of 80bps for 5-year UK government bond yields, as the market anticipates more aggressive tightening from the Bank of England to get on top of inflation. The market is pricing a rate hike of around 140bps for the BoE’s next meeting in November. In contrast, the BoE’s intervention at the long end of the UK gilt market has helped settle things down in 30-year bonds, for now at least. Amazingly, the UK 30-year bond rate has all but erased its big move higher after the mini-Budget, although there remain residual concerns about what will happen after the BoE’s bond buying stops next week.
In other economic data, the Chicago PMI dropped to a new post-Covid low of 45.7, warning of downside risks to the consensus estimate for the ISM survey (released tonight) of 52.1. US personal spending was stronger than expected in August, rising 0.4% on the month, as households continue to draw down on their huge ‘excess savings’ accumulated during the pandemic (currently estimated at around US$1.4 trillion). The Atlanta Fed’s GDPNow estimate for US Q3 GDP is now sitting at a far more respectable 2.4% (q/q%, annualised), up from just 0.3% earlier in the week.
The Chinese PMIs, released on Friday, suggest an economy still struggling under the weight of the country’s zero-Covid policy. The Manufacturing PMI was slightly stronger than expected, but, at 50.1, was only barely expansionary. Meanwhile the Non-manufacturing index slumped to 50.6, much softer than markets had expected, with close contact industries, such as retailers struggling.
NZ rates were higher on Friday, capping off another volatile week. Swap rates were 5-6bps higher between 5 and 10 years while government bond yields were up as much as 12bps at the very long end. As we enter October, domestic focus is likely to shift to NZGBs’ forthcoming entry into the FTSE-Russell World Government Bond Index (or ‘WGBI’) on 1 November. We have previously estimated there might be around NZ$2b of offshore inflows into the government bond market in the first month of index inclusion and possibly up to NZ$4b over the first three months, mainly from so-called ‘passive’ funds which seek to replicate the underlying benchmark.
In domestic data, the ANZ consumer confidence survey remained at extremely low levels in September, at 85.4, similar to where it reached during the depths of the GFC. Meanwhile, building consents fell back modestly in August, albeit from what were very strong levels. Record low residential investment intentions warn that building consents could decline sharply over the next year or so.
The domestic highlight this week is the RBNZ meeting on Wednesday. We (and the market) are expecting a 50bps hike from the RBNZ which would take the OCR to 3.5%. With a 50bps hike seen as all but a done deal, the market’s focus is on the RBNZ’s characterisation of the policy outlook. The RBNZ had previously signalled that it thought it might be appropriate to pause its tightening cycle once the OCR reached 4% or 4.25%, but market pricing has moved well above that now, with a terminal cash rate of around 4.80% priced in.
The highlight of the session ahead is the ISM Manufacturing survey which is expected to show a small dip down to 52.1, still consistent with growth in the sector. The nonfarm payrolls report is the highlight later in the week, with another month of robust job gains expected (+250k) and the unemployment rate expected to remain at an ultra-low 3.7%. Fed officials are again out in force, including NY Fed President Williams tomorrow morning and Fed Governor Waller on Friday morning. The RBA is expected to raise rates by 50bps at its meeting tomorrow, which would take its cash rate to 2.85%. Elsewhere, OPEC+ will now be meeting in person in Vienna this week (a last-minute change from what was originally going to be a video conference call), which suggests the cartel is planning a big oil production cut, possibly more than 1 million barrels per day according to Bloomberg. Change from what was originally going to be a video conference call), which suggests the risk the cartel is planning a big oil production cut.