Investor sentiment remains fragile amid fallout from the war in Ukraine and the prospect of major central bank tightening this year. US stocks continued to fall on Friday as the US 10-year yield hovered around the 2% mark. The USD strengthened overall, with USD/JPY hitting a five-year high and NZD falling back towards 0.68. The 10-year break-even inflation rate in the United States has reached an all-time high, just below 3%. In addition to ongoing developments in the Russian-Ukrainian war, the focus this week is on the FOMC meeting where the Fed is expected to kick off its tightening cycle with a 25 basis point rate hike.
Markets remain extremely volatile and choppy. On Friday night, S&P500 futures jumped 1.8% after Russian President Putin said talks with Ukraine had seen “some positive changes”. But the positive sentiment did not last long, with Ukraine’s foreign minister retorting that there had been “zero progress” in talks. Equity markets and the euro then reversed course, with the S&P500 falling back into negative territory and closing down 1.3%. It was the fourth weekly loss in the past five weeks for the S&P500, leaving it down 12% year-to-date. European markets were not open as US stocks fell sharply at the close, so the EuroStoxx 600 index managed a 1% gain.
Over the weekend, messages about the possibility of a ceasefire were mixed. After a joint call between Macron, Scholz and Putin, French officials said Russia had no intention of ending the war. More encouragingly, the FT reported that there has been “some hesitant signs of movement” on the Russian and Ukrainian side. Russia’s chief negotiator told state media “I personally expect that this progress can, in the coming days, result in a unified position of the two delegations and in documents ready to be signed.”
In addition to the war in Ukraine, investors fear central bank tightening this year could hamper economic growth at a time when soaring energy prices are already squeezing disposable incomes. The FOMC meeting takes place Thursday morning amid near-universal consensus that the Fed will kick off its tightening cycle with a 25 basis point rate hike. With a 25 basis point rate hike considered a done deal, investors are mostly interested in how many rate hikes the new “dot chart” indicates. In December, the median member of the FOMC forecast four hikes this year, although most Fed officials have become markedly more hawkish since then. The market expects just under seven 25 basis point hikes in the remaining seven meetings this year. Powell is also likely to be pressured by the circumstances under which the Fed would consider a 50 basis point rate hike in future meetings.
On Friday, the US 2-year rate rose 5 basis points to 1.75%, its highest level since 2019, while the 10-year rate continued to hover around 2%. The FT said quarterly rebalancing could see fund managers selling up to $230bn of bonds and reallocating them to equities later this month to maintain portfolio weightings, analysis shows. by JP Morgan.
US 10-year “break-even inflation,” a market-based measure of inflation expectations, approaches 3% for the first time. The 10-year breakeven jumped 9 basis points on Friday, closing the week at 2.97%. The high level of inflation expectations primarily reflects expectations that inflation will be extremely high over the next two years. But longer-term measures are also drifting higher, with the 5-year/5-year inflation swap closing at 2.72%, its highest level since mid-2014. Central banks tend to watch the 5y/5yr measure closely, to determine whether long-term inflation expectations remain consistent with their inflation targets. Over the week, the US 10-year real yield was broadly unchanged at around -1%, while the 10-year nominal yield rose 26 basis points.
In economic data, the University of Michigan consumer confidence index fell to a new 11-year low of 59.7, below market expectations. As in New Zealand, US consumer confidence is under pressure due to rising gasoline prices and rising inflation (which are eroding real incomes) as well as faltering stock market returns. Economists still believe that consumer spending should hold up, despite the depressed level of confidence, due to the large stock of household savings built up during the pandemic.
The USD saw broad-based strength on Friday, appreciating against all G10 currencies except the CAD. The BBDXY USD index rebounded 0.5% to near its highs for the year. Of note, USD/JPY hit a five-year high, up 1% to 117.30. The USD/JPY move partly reflects broader USD strength, although JPY weakness was amplified by the widening interest rate gap with the US as the BoJ continued to suppress Japanese yields thanks to its yield curve control policy. Japan is also a large net importer of oil, so the recent spike in oil prices will weigh on the country’s growth prospects.
Illustrating that this is not a classic “risk aversion” episode, the yen and the Swiss franc were the two worst performing currencies last week, down 2.2% and 1. 9% respectively. Similarly, U.S. Treasuries typically rally when stock markets are under pressure, but that hasn’t been the case this time around as markets wary of the inflationary impulse from rising oil prices. energy and the Fed is expected to continue its tightening cycle this week.
The CAD was the star of the currency markets on Friday, appreciating 0.3%, after an extremely strong Canadian labor market report. Job growth was nearly three times better than expected while the jobless rate fell 1%, to 5.5%, near its pre-Covid lows. Bank of Canada tightening expectations rose after the report, with the market pricing a 65% chance of a 50 basis point rate hike at the next meeting in April and the 2-year bond rate rising of 11 basis points.
The NZD and AUD were down on Friday amid a significantly stronger USD. The NZD was down 0.6% and the AUD 0.9%, with the NZD ending the week just above 0.68. The NZD/JPY cross traded above 80 for the first time in nearly four months on Friday, before closing the week just below that level.
After their recent strong rise, commodity prices were generally lower last week. Brent crude rebounded 3% on Friday but was still down 5.6% last week. Oil prices were supported on Friday by news that talks between major countries and Iran on a nuclear deal had been “suspended”, dealing a blow to those who hoped lifting Iranian sanctions would increase the market supply.
New Zealand rates continue to rise on global forces and expectations of aggressive RBNZ tightening. The 2-year swap rate briefly touched 3%, before settling 2 basis points on the day at 2.98%, while the 10-year swap rate jumped 5 basis points to reach a new cycle high of 3.22%. There is around 85 basis points in price for the next two RBNZ meetings, with the market now seeing a more than equal likelihood of an OCR increase of 50 basis points in both meetings. While not our central call, there is clearly a risk that the RBNZ feels the need to validate market pricing of a 50bp move to avoid a wholesale rate pullback which could then ripple through mortgage rates and other real economy lending rates.
Along with the FOMC meeting, the Bank of England is also meeting this week, with markets pricing in another 25 basis point hike, which would take the cash rate to 0.75%. Australia sees the release of its monthly jobs report, with our NAB colleagues tipping the unemployment rate to a post-GFC low of 4%. Australia’s extremely tight labor market is one reason to be cautious about expecting a big rush into New Zealand, even if border restrictions are eased. New Zealand’s GDP is the highest nationally. We are in line with the consensus in looking for a 3.2% rebound in growth in the fourth quarter, although the data is very old and unlikely to move the needle for the market.
