A further slowing in growth
Another volatile session in markets with an upward surprise in the April US inflation data release adding an extra layer of uncertainty
It has been another volatile session in markets with an upward surprise in the April US inflation data release adding an extra layer of uncertainty. After a positive lead from APAC, European equities rose vigorously while the stronger than expected US inflation print heightened concerns over the need for the Fed to accelerate its policy tightening path, rattling US equities and flattening the UST curve. After some wild moves following the US CPI release, FX markets are little changed with GBP (Brexit news) the notable underperformer while JPY has benefited from the move lower in 10y UST yields. Oil prices have led a rebound in commodities while in other news ECB Lagarde has endorsed QE ending in June with rate hike to follow weeks after.
Monthly US headline (0.3% vs 0.2%) and Core CPI (0.6% vs 0.4%) rose by more than expected while the YoY readings fell by less than expected (headline to 8.3% from 8.5% and Core to 6.2% from 6.5%) with both yoy declines driven by favourable base effects. Services costs accelerated and inflation for most goods remained stubbornly high, underscoring the persistence and breadth of price pressures. Many analysts have been hoping/expecting for a moderation in good prices as consumer look to enjoy life after lockdowns, shifting their spending patterns towards services and away from goods. Not so fast, the annual gain in food costs was the biggest since 1981 while within services, costs for home utilities such as electricity rose 13.7%yoy in April, the most since 2008. Airfares jumped a record 18.6% on a monthly basis. Shelter costs, which includes rents and hotel stays, also rose 0.5% for a third month, which has been the highest since 2005.
The stronger than expected US inflation print provides further ammunition to hawks within the FOMC calling for a faster pace of policy tightening alongside the need to take the Fed funds rate above neutral. The Fed meets again on June 15 and a 50bps Fed funds rate hike looks like a done deal with a 25bps hike is definitely no longer a consideration, that said the May CPI print is released on June 10, and if we get another “shocker”, then a 75bps hikes becomes a strong possibility. The market currently prices a 53bps hike for June with a funds rate seen at 2.762% y the end of the year.
The stronger than expected CPI print triggered some wild moves in markets . Looking at the rates markets first, the initial market reaction saw a jump in yields across the curve, but the move proved short lived. The 2-year Treasury rate rose as much as 13bps in the aftermath of the CPI report to 2.74% and has since reversed most of that move, currently trading at 2.64%. The 10-year rate fully reversed a 14bps lift to as high as 3.07% and is currently down to 2.925%, down around 6bps relative to Sydney’s closing levels. Overall, the 2s10s yield has flattened by some 9bps on the day. Meanwhile in Europe, after a similar initial move 10y Bunds ended the day -1bps at 0.99%.
Speaking after the CPI release, Atlanta Fed President Bostic said that “I am going to be supporting moving more” on interest rates if inflation continued at the current high pace. He backed 50bps increments until the Fed Funds rate was raised to a neutral level.
Moving onto equity markets, Europe embraced the positive lead from APAC which saw China’s CSI 300 index end the day +1.44% and a recovery in the Nikkei back above positive territory (+0.18%). A key factor for the positive vibes was a decline in China Covid cases, raising hopes restrictions could be ease soon. Shanghai said half of the city’s districts have reached “basically no community spread”, the city reported 1,259 local asymptomatic Covid cases and 228 confirmed infections for May 10. Meanwhile Beijing reported 37 local Covid cases for May 10, including 24 confirmed cases and 13 asymptomatic cases.
That said this optimism may not be shared by all in China. After the head of the WTO called China’s zero-Covid strategy “unsustainable”, domestically the narrative remains very supportive of current restrictions. According to researchers at Shanghai’s Fudan University – China risks a “tsunami” of coronavirus infections resulting in 1.6 million deaths if the government abandons its long-held Covid Zero policy and allows the highly-infectious omicron variant to spread unchecked.
The Stoxx Europe 600 Index closed 1.7% higher with all major EU regional indices also closing with decent gains. The NY equity session began on a positive tone, but then the stronger than expected US inflation print triggered a big U turn as investor ponder the risk of a more aggressive Fed tightening path ahead. Tech stocks led the decline with the NASDAQ closing the day at -3.18% while the S&P 500 was -1.65%.
The spike in volatility post the US inflation print was also evident in the FX market, but after some wild swings the net effect has been quite minimal with most G10 pairs little changed relative to levels this time yesterday. After edging a little bit higher during our APAC session back above the 70c mark, the AUD fell almost one cent to 0.6928 in the immediate aftermath of the US CPI release, then a few hours later it traded to an intraday high of 0.7054, giving it all back again and now trades at 0.6938, essentially unchanged over the past 24 hours. In a similar price action, NZD traded down to just over 0.6280 post US CPI, whipped up to 0.6380, and is now back down to around 0.63
JPY has been well supported (+0.41%), with US 10-year rates lower and USD/JPY at ¥129.96 as I type. Meanwhile GBP is down 0.54% overnight to 1.2251. Brexit is returning to the front pages, on speculation that UK PM Johnson intends to announce plans next week to unilaterally tear up post-Brexit trading arrangements for Northern Ireland. This would put the UK on a collision course with the EU, which would look to suspend trade if the UK revokes the Northern Ireland protocol.
The Euro on the other hand has been steadier, now trading at 1.0515. Bloomberg and the FT published articles summarising what we have been hearing over the past couple of weeks, that members of the Governing Council increasingly see the deposit rate – currently at minus 0.5% – exceeding zero this year, with a series of rate hikes likely beginning in July.
Lagarde, who has been reluctant to entertain the higher rate view and has been seen as passenger, lagging her more forthrite colleagues, overnight said it was appropriate for policy to return to normal settings, with a hike possible weeks after the end of QE early in Q3 i.e. early July. She added that new forecasts to be published next month were “increasingly pointing towards inflation being at least on target over the medium term”.
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