Today’s podcast

Overview: Hotel California

• Yields continue their march higher; US 10yr now at 2.85% and real yield -0.09%
• Fed’s Williams on Thursday the catalyst, “may need to get a little above” neutral
• Equities reacting to higher yields; S&P500 -2.1% last week and flat on Monday
• USD stronger (DXY +0.7% last week and another 0.3% on Monday), AUD at 0.7349
• China’s lockdown more worrying; encompasses 24% of population & 40% of GDP
• Coming up today: RBA Minutes, US Housing Starts, IMF/World Bank Spring Meetings

“I had to find the passage back; To the place I was before; ‘Relax, ‘ said the night man; ‘We are programmed to receive; You can check-out any time you like; But you can never leave!” – Hotel California, Eagles, 1976.

Global yields continued their March higher over the Easter period with the US 10yr yield hitting a fresh cycle of 2.88%, its highest since 2018. The Fed’s Williams was the catalyst for the move on Thursday where the 10yr yield leapt some 17bps in thin trade to 2.83%, with those moves holding on Monday with the 10yr yield currently trading at 2.85%. The other big mover was the oil price with Brent oil at $113 a barrel on a combination of supply disruptions in Libya and headlines on Thursday of the EU drafting a ban on Russian oil imports. In economic news China’s weaker than expected retail sales overshadowed better than expected Q1 GDP figures. More importantly, China’s near-term outlook has dimmed given partial/full lockdowns are now encompassing some 24% of the population or around 40% of GDP. In FX it is all about USD strength with the DXY up 0.7% last week and up another 0.3% on Monday. Risk sentiment as summed up by equities has softened with the S&P500 -2.1% last week and was broadly flat yesterday (S&P500 -0.0%).

First to the Fed’s Williams who spoke on Thursday and was the catalyst for the move higher in yields. The main headline was that he thinks the Fed needs to move “expeditiously towards more-normal levels of the federal funds rate.” Adding that he sees neutral being somewhere in the range of 2% to 2.5%. But what likely got the markets attention was his comments around the limited ability of the Fed to tolerate inflation above 2% . There had been some thought that given the Fed’s dual mandate that if inflation persisted high and growth weakened, the Fed could ease off the brake. Not so according to Williams who quashed any thoughts of the Fed willing to tolerate a period above 2% inflation: “we have a 2% longer-run goal” and “we are going to get inflation back to 2%”.

Williams also noted “we will need to get real interest rates….back to more normal levels…by next year…and we may need to go a little above that depending where inflation is”. One proxy for real interest rates used by many for asset valuations is the US 5yr and 10yr TIP yields and it is worth noting the 10yr TIP is getting closer to positive territory at -0.09% and that the 10yr TIP yield averaged positive around 0.50-1.00% (see Bloomberg: Fed’s Williams on Inflation, Policy, Balance Sheet, worth a listen). Meanwhile as your scribe types the Fed’s Bullard is hitting the airwaves, repeating his hawkish commentary that the Fed should be open to a 75bp move, though “more than 50 basis points is not my base case at this point”. Bullard also repeated he “want[s] to get above neutral as early as the third quarter and try to put further downward pressure on inflation at that point” and hiking to a rate of 3.5% would be appropriate given where inflation is.

Sticking to the US, data flow remains mixed. Retail Sales suggests some moderation occurring with core control retail sales -0.1% m/m against +0.1% expected. Core retail sales have now fallen for two consecutive months (retail was -0.9% m/m in February) and given the Cleveland Fed’s Trimmed Mean CPI in February and March was 0.5% m/m, this suggests a bigger hit to volumes over the past few months. Consumer Confidence also came out and while better than expected at the headline (65.7 against 59.0 expected), the index is still around the levels seen in January 2022 which is still around the lowest levels since 2011. Meanwhile Industrial Production was stronger than expected (0.9% m/m vs. 0.4% expected)  as was the NY Empire Fed Manufacturing Survey (24.6 vs. 1 expected). Jobless Claims ticked up to 185k from 167k, but remains at extraordinary low levels.

China’s near-term growth momentum meanwhile looks like it will slow sharply. Analysis by Nomura shows around 24% of the Chinese population (equivalent to 373m, up from 193m last week) are in partial/full lockdown. Importantly the cities that have these restrictions comprise up to 40% of GDP. It’s no surprise then why analysts focused on weaker than expected Retail Sales figures yesterday (-3.5% y/y vs. -3.0% expected) instead of the better than expected Q1 GDP (1.1% q/q vs. 0.7% expected). It is still very unclear when China will/is able to pivot away from its zero-Covid policy and while zero-COVID exists, markets will remain sceptical China can reach its 2022 GDP goal of 5.5%. Meanwhile Shanghai reported its first deaths from Covid-19 on the weekend.

Commodities remain volatile, buffeted by Russia/Ukraine and China’s lockdown. Oil prices have risen with Brent at $112 a barrel on news that Libya’s oil production has fallen by 535k barres a day. The Sharara field in the west of the country, which can pump 300,000 barrels each day, was closed after protesters gathered at the site. Meanwhile Russia’s invasion of Ukraine is likely to step up a notch in the east with President Putin reportedly wanting to a delivery a key victory ahead of May 9 celebrations that mark the Soviet defeat of Nazi Germany. The EU also continues to tighten sanctions on Russia with proposals for a ban on Russian oil likely to emerge after the French presidential elections according to press reports.

Sticking to Europe, on Thursday the ECB left policy settings unchanged, including the accelerated asset purchase program taper announced at the prior meeting.   There had been some expectations that a definitive end to APP in Q2 might be confirmed, which would more clearly open the way for a rate hike in July.  However, with the ECB retaining optionality on the APP running through Q3 and President Lagarde remaining noncommittal on how long the gap between asset purchase end and tapering might be, pricing for a July rate hike has been trimmed a little.  There’s still more than 11bp of hikes priced for July, but a full 25bp hike is now by September. Bond yields initially fell on the ECB news on Thursday night.  However, US data then began to be released and the Fed’s Williams started to speak which saw yields leap higher (see above for details).

Finally in FX, the USD is broadly stronger against a backdrop of higher Fed rate hike expectations and softer risk appetite.   USD/JPY has reached a new 20-year high, the EUR has fallen to a two-year low after the ECB failed to live up to elevated market expectations and the AUD is back to 0.7349. The EUR has fallen to a two-year low, below 1.08, as the ECB meeting on Thursday night failed to live up to the elevated market expectations.

Coming this week:

• Australia: RBA Minutes the focus. The Minutes will be closely parsed for any hints of whether the RBA could contemplate starting its hiking cycle as early as May. Guidance from the then post-Meeting Statement strongly hinted rate hikes from June with the RBA Board noting it was waiting for “ important additional evidence…on both inflation and the evolution of labour costs”. Note CPI is 27 April, WPI 18 May, and National Accounts 1 June, meaning inflation and labour cost data will be available in time for the RBA’s June meeting on Tuesday 7 June. Across the ditch, NZ’s CPI on Thursday is also worth a look ahead of Australia’s next week. NAB’s forecast for Australia’s Trimmed Mean inflation is 1.2% q/q and 3.4% y/y. Politics will also dominate given the election campaign with the Coalition government now neck and neck with the Opposition at $1.88 according to Sportsbet.
• Offshore: US: profit reporting season will likely dominate with the first of the big tech names to report – Netflix reports on Tuesday and Tesla is Wednesday. As for data it is a housing focused week with housing figures likely to gain more interest given the sharp rise in the 30yr fixed mortgage rate which is currently sitting at 5.25%, its highest since 2010 after having risen 198bps since the end of 2021. There is also plenty of Fed speak with four Fed speakers scheduled including Chair Powell who is on a panel with the ECB’s Lagarde on Thursday at the IMF Spring Meetings. Europe: a quiet week with only the global PMIs of note on Friday where the consensus is for still robust reads despite the Russia/Ukraine fallout, downside risks likely (consensus for the EZ PMI composite is 53.9 from 54.9 previously). UK: an update on the consumer with retail sales for March on Friday with the consensus for core sales at -0.4% m/m with downside risks given the real income squeeze. CH: it is all about lockdown news given full/partial lockdown now touches 26% of population & 40% of GDP.

Coming up today:

• Domestically the RBA Minutes (see above for a preview), while offshore the most notable is US Housing Starts. The semi-annual IMF/World Bank meetings kick off today as well with G-20 finance ministers and central bankers gathering in Washington – expect headlines on the side, while the IMF publishes its latest forecasts in the World Economic Outlook.

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