Todays podcast

Overview:  Keep doing what we’re doing

• US ISM services beat expectations. Expansion continues with modest decline
• OPEC + agrees 2m b/p oil supply cut. Energy stocks outperform
• After opening lower, US equities recover but still end marginally lower
• UST curve bear steepens. 10y UST yields +12bps to 3.75%
• Fed Daly – There’s a high bar for slowing pace of policy tightening
• USD broadly stronger but NZD and AUD outperform
• GBP and EU currencies under pressure
• Coming up: AU Trade Balance, BoJ Kuroda, ECB Accounts, Jobless claims, Fed speakers

Events Round-Up
NZ: RBNZ Official Cash Rate (%), Oct: 3.50 vs. 3.50 exp.
US: ADP employment change (k), Sep: 208 vs. 200 exp.
US: Trade balance ($b), Aug: -67.4 vs. -67.7 exp.
US: ISM Services index: 56.7 vs 56 exp.

It has been another volatile session in markets, US equities opened lower not helped by anticipated news of a bigger oil cut supply agreement by OPEC +. Then, the initial reaction to a better than expected US ISM services extended the equity rout followed by a big reversal before the close. After falling close to 2%, US equities ended the day marginally lower while the US Treasury curve bear steepened with the 10y Note yield climbing 12bps to 3.75%. Fed Daly reiterates the “data dependency” message, noting that “When the data don’t show it, then we’re going to have to keep doing what we’re doing.”. The USD has been broadly stronger, mostly at the expense of European currencies while NZD and AUD have managed to hold their own.

After a great deal of speculation on the size of oil supply cuts, news ahead of the OPEC + meeting hinted at supply reduction at the top end of the 1 to 2m range expected. Expectations of a supply cut has been a supporting factor for oil prices in recent days with news of a 2m reduction providing an additional impetus to the move up . OPEC + agreed to reduce their collective output by 2m b/d from November. Given outdated production baselines which didn’t account for actual production (which was less than the official figures) the effective oil supply reduction is expected to be about half of the headline number, nevertheless it’s still the biggest cut since 2020 and an unwelcome inflationary dynamic to the world’s economy.

Reacting to the news, the White House accused OPEC + of aligning itself with Russia with President Biden noting in a statement disappointment “by the short-sighted decision by OPEC+”. The US also announced a decision to release another 10 million barrels of oil from the Strategic Petroleum Reserve in November, adding that “the president will continue to direct SPR releases as appropriate to protect American consumers and promote energy security.”. Oil prices have closed the NY session 1.7% (Brent) and 1.47% (WTI) higher and are up 5 to 7% higher over the past five days.

Half an hour of so after the NY open the release of the ISM Services survey was greeted with a classic case of good news being bad news. The survey beat expectations modestly declining to 56.7 from 56.9 against expectations for a moved down towards 56. Reaction to the release extended the US equity rout with the S&P 500 declining to an intraday low of -1.80%.

Details in survey revealed a picture of a robust expansion in the sector with some modest give back in the pace of activity. The key New Orders subcomponent remained at very healthy levels, above 60 and notably for Fed policy expectations, the employment sub index advanced to the highest level in six months, rising to 53 from 50 in September. The Prices Paid component fell again, but, at 68.7, it remains relatively high (the manufacturing equivalent is just 51.1), consistent with still-elevated inflationary pressures in the services sector.

So, after an increase in expectations of an imminent Fed pivot given the softer than expected US ISM manufacturing survey last Friday, the strength in the Services ISM overnight not only eases concerns of an imminent US recession, it also refutes any notion that the Fed will look to take its foot of the tighten pedal any time soon . Speaking to Bloomberg TV, Fed Daly reaffirmed this view noting that ““We’re data dependent. When the data show what we need to see, then we will downshift,” then adding that “When the data don’t show it, then we’re going to have to keep doing what we’re doing.”. Daly then also stressed that it’s “really challenging” to slow the pace of policy tightening amid rising core inflation. Focus now turns to the non farm payrolls report on Friday and US CPI next week, where as Daly has noted the Fed attention is going to be on the core readings rather than the headline print.

After trading lower at the open and extending the decline following the ISM release, US equities staged a decent recovery in the afternoon session moving back into positive territory before closing marginally lower. The S&P 500 closed down 0.2% while the NASDAQ was -0.25%. Earlier in Europe, all regional indices closed sharply lower with the Euro Stoxx 50 down 1.05%.

Meanwhile the rise in UST yields which began during our APAC session yesterday, accelerated during the overnight session with the curve bear steepening . The 2y note is 5bps higher over the past 24 hours to 4.142% while the 10y year has climbed 12bps to 3.75%. The 10-year rate is now essentially back to where it was on Monday, before the manufacturing data.  Near-term Fed rate expectations haven’t changed that much (70bps is still priced for next month’s meeting and a terminal rate a touch above 4.50%), but the market has pared back some of the rate cut pricing from mid next year. Likewise, the USD is up around 0.7%-1.1% in index terms overnight, reversing most of the previous day’s move. 

Gains in the USD have come largely from European currencies with GBP leading the decline, down over 1% t0 1.1324 while after almost touching parity the euro is down 0.9% to 0.9893. USD/JPY remains much less volatile than the other majors and has cautiously pushed higher to 144.65, with investors likely wary of the potential for renewed Japanese FX intervention above 145.  The NZD and the AUD have been the two best performing currencies over the past 24 hours, both marginally higher against the USD compared to this time yesterday.  NZD start the new day at 0.5738 and the AUD is at 0.6491.

The statement emphasised that core inflation, both in NZ and offshore, was still too high and it was appropriate The RBNZ raised the OCR by 50bps at the MPR yesterday, as expected, taking the cash rate to 3.50%.  to continue tightening monetary policy “at pace”.

My BNZ colleague, Nick Smyth, notes that main surprise was the revelation that the MPC had debated a 75bps hike, on the basis this might reduce the expected peak in the OCR, before settling on a 50bps move.   The discussion is intriguing since, logically, the higher the cash rate gets (and the closer it is to the likely terminal rate), the less compelling larger interest rate hikes become.  Unlike the RBA of course, which has been the first of the major central banks to step down the pace of its tightening cycle the previous day, when it raised its cash rate by 25bps to 2.60%.

Coming Up

• This morning Australia gets trade data for August (trade balance $4.7bn exp. vs $5.4bn prev.) and sometime during our day BoJ Governor Kuroda speaks at a Branch Manager’s meeting.
• Later today the ECB publishes Account of its September policy meeting, Germany releases factory orders for August (-0.7% mom exp. -1.1% prev.) and the eurozone gets retail sales (Aug -0.4% mom exp. vs 0.3% prev.).
• Jobless claims are out in the US tonight (203k exp vs 193k prev.) and Fed’s Evans, Cook, Waller and Mester speak.

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