Podcast of the day
Overview: rude service
- Overnight volatile session sees risk on, risk off and then risk on again
- Media speculation over a U-turn in the UK government’s spending plan, the good news
- … A much stronger than expected U.S. core CPI reading, at 40, the bad news
- The market is forced to revalue the Fed, 75 basis point hikes are now seen in November and December
- Front-end yields lead to curve flattening UST.10y UST little changed, after hitting 4.07%
- After trading higher after the CPI, the USD ends the day overall weaker
- The GBP leads the G10 gains against the USD. Another big fall in UK rates helps
- AUD and NZD make a new low before recovering. USD/JPY breaks above 147
- Upcoming: NZ Manufacturing PMI, CH CPI/PPI, US retail sales, US Mich. Survey, U.S. Bank Earnings Reports
Overview of events
NZ: Food prices (y/y), Sept.: 8.3 vs. 8.3 prev.
United States: CPI (m/m%), September: 0.4 vs. 0.2 exp.
United States: CPI excluding food, energy (m/m%), Sept.: 0.6 vs. 0.4 exp.
United States: CPI (y/y%), September: 8.2 vs. 8.1 exp.
United States: CPI excluding food, energy (y/y%), Sept.: 6.6 vs. 6.5 exp.
US: Initial Unemployment Insurance Claims (k), 8-Oct: 228 vs. 225 exp.
Markets endured a volatile overnight session with initial risk of movement backed by media reports noting that the UK government was about to backtrack on its tax cut plan. Then, markets took the risk on a stronger than expected US core CPI print at a 40-year high, led by a negative surprise in the services component. Ultimately, the risk-off move proved to be short-lived with positioning, news from the UK and the sentiment that stronger US inflation today still does not negate expectations for a sharp drop ahead (wishful thinking?) All combined for a turnaround in sentiment with all major US stock indices ending the day with decent gains. Rising Fed rate hike expectations triggered a flattening of the UST curve, leaving 10-year UST yields little changed at 3.95%, GBP led the gains against the USD, AUD and NZD recovering after hitting new lows.
The overnight session started with Europe benefiting from a broad positive backdrop led by a decent outperformance in UK Gilts, in particular the long end of the curve with the 30yr initially down 25bps, extending the 2-day decline to 60bps from yesterday’s high of 5.14%. Media speculation of a U-turn by the UK government on its budget plan has increased in recent days with an overnight report noting that the government was considering several options for a U-turn, but this time confirmed by government sources.
According to The Sun, government officials and the Treasury are working on several options, including scrapping Truss’ pledge to keep corporation tax unchanged next year, and instead raise it as planned by his predecessor Boris Johnson. This news and the BoE’s gilt buying which has also intensified over the past two days (£4.7bn of gilts, including £3.1bn of indexed bonds over the past two days) have clearly calmed the markets. In addition to lower yields on longer-dated UK gilts (30-year close down 26bp at 4.53%), the market also reduced expectations for a BoE rate hike, presumably based on that less government spending means less inflationary pressure next year. The BoE’s cash rate peak next year is now around 5.55%, down from 6.27% at the end of September.
The US CPI print was touted as the glamorous stat to watch this week and from that perspective, its release certainly did not disappoint, but those hoping for an easing of underlying inflationary pressures in the US United were severely disappointed. The headline and core CPI readings surprised on the upside with stronger yoy and mom readings, the headline print came in at
8.2% YoY vs. 8.1% expected while the most important base reading came in at 6.6% vs. expectations of 6.5%. The core CPI print was the highest in 40 years, with the monthly reading coming in at 0.6% m/m (0.4% expected), which does not yet imply an easing of inflationary pressures, five of the last six months having reached this rate or more.
In detail, commodity price pressures have been concentrated in the services sector, with commodity prices unchanged. In the services sector, most of the damage relates to rents, which rose by 0.8%, after a series of increases of 0.6 to 0.7%. This is where the debate on the outlook for core inflation in the United States is likely to focus over the next few months, the housing market is already in recession, suggesting that inflationary pressures on rents should also subside, but the way that’s measured in the United States has a lag effect that depending on who you read, it could take a few months and or potentially more than a year. So while there is evidence of ease in new rentals, rent renewals are what matter for the CPI and there is arguably still a lot to do.
Also released overnight and an important read for the Fed, the Cleveland Fed’s alternative measures of underlying inflation suggest the same persistent inflation message as the core CPI. Median CPI +0.7%/7.0% after 0.7%/6.7%, trimmed mean 0.6%/7.3% after 0.6% 7.2%. From the Fed’s perspective, all of these inflation numbers suggest that a 75 basis point hike in November seems like a done deal, while another 75 basis point hike in December also looks increasingly more likely. As for the Fed Funds futures, the market is eyeing the option of a 100bp hike in November with a price of 0.794bp while 63bp is expected in December. The terminal rate of the cycle has also increased slightly with a peak now seen at 4.92% at the beginning of May next year.
Rising Fed Rate Hike Expectations Triggered UST Curve Flattening with the 2-year note ending the day up 12 basis points at 4.409%. The 10-year yield traded at an overnight high of 4.075% following the CPI release, but then gave back most of it, ending the session at 3.95%, 1 bp more in the last 24 hours. As noted above, the big move in global core bond yields came from the UK, with longer-dated gilts leading the drop in yields, 10-year gilts closed at 4.198%, 24bps lower on the day.
The equity and currency markets were not immune to the volatility seen in the rates world, indeed some of the movements in equity and currency were likely to be more volatile. Starting with US stocks first, after opening sharply lower it was up and up, the S&P 500 opened 2.38% gap then closed 2.0% higher, 64%, i.e. on a range of 5% over the day. The NASDAQ ended the day at +2.23 and the Dow at 2.83%. Good economic news has been treated as bad news by the stock market lately given the implications for further Fed hikes, overnight, however, the stronger than expected CPI has triggered a rise Fed hike expectations, but this time equity investors have apparently decided that stronger US inflation today still doesn’t quash expectations of a sharp price decline to come. This may be true, but there is still a lot of uncertainty as to how quickly this decline will unfold and for the Fed, this decline must be significant, a drop of 6-4%, will not be enough, the Fed wants assurances that facing CPI will come down to 2% and we are still a long way from that target.
Another explanation for the strong rally in US equities was a mass of a short hedging wave with a test of some technical levels also favoring the move., with Bloomberg at one point suggesting that the benchmark S&P 500 had returned 50% of its post-pandemic rally, triggering timed buying. Either way, if the cause of the rally was one of these two drivers, it’s hard to suggest we’re at the start of a new uptrend. Instead, an aggressive Fed and inflation concerns are likely to keep markets volatile.
The USD jumped on the CPI release, with the DXY index trading at an overnight high of 1.1388 before falling to 112.47, down 0.75% on the day. . The GBP led the gains against the USD in the G10, up just over 2% to 1.1325, reflecting how bad news has been in its pricing when there is plenty of pressure. upcoming uncertainty, in addition to the British budget plan, will the BoE hold the +200bps valued over the next two meetings?
The AUD and NZD remained at the mercy of risk appetite, trading to fresh lows as equity markets tumble, then surging as they recover. AUD fell to 0.6170 and rallied to start the new day at 0.6296 while NZD fell to new low of 0.5512 following the US CPI report but recovered around 2½% of this nadir to trade down to 0.5642.
USD/JPY traded as high as 147.67, 1 pip above the 1998 high and is now trading at 147.2475 with speculation of another round of intervention rising, although we have a feeling that intervention from here will be on the rate of depreciation rather than a specific level
- This morning, New Zealand gets its manufacturing PMI for September ahead of China’s PPI and CPI for September. Another drop in China’s PPI is expected to 1.1% from 2.3% previously, while CPI is expected to drop from 2.5% to 2.8%, still comfortably below any level likely to rise. worry officials in Beijing. China’s trade data also due out today (expected $80.8 billion surplus)
- Later in the day, France gets its final CPI reading for September (unchanged at 5.6%) and ECB Holzman is speaking.
- US retail sales are the data release to watch tonight with the ex-auto and gasoline reading seen at 0.2%mom (prev. 0.3%mom) and the retail sales control band is expected to climb to 0.3% from 0% previously. The University of Michigan survey (58.6 exp vs. 58.8 prev) is another data release to watch with Fed Governor Cook and ECB Nagel speaking early this Saturday morning.
- US reports shifted to banks on Friday with JPMorgan, Citi, Morgan Stanley and Wells Fargo all reporting today.