RBNZ Delivers a Dovish Hike and UK Inflation Surprises to the Upside

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Marc Chandler
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Overview: Equities in the Asia Pacific region and Europe are being led lower by the sell-off in the US yesterday. All the large Asia Pacific markets fell with Hong Kong and mainland shares setting the pace. Europe's Stoxx 600 is off nearly 1.5%, which would be the largest loss in two months. Consumer discretionary, financials and real estate sectors are off nearly 2%. US equity futures have a softer bias. European 10-year yields are mostly 2-3 bp lower, but the UK inflation shock (1.2% month-over-month and a new cyclical high in the core rate) has seen 10-year Gilt yields jump around eight basis points to near 4.25%, the highest since last October.

The greenback is mostly firmer against the G10 currencies. The Reserve Bank of New Zealand's dovish hike has seen the Kiwi drop around 1.8% and dragged the Aussie below the $0.6600 area. The UK's inflation surprise has seen sterling reverse from the $1.2475 area to push below $1.2400. The euro and yen are straddling unchanged levels. Emerging market currencies are more mixed. Of note the Hungarian forint is better bid today after easing on the central bank's rate cut yesterday. Also, the Mexican peso, which fell to around a three-week low is also better bid today, ahead of the first half of May CPI today. Gold held support near $1950 yesterday. It looks poised to test the upper end of its recent range near $1985. July WTI is extended yesterday's recovery, helped by the Saudi warning against bearish speculators and an estimated 6 mln barrel draw down of US stocks by API. A move above $75 would target this month's high near $76.50. Lastly, we note that July copper is extended its losses and nis now below $360 for the first time since last November. 

Asia Pacific

The Reserve Bank of New Zealand lifted its cash target rate by 25 bp to 5.50%, but it surprised the market was signaling its was done. After surprising many with a 50 bp hike in April, the derivatives market had a greater chance of another half-point move. With consumer prices rose 6.7% year-over-year in Q1, the swaps market had seen the terminal rate of 5.75%-6.0% toward the end of the year. The central bank now envisions a rate cut in Q3 2004. With today's move, the RBNZ has lifted the policy rate by 125 bp this year. The currency was punished by the unexpected dovish hike and roughly doubled this year's loss to about 3.5%.

Japan's weekly portfolio flow report will be released tomorrow. Last week, foreign investors continued to pour money into Japanese equities. It was the ninth consecutive week, and over that span it bought what seems like a record of about JPY6.2 trillion (~$45.6 bln). Last year, they were sellers at an average weekly pace of about JPY 17 bln (cumulative $6.8 bln) In 2021, foreign investors bought an average of around JPY28 bln a week of Japanese equities. Typically, the foreign exchange of equity investments is not hedged or considerably less hedged than fixed income. Foreign investors have bought an average of JPY45.5 bln of Japanese bonds a week this year. These are likely hedged back into dollars, euros, and sterling. Last year, foreign investors were buying at an average pace of JPY207.5 bln. From the other side, the sale of foreign bonds by Japanese investors was a key element of narratives about the poor performing bond markets. Last year, Japanese investors sold about JPY418 bln of foreign bonds a week on average (cumulative JPY21.7 trillion). This year, they have been buying foreign bonds at an average pace of almost JPY510 bln a week (cumulative JPY9.6 trillion). With a booming domestic stock market, Japanese investors do not have much interest in foreign stocks so much this year. They have been net sellers of around JPY20 bln a week. Last year, they were buyers at an average pace of JPY68.5 bln. 

The dollar is confined to about a half a yen range below JPY138.75 in quiet turnover. There are ae options for about $320 mln that expire at JPY139.05 today. We have highlighted the formidable technical resistance in the JPY139.50-JPY140 area. An important tell is whether the 10-year US Treasury yield pushes above the 3.75% area, seen yesterday for the first time since March 10. That said, continued consolidation will not weaken the greenback's technical tone unless the JPY137.25-50 area yields. The dramatic sell-off of the New Zealand dollar has pushed the Australian dollar below the late April low near $0.6575. Thus far, the year's low set in March around $0.6565 is holding. While the $0.6600 has given way, but the key is the close. And with intraday momentum indicators stretched, a little recovery can go a long way to neutralizing the negativity. This requires a close back above $0.6600. The dollar initially rose to new highs for the year against the Chinese yuan near CNY6.0675 before reversing lower and slipping through yesterday's low (~CNY7.04). If the exchange rate was not so closely managed, this would be a bearish technical development for the dollar. Despite the verbal warning at the end of last week, the setting of the daily reference rate shows little concern. The fix today was at CNY7.0560, which was a little above the projection of CNY7.0549 from the Bloomberg survey.

Europe

The UK CPI fell sharply as a result of the base effect, but the monthly increase illustrates the underlying problem. In April 2022, the UK inflation spiked by 2.5% in the month. This drops out of the 12-month comparison. It was replaced with a stronger than expected 1.2% increase last month. On the one hand, this means that the year-over-year rate tumbles from 10.1% to 8.7% (median forecast in Bloomberg's survey was for an 8.2% year-over-year rate. On the other hand, the 1.2% increase means that UK inflation has risen at a 7.5% annualized pace through April. By comparison, through the first four months of the year, the US CPI has risen at an annualized rate of about 5.2%, while EMU's CPI rose an 6.3% clip. Adding to the disappointment, UK's core rate unexpectedly rose to 6.8% from 6.2% year-over-year. This is a new cyclical high and confounds expectations for an unchanged pace. It was at 6.2% in April 2022.

Germany's DAX is up 16% this year and set record highs last week. The terms of trade shock have unwound, and Germany's trade surplus has been restored. However, the current assessment and expectations in the IFO survey slipped last mon. The former remains in the trough seen at the end of last year and was in line with expectations at 94.8 (from 95.1), while the latter snapped a six-month improvement trend to stand at 88.6 (from 91.7). The overall IFO measure of the business climate also fell for the first time since last October. It stands at 91.7, down from 93.4. 

The euro is trading quietly in a narrow range (~$1.0768-$1.0795). If it is sustained, it would be the first session in two months, it has not traded above $1.08. It is continuing to consolidate. Last week's low near $1.0760 held yesterday. The $1.0735 area corresponds to a (61.8%) retracement of the euro's gains from the mid-March low (~$1.0515). A move above the $1.0810-20 area would improve the tone. Sterling slipped slightly below $1.2375 yesterday to set a new one-month low. It recovered to close near $1.2415. It reached $1.2470 today in Asia-Pacific turnover but has been turned back to return to session lows near $1.2380 in Europe. A break of the $1.2375 brings the $1.2345 retracement objective into view. There are options for GBP640 mln that expire today at $1.2375 and another set for GBP450 mln at $1.2350. A final batch for GBP300 mln is struck at $1.2325. 

America

The market will receive the minutes from this month's FOMC meeting at which Chair Powell signaled the possibility of a pause in June with a little more than a 25% chance of a hike discounted. In addition, the year-end effective Fed funds rate is seen near 4.73% up from 4.0% earlier this month, which still seems aggressive. The FOMC minutes will shed more light on whether a pause in June was part of the cost of having a unanimous decision for a hike when some seasoned observers thought there could be a dissent. Is a pause the default setting for June, or is it as Dallas Fed Logan suggested that there has not been compelling evidence to top? A "skip", which some observers have talked about seems difficult to differentiate from the kind of "conditional pause" of the Bank of Canada. Can Powell & Co deliver a hawkish hold?

Mexico's central bank paused it tightening earlier this month and signaled that it intends to keep the overnight cash target rate high (11.25%) for an extended period of time. Softening of price pressures gave it the space. Today, Mexico reports CPI for the first half May. The headline rate may have fallen a little, which would be the second time in a month-and-a-half. This could see the year-over-year pace slip to 6.17% from 6.27%. It was at 7.86% in the second half of last December. The core rate is seen easing to 7.49% from 7.59% and it has not risen since the second half of January. It was at 8.34% at the end of 2022. 

The US dollar is firm against the Canadian dollar and is approaching yesterday's high near CAD1.3550. Last week's high was set near CAD1.3570, and the trendline, we have been monitoring, drawn off the two March highs and April's peak is around CAD1.3575 today. A break could spur a return to this month's high in the CAD1.3630-40 area. Note that there are about $585 mln of options at CAD1.3600 that expire tomorrow. The greenback reached a three-week high yesterday against the Mexican peso slightly shy of MXN18.00. Chart resistance is seen in the MXN18.07-11 area. Still, the dollar is trading with a heavier bias today. It is poised to snap a six-day advance, and a close below MXN17.85 could be an early sign that the short-squeeze is over. The peso's underlying bullish drivers are intact: high rates, relatively low vol currency, near-shoring/friend-shoring, meme, and favorable portfolio and direct investment inflows, and strong domestic institutions (central bank and Supreme Court).