Inflation remained the dominant topic across markets in October. Specifically, that inflation is lingering for longer than expected and the potential policy response from global central banks. Interest rate markets experienced volatile moves over the month as the expectation of central bank hikes was priced in. The NZD 2-year rate moved from 1.40% to 2.26; largest one month move since 1999.
Central banks have begun to respond to increasing inflation. The Bank of Canada has ended its Quantitative Easing (QE) programme and the Reserve Bank of Australia removed its yield curve control programme. This month the US Federal Reserve is expected to formally begin the taper of their QE programme, and there is a possibility that the Bank of England hikes interest rates. With inflation now well established, central banks are looking to employment data to confirm the strength of the economy.
Locally, the RBNZ increased the Offical Cash Rate by 0.25% to 0.50%, as widely anticipated. The key indicators the RBNZ are focused on, inflation and employment, continue to point to a strong economy and no need for such accommodative monetary policy settings. The 3rd quarter CPI reading in late October highlighted this. Annualised inflation was 4.9%, well above market expectations and the RBNZ’s target band of 1-3%. The data showed price increases in items that are typically not impacted by transitory inflation, pointing toward a broader inflationary environment. The market expects the RBNZ to raise rates again in November and February.
The RBNZ and global central banks have signalled they will be cautious in their approach to reducing stimulus. A prudent approach given the uncertainty caused by COVID, supply chain disruptions and elevated energy prices. This gradual, cautious approach has helped stock markets become more comfortable with the notion of rising interest rates.
The performance in stock markets over the month was also supported by a more general increase in risk sentiment, as concern over potential knock-on effects from the issues with Chinese property developer, Evergrande, and the US debt ceiling decreased. This increase in risk appetite coupled with higher commodity prices saw currencies such as the Australian and NZ dollar appreciate against most peers. The NZD ended the month 3.75% higher vs the USD.