Global markets had a relatively slow start to the year, tracking sideways for the first half of January as investors digested economic data but then picked up momentum in the second half. Equity markets saw decent gains, with the S&P500 index up +1.6% in USD terms, while US bond yields had a round trip after initially climbing higher, with the US 10-year rate moving up just +0.03% to 3.91%.
US economic data was stronger than expected, signalling a resilient economy. Inflation unexpectedly increased in December, which drove interest rates higher as investors reduced the magnitude of interest rate cuts expected this year.
The US Federal Reserve (Fed) left interest rates unchanged, acknowledging they have seen encouraging signs that inflation is under control, but indicating a reluctance to declare victory for the time being. Like many central banks, they are concerned that core inflation (e.g. from services) is proving stickier than hoped. The Fed Chairman poured cold water on the idea of an interest rate cut as early as March, as they wait for more data to gain confidence that inflation will continue to move back to target. The interest rate market remains well ahead of the last Fed projections, pricing in 5 cuts.
Australian economic data continued to deteriorate, with employment and inflation data both falling more than expected. This gave interest rate markets comfort that the Reserve Bank of Australia has completed its hiking cycle and will be looking to ease rates later this year.
In New Zealand, headline inflation fell from 5.6% to 4.7% as expected by the market, but by more than the Reserve Bank of New Zealand (RBNZ) had forecast. However, in the details, the decline was mainly driven by falls in tradeable inflation. Non-tradeable inflation was stronger than expected and will be a concern to the RBNZ who are worried that domestic service driven inflation is not coming down as quickly as they would like.
A speech by the RBNZ’s Chief Economist late in the month reiterated that the RBNZ remains comfortable with current monetary policy settings. Until they are more confident that inflation, especially domestic non-tradable inflation, is heading back toward the target band they are unlikely to begin cutting rates.
Interest rate markets still expect the RBNZ to cut rates over 3 times this year, which is at odds with RBNZ’s, admittedly old, November forecasts of no cuts in 2024. The central bank will meet at the end of February and will provide the market with a new set of forecasts incorporating the new data received.
The stronger than expected non-tradable inflation data pushed rates higher. The 2-year rate moved up +0.1% and the 5-year up +0.19%.
The resilient US data and the interest rate market’s reduction in Fed cut expectations saw the USD appreciate, pushing the NZD down -3.2% over the month.
Markets are confident that the US economy in particular remains resilient. However, while inflation continues to ease, central banks have shown concern that core measures may be difficult to get back into range. Investors will be keenly watching data with the hope that they can gain confidence of their expectations that there will be multiple interest rate cuts this year.