Inflation expectations turn higher; yields rise in EU and US; US service sector expands strongly; Aussie bank treasurers face higher costs; UST 10yr yield at 2.53%; oil higher, gold drops; NZ$1 = 72.3 US¢, TWI-5 = 78

Here’s my summary of the key events overnight that affect New Zealand, with news we may be at an inflection point in interest rate markets.

Holders of high grade corporate and sovereign bonds are seeing their capital values fall. Yields are rising. We saw that in the recent NZGB tenders where demand is brisk but that investors want, and are getting, higher yields. It is also reflected in the steepening of the interest rate curves. For committing long, investors want higher compensation because they now think rates will be higher in the future.

This trend was started with the end of additional QE by the US Fed and the beginning of official benchmark rate rises. Briefly, the Trump effect boosted yields. Now is it the European markets that are leading the way. German bund yields are rising, and those for other major economies in the region are rising as well. Behind all this is rising current inflation, and rising inflation expectations. And ECB members are now starting to talk about exiting their QE programs.

The higher European rate rises cannot be sustained on their own, but if rates also keep rising in the US, together this can move markets in the intermediate term. For us here, expect our Kiwisaver funds exposed to bond prices to struggle to maintain their unit prices. And higher yields will likely hurt other asset prices – like real estate. Commercial real estate first, but residential as well if the interest rate rises are sustained for a few quarters.

The giant American service sector is expanding in January at its fastest pace since November 2015, fourteen months ago. This is being driven by faster rises in business activity and new work. Input cost inflation however has slowed since last month. Firms are reporting their strongest business outlook in nearly two years. That input cost inflation could turn up quickly if the trend is sustained.

Sales of newly constructed American homes reached 563,000 in 2016 which is +12.2% higher than for the previous year. However the year ended on quite a soft note.

In Australia, bank treasurers will need to raise AU$135 bln of funding in debt markets this year, mostly replacing existing arrangements that are expiring. So far in January, they have placed A$5.3 bln in local markets and AU$8 bln in international markets. That is a quicker pace than usual but there is still more than $120 bln to go. There are two risks for them other than rising rates: the likely downgrade of the Australian sovereign credit rating will probably add 0.2% to their costs, and the portion they would normally source in the US private placement markets will find lower demand and higher costs due to new American rules on what risks fund managers there can take.

In New York, the UST 10yr yield is holding at 2.53% today, after some solid rises recently. We should also note that credit spreads for Australasian investment grade debt are actually at their lowest level since November 2007. In other words, their lowest in more than nine years. Wholesale interest rates may be rising – and they are – but banks can currently access funding at tighter spreads than we have seen in a long time.

Oil prices are higher today by between 50 USc and US$1, now just under US$54 for the US benchmark, while the Brent benchmark is still just under US$56.50 a barrel.

The gold price is sharply lower however, falling -US13 to US$1,186/oz

The New Zealand dollar also a little lower at 72.3 US¢. On the cross rates we are at 96 AU¢, and against the euro at 67.8 euro cents. The NZ TWI-5 index is still high at 78.

If you want to catch up with all the changes on yesterday, we have an update here.

The easiest place to stay up with event risk today is by following our Economic Calendar here ».

Daily exchange rates

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