The US dollar index made a three-week high

Market wrap

Global market sentiment: The markets continued to react to the Fed’s tapering signal. Until midday London, equities pushed lower and US interest rates and the US dollar pushed higher. The NY session saw a partial reversal, coinciding with some cautionary Fedspeak from Dudley, Kocherlakota, and Fisher. The former two doves argued for a continuation of QE while hawk Fisher warned the “feral hogs” of financial markets against overreacting to the Fed signal. The S&P500 is currently down 0.5% (from -2.0% earlier).

Interest rates: US 10yr treasury bonds yields extended gains until noon London, from 2.58% to 2.67% - a fresh two-year high, and taking the total reaction to the FOMC signal to 47bp. The total reaction since Fed tapering was first hinted at in early May is 106bp.

Australian 3yr government bonds yields rose further from 3.02% to 3.14% - a three month high – but reversed during the NY session to 3.01%. The 10yr yield rose from 4.05% to 4.15% - a 15-month high – and then retraced to 4.00%.

Currencies: The US dollar index made a three-week high and then retreated during the London afternoon. EUR initially fell from 1.3120 to 1.3059 but then bounced to 1.3144. USD/JPY fell from 98.60 to 97.22 before bouncing to 97.79. AUD started the London session at a fresh three-year low of 0.9148 but then formed a reversal day to reach 0.9298. NZD made a fresh one-year low at 0.7684 before bouncing to 0.7791. AUD/NZD bounced from 1.1860 to 1.1970.

Economic wrap

US Dallas Fed factory index jumped from –10.5 to +6.5 in June, mirroring sharp jumps in the NY and Philadelphia Fed survey headlines. The Dallas detail (like Philly but unlike NY) on orders, production and shipments was also stronger, though jobs were just flat in June after falling in May.

US Chicago Fed national activity indicator rose from –0.52 to –0.30 in May. This index is based on 85 data series and is effectively a coincident index of the economy. It was more volatile than usual around the turn of the year, within the range +0.86 to –0.55 between November 2012 and this March, but that volatility has been largely resolved now towards the lower end of that range.

German IFO business climate index rose from 105.7 to 105.9 in June with renewed but modest slippage in the current index after its May rise, offset by the first gain in expectations since February. Expectations remain in a downtrend from their near two year high four months earlier, while the current index is not far above its late 2012 cycle low.

Market outlooks

Event risk today: The local calendars are empty, and there’s little to watch until the US data tonight – durable goods, house prices and home sales.

NZD/USD 1 day: Yesterday’s corrective bounce should continue past 0.7800.

NZD/USD 1-3 month: A three-year trend support line was broken last week at 0.7760 and if sustained this week argues for 0.7455 next. Fed tapering expectations will remain a depressant and NZ’s economic data momentum is likely to slow during the next few months.

AUD/USD 1 day: Yesterday’s corrective bounce should continue past 0.9300.

AUD/USD 1-3 month: The 16 May decisive break below a two-year contracting range was a very bearish signal pointing towards 0.9200 initially. Technically it could run as far as the low 0.80’s. The Australian data flow is unsupportive, and the RBA is likely to ease further to 2.0% by Q1 2014.

AUD/NZD 1 day: Bouncing around a wide range near term.

AUD/NZD 1-3 month: June’s consolidation persists but should eventually give way to the trend decline towards 1.1500, possibly as far as 1.1100. Relative fundamentals (e.g. RBA easing to 2.0% vs RBNZ stuck at 2.5%) favour the NZD medium term.

NZ swap yields 1 day: Taking the lead from US and Australian bond yields overnight (see above) the 2yr should open up 1bp at 3.25%. The 10yr should open unchanged at 4.65%.

NZ swap yields 1-3 month: The uptrend since June 2012 remains intact. By late-2013 we would expect to see the 2yr above 3.40% based on NZ’s improving fundamentals and eventual RBNZ tightening in 2014. The US-influenced 10yr yield has also confirmed its uptrend and targets 4.68% next.