Markets cautiously optimistic despite the US payrolls weaker than expected. Global equities and US Treasury yields consolidated. The NZD up. NZ rates up sharply across the curve

The positive sentiment surrounding the resumption of US-China trade talks continued to be felt on Friday.  Equity markets largely shrugged off the weaker than expected jobs numbers in the nonfarm payrolls report and comments from White House Economic Advisor Larry Kudlow, who cautioned it could take a very long time to reach an agreement with China.  The S&P500 was up 0.1% on Friday and 1.8% on the week, leaving it less than 2% from its all-time highs.  Markets have been taught to be sceptical that US-China trade talks will lead to any substantial progress on the key structural issues dividing the two countries but, at least in the short-term, the resumption in talks should help calm fears about any further escalation in tensions. 

The monthly nonfarm payrolls was mixed, with job growth slowing to 130k in August (vs 160k expected) and wage growth picking up at a faster than expected rate.  The temporary hiring of 25,000 workers for the 2020 census flattered the headline result.  US job growth has slowed to a 158k monthly pace in 2019, well below the 223k average last year, in line with the broader moderation in the economy.  Even this year’s slower rate of payrolls growth should still be sufficient to keep downward pressure on the unemployment rate but the trend in job growth appears to be down.  There were signs that the tight labour market was seeping through into faster wage growth with average hourly earnings rising 0.4% in August and 3.2% on a year ago (vs 3% expected), although this won’t stop the Fed cutting rates when it meets later this month (the market fully-prices a 25bp cut).  

The weaker than expected payrolls gain halted the rise in US Treasury yields, with the US 10 year yield falling back from a two-week high of 1.6% to 1.56%.  The 2 year and 10 year Treasury yields were flat on the day, stabilising after their sharp rises the previous session.   There was little reaction to Chair Powell’s speech (and Q&A) in Zurich, where he said the US economy was “in a good place” but there were significant risks and the Fed would “act as appropriate to sustain the expansion”.  Powell went on to say that so-called ‘make-up’ strategies for inflation (whereby the Fed would target above-average inflation to counter a period where inflation had been below target) were a “great idea”, although there were difficulties implementing these in practice.  The Fed is currently reviewing its monetary policy framework and several Fed officials have voiced support for ‘average inflation targeting’ (a form of make-up strategy).  At a minimum, it suggests the Fed is unlikely to be worried by inflation rising modestly above the 2% target and its primary focus will remain on the downside risks to growth. 

Ahead of the much-anticipated ECB meeting this week, European government bond yields fell 4-7bps, reversing around half the previous day’s rises.  According to a Bloomberg survey of economists, the consensus is for a 10bp cut to the ECB’s deposit rate (to -0.5%) and the announcement of a resumption to QE, with the median estimate for a €30b pace of purchases for one year.  Market expectations for the ECB are very high and, were it to disappoint, it could cause a major rise in bond yields globally, at least over the short-term. 

NZ rates experienced a big rise on Friday, in-line with the sell-off in global bonds the previous night.  The 2 year swap rate rose 5bps to 0.965%, despite ANZ changing its OCR call to forecast the RBNZ cutting the cash rate to 0.25% in May.  The 10 year swap rate was up 11bps to 1.3%, its highest level in almost a month. 

Commodity currencies performed well on Friday amidst the continued positive tone to risk assets.  The NZD was the top performing currency on Friday, rising almost 0.8% to 0.6428, while the AUD and CAD both increased around 0.5% (the CAD benefiting from a much larger than expected increase in job growth in August).  On the week, the NZD was 1.8% higher, benefiting from a weaker USD (which was down 0.5%-0.6% in index terms) and a more positive tone to US-China trade negotiations (the offshore renminbi was 0.8% stronger on the week).  Short covering among investors also likely to have played a role in the NZD’s appreciation last week; the latest CFTC report showed that speculative investors had their largest net short position in the NZD since November last year. 

The USD was down only slightly in index terms on Friday as it mostly recovered its initial payrolls-driven losses against the EUR and JPY.  The GBP gave back some of its recent strong gains and was the worst performing currency on Friday, down 0.4% to 1.2283.  Brexit-related developments continue to come thick and fast.  On Friday, opposition parties agreed not to back PM Boris Johnson’s call for an election before the EU Summit on 17/18 October, in a bid to force him to seek an extension from the EU to the Brexit deadline.  Speculation is mounting, however, that Johnson will try to find a way to avoid doing so.  Foreign secretary Dominic Raab said that the government “look very carefully” at “our interpretation” of the legislation, implying the government is looking for loopholes to avoid an extension, and there is also the chance that Johnson calls a vote of no confidence in his own party.  The betting market puts the odds of a no-deal Brexit this year at around 23%, much lower than the implied probability a week ago. 

In other news, the PBOC announced that it would reduce the reserve ratio requirement by 0.5% for all banks from 16th September (and an additional 1% for qualifying commercial city banks in October and November), which will free up around $126b in liquidity.  The announcement wasn’t unexpected and the PBOC said that “the stance of prudent policy has not changed”.  The PBOC’s decision comes against a backdrop of slowing growth in China, reinforced by trade data over the weekend which showed Chinese exports fell in USD terms in August as recent tariffs and slower global growth start to bite. 

The ECB meeting is the focus for the week ahead, with US CPI and retail sales the highlights data-wise.  Expect more news on Brexit as well.