Net result is a rally in bond and equity markets, stronger risk currencies like the NZD and weaker European currencies; US Treasury yields have pushed lower, although more so at the long end of the curve

It has been an eventful overnight session in markets, driven by a dovish speech by ECB President Draghi and President Trump confirming that he will meet President Xi later this month. The net result is a rally in bond and equity markets, stronger risk currencies like the NZD and weaker European currencies.

At the annual offsite central banking forum in Portugal, the ECB’s Draghi changed the policy narrative, commenting in a speech that additional stimulus will be needed “in the absence of any improvement” to the outlook for growth and inflation. The central bank has a number of weapons in its arsenal to take action if inflation doesn’t pick up and this applies to all instruments, he said, adding that “further cuts in policy interest rates and mitigating measures to contain any side effects remain part of our tool.” In a panel discussion he later stressed that the language is a deliberate change from less than two weeks ago, “this is because of this lingering uncertainty that is by itself a materialisation of risk”.  Bloomberg later reported that the ECB anticipates using an interest-rate cut as its first stimulus move if the Bank needs to act again to boost inflation, according to three euro-zone central bank officials.

The ECB next meets in five weeks in late July, so a policy move could be implemented then depending on how things pan out over coming weeks. EUR immediately fell on the speech headlines and the move has been sustained, taking it down from 1.1240 and finding some support just under the 1.12 mark.  Falls in SEK, NOK and CHF round out the bottom of the leaderboard for currencies.  European bond yields have seen some big moves, with 10-year rates down 22bps in Greece, 19bps in Italy and 13bps in Spain. Germany’s 10 year rate is down 8bps to minus 0.32%, a fresh record low.

Draghi’s dovish talk drew the ire of President Trump who tweeted “Mario Draghi just announced more stimulus could come, which immediately dropped the Euro against the Dollar, making it unfairly easier for them to compete against the USA. They have been getting away with this for years, along with China and others.”  Still, after having another dig at China, Trump confirmed that a meeting with President Xi will proceed at the G20 summit at the end of this month, tweeting, “Had a very good telephone conversation with President Xi of China. We will be having an extended meeting next week at the G20 in Japan. Our respective teams will begin talks prior to our meeting.”

As we’ve noted in previous reports, the outcome of this meeting will be crucial for how markets perform in the second half of the year.  Until today, there was some doubt that the two Presidents would even meet, with Xi previously not willing to commit to a meeting.  The combination of the dovish tone from the ECB and confirmation of a Trump-Xi meeting has supported equity markets, with the S&P500 currently up 1.1%, after being up as much as 1.4% in early trading.  Still, there’s no guarantee that the trade war will ease.  US Trade Representative Lighthizer told senators at a hearing in Washington that the Trump administration will stay tough and this follows the weekend comment by Commerce Secretary Ross downplaying the prospect of a major deal in the near term.

Despite the risk-on backdrop, US Treasury yields have pushed lower, although more so at the long end of the curve, with the 10-year rate down 4bps to 2.055%, climbing from a low of 2.015% after Trump tweeted about his phone call with Xi. As well as the tailwind from lower European rates the theory might also be that further policy easing by the ECB would ease the path for the Fed to cuts rates as well.

Higher risk appetite sees the NZD at the top of the leaderboard, albeit up a modest 0.5% to 0.6525.  AUD is up slightly less, taking it to 0.6875 and helping push NZD/AUD up to around the 0.95 mark, with the RBA’s minutes yesterday noting that further policy easing was more likely than not in the period ahead.  The NZD’s outperformance sees it higher on all the key crosses, with NZD/GBP around 0.52, NZD/EUR at 0.5830 and NZD/JPY at 70.75.

The GDT dairy auction overnight saw the price index fall by 3.8%, close to our estimate of a 4% reduction, making those muddy gumboots worthwhile for our resident cow-whisperer Doug Steel. The obvious weakness in pricing confirms the downward turn we’ve been expecting and reinforces the caution we’ve long had about the 2019/20 milk price.

In the day ahead we’re likely to see markets move into a holding pattern ahead of the FOMC update at 6am NZ time tomorrow morning, where the Fed is expected to downgrade its inflation forecast, lower the dot-plot of Fed Funds projections and remove its “patience” comment in the outlook for policy – a dovish tilt from the last meeting, but not as dovish as current market pricing, so the comments from Fed Chair Powell at the press conference will be important and ultimately determine the market reaction.  He might be feeling a little sheepish after Bloomberg reported that the White House explored the legality of demoting him in February, soon after President Trump talked about firing him, according to people familiar with the matter.

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