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NZD drags the AUD down after surprise RBNZ decision. Global outlook gets negative views in most markets and benchmark interest rates ease further in race to zero or below

Currencies
NZD drags the AUD down after surprise RBNZ decision. Global outlook gets negative views in most markets and benchmark interest rates ease further in race to zero or below

Market jitters continue around the US-China trade war escalation and a trio of surprise policy moves by central banks, including our own RBNZ, got the market’s attention. 

US equities plunged around 2% soon after the open, but have since pared that loss to sit flat for the day.

Global rates around the world have made fresh lows. The NZD and AUD have recovered strongly overnight after big losses during local trading hours.

The RBNZ made headlines yesterday with a larger than expected easing of 50bps, taking the OCR down to a record low of 1%. This was later followed by a larger than expected easing by India’s central bank (opting for 35bps than 25bps expected) and a surprise 25bps cut by the Bank of Thailand. The common factor here is the increased global risks that have emerged following Trump’s decision at the end of last week to pile on more tariffs on Chinese imports to try to win an unwinnable trade war. Of course, the global economy is already in a fragile state and yield curves signal much higher than usual recession risks ahead so the market continues to toy with the idea that recession might now be inevitable. In data overnight, Germany industrial production fell by more than expected in June, taking the annual fall to more than 5% and supporting the case that the economy contracted in Q2, and not helping the mood of markets.

The RBNZ’s move got the attention of Trump who tweeted about the three central banks that cut rates, but he blamed the US Fed, saying “…They must Cut Rates bigger and faster, and stop their ridiculous quantitative tightening NOW. Incompetence is a terrible thing to watch, especially when things could be taken care of sooo easily.”  Yes Mr Trump, it would be very easy to take care of “things”, but I wouldn’t be blaming the Fed.

Nerves around the global outlook and heightened expectation that central banks will ease further in a race to zero rates (and more negative for those central banks already beyond that level) sees lower bond rates around the world. European 10-year rates have ventured deeper into negative territory, with Germany’s 10-year rate down 5bps to minus 0.59% and France down the same at minus 0.32%. The US 10-year rate had a quick look just below 1.60%, but has since recovered to 1.67%, close to the level at the NZ close and 3bps lower for the day. The 30-year rate got down to 2.12%, just shy of its record low of 2.09% set two years ago. Chicago Fed President Evans told reporters that more headwinds since the Fed’s rate cut have emerged and risk management around the inflation outlook would alone argue for more accommodation. And “as we think we’re going to get closer to the zero lower bound with higher probability, that would also call for more accommodation”.  The trough priced in the Fed Funds rate is down to 1.02%.

US equities began the session on a poor note and were quickly down by nearly 2% early on, but have recovered and are now close to flat for the day. Falling rates and a flatter yield curve sees downward pressure on Financials, while oil prices continue to head south, down 4%, and dragging down energy stocks. Brent crude is down to $56.50, well down from the $75 peak in April and down nearly 14% for the month-to-date alone.

Back to the RBNZ’s decision, the committee debated the options of cutting 25bps or 50bps and reached a consensus that the larger initial monetary stimulus would best ensure the Bank continues to meet its inflation and employment objectives. The Bank maintained an easing bias, with Governor Orr’s response to the first question at the press conference being that “today’s cut doesn’t rule out future action”. Orr mentioned that the bank was looking at the "full suite" of unorthodox measures if needed and that it was easily within the realms of possibility that “we may have to use negative interest rates in the future”. However, he added that cutting rates more now decreases the chance of needing unconventional policy measures.

The market response was commensurate with the shock value of the larger than expected easing, with the 2-year swap rate down 18bps for the day to 1.01%, with 16bps of that move coming after the MPS announcement.  The 10-year swap rate fell by 13bps to 1.36%. Pre-statement the OIS market was pricing in a low in the OCR of 0.82% and by the end of the day it was priced at 0.67%. In essence, the Bank simply brought forward the easing that it was expected to do anyway and the market priced in an extra 15bps of easing to come for good measure.

The NZD got hammered by the shock decision and it is easy to say now that it over-reacted.  NZD/USD fell by as much as 2.6% to a low of 0.6378 but it has since recovered strongly overnight to sit this morning at 0.6465, down “only” 0.8% from this time yesterday. One way to look at it is that the NZD held up surprisingly well after the escalation of the trade war (pre-RBNZ the NZD was only 30pips lower since Trump’s fateful tweet to ramp up tariffs) and the current level now better reflects the increased global risks, with the extra 15bps of easing priced into the OIS curve helping get the NZD down to a fairer level.

The weaker NZD dragged down the AUD, with the market taking the view that the RBA will also adopt an earlier and more aggressive easing policy. The market now prices a high chance that the RBA will ease again as soon as next month. The AUD fell to a multi-year low of 0.6677 and has since recovered its losses to sit at 0.6770, up slightly from this time yesterday.  NZD/AUD has settled around the 0.9550 mark, down about a cent for the day.

By comparison, other majors haven’t shown a great deal of movement with USD indices barely lower with small movements in EUR and GBP.  USD/JPY got down to 105.50 overnight, but has moved back up to a 106 handle.

The economic calendar is fairly bare for the day ahead, with some interest in China trade data, but the mood around the global economy and trade war will continue to dominate market pricing.

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3 Comments

An excellent article Jason.
We live in interesting times; the nature of the protagonists is such that a compromise and settlement in the near future is seemingly unlikely.

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Negative interest rates on the way to drive more cash into the bubbles. We are all about to be asset stripped. Watch gold head to $3k and beyond as the search for safety goes full throttle.

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Why would anyone "get out there and spend" with Armageddon imminent ?
With zero or negative interest rates, chances are, most things will be cheaper further down the road.

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