Market sentiment improves, and both equity and bond yield markets push higher. China's management of their exchange rate cheered by markets. But the NZD faces headwinds as the yuan depreciates

Market sentiment has improved, helped by the stronger than expected CNY fix yesterday. 

Global equity markets show strong gains and global rates pushed higher, but as we go to print, US rates are heading lower again. 

Commodity currencies have outperformed overnight and the NZD is on track to break a 10-day losing streak.

Yesterday the PBOC set the CNY reference rate above 7 for the first time since 2008, at 7.0039. There was no shock value from printing a 7-handle, as that occurred on Monday when the market pushed spot CNY above 7 and the PBoC didn’t try to push it below that level.  More newsworthy than setting a 7-handle, the fix was more than 100bps stronger than the market estimate surveyed by Bloomberg, suggesting that the central bank was applying its “counter-cyclical” rule to send a message to the market that it wanted to stem the depreciation in the currency.  In Trump’s words, yes the PBoC is manipulating its currency, but in a direction contrary to market forces.

The PBoC’s actions have helped calm some nerves around the US-China trade war and improved market sentiment. The data calendar has been light, but Chinese exports and imports were stronger than expected in July, supporting the sense of calm.

Risk assets have recovered some lost ground with the Euro Stoxx 600 index up 1.7% and the US S&P500 index trending higher straight from the open and currently up 1.6%, with all sectors showing gains.

Global bond rates have pushed higher, albeit not by much, with key European 10-year rates (Germany, France, UK) up 2-4bps.  The US 10-year rate pushed up to 1.78% but has since fallen back down to 1.72% as we go to print, even after a softer 30-year auction. Intra-day volatility is currently high, and after we went to print yesterday, the rate inexplicably shot up 5bps into the NY close, completing a key-day reversal. From its low point of just below 1.60% less than 30 hours ago, the 10-year rate still trades 12bps higher.

Much higher US rates would normally have spilled over into the NZ market, but there looked to have been some significant positioning adjustments, to put it mildly, after the RBNZ’s 50bps rate cut shock and NZ rates showed notable falls to fresh lows. The 2-year swap rate closed below 1% for the first time, down 4bps to 0.97% and the 10-year rate fell by 6bps to 1.30%. NZ’s 10-year government rate fell 6bps to a record low of just 1.10% – this is not a typo!

In currency markets, President Trump has been lamenting the “strong” dollar.  He tweeted, “As your President, one would think that I would be thrilled with our very strong dollar. I am not! The Fed’s high interest rate level, in comparison to other countries, is keeping the dollar high, making it more difficult for our great manufacturers…to compete on a level playing field…” and he had another dig at the Fed, “they have called it wrong every step of the way”. The dollar jumped around a little bit after this as the market is nervous of a possible unilateral currency intervention. For the day, USD indices are relatively flat.

Better risk appetite sees commodity currencies head the leaderboard.  The NZD is on track to make its first gain in 10 days if it can hold above 0.6446 through to the NY close (9am NZ time). It’s well on its way to doing that and currently sits at 0.6480, up 0.6% for the day. After Trump’s escalation of the trade war late last week we flagged downside risk to our NZD forecasts and we remain concerned about the outlook, given the NZD’s strong link to CNY since the trade war began early last year. The prospect of market forces driving CNY weaker as China’s economy continues to suffer under the weight of tariffs is a clear headwind for NZD performance.

The AUD has recovered slightly stronger than the NZD, pushing above 0.68 and seeing NZD/AUD nudge down to 0.9525.  We remain negative on the cross and the RBNZ’s larger than expected rate cut earlier this week has helped nudge it lower in the direction of our forecasts.

The focus on the trade war means that commentary on Brexit has been absent from our daily reports this week. GBP pushed down to a sub-1.21 level overnight and has since recovered to 1.2140. The FT reported that Boris Johnson would hold a general election in the “days after” the UK has left the EU on October 31 if he is forced to go the polls following a successful parliamentary no-confidence vote in his government, according to senior aides to Johnson. Johnson seems over-confident in urging the EU to show some “common sense” on Brexit and sees “bags of time” for negotiations, but most would disagree with those sentiments.

EUR is slightly weaker, slipping below 1.12. Italian political risk has re-emerged, with Deputy PM Salvini saying that the government no longer has a majority and has called for “swift” elections.

The calendar ahead is full, with the RBA in focus as Governor Lowe speaks to a Parliamentary committee and the Bank releases its statement on monetary policy. Japan and UK GDP growth figures for Q2 are expected to be close to zero, while Chinese credit data will also be of some interest.