US-China agree ‘mini’ trade deal – China buys farm goods, US suspends October tariffs. Brexit optimism continues as EU and UK “intensify” negotiations over weekend – GBP +1.8%. Equities and bond yields head higher, USD weaker

US-China agree ‘mini’ trade deal – China buys farm goods, US suspends October tariffs. Brexit optimism continues as EU and UK “intensify” negotiations over weekend – GBP +1.8%. Equities and bond yields head higher, USD weaker

Positive market sentiment continued on Friday as the US and China agreed to a partial trade deal and the UK and EU agreed to intensify negotiations over a possible Brexit deal. 

Equity markets and bond yields rose sharply for the second day running as the market started to price-in a more positive economic outlook and investors rotated out of safe havens. 

The improvement in risk appetite led to falls in the JPY and USD, while the GBP had another big rise on Brexit optimism.  The NZD was slightly stronger while NZ rates had a large move higher on Friday. 

The US and China announced a ‘mini’ trade deal on Friday, with China committing to buy more agricultural goods from the US and the US suspending tariffs that were due to come into effect this week (from 25% to 30% on $250b of Chinese imports).  There was no roll-back of existing US tariffs or any break-through on the major issues underlying the conflict, such as Chinese state subsidies, although Trump made some vague references to progress on intellectual property protections and currency.  In a later tweet, Trump claimed China would also purchase $16-$20b in Boeing planes.  Trump described it as a “substantial phase one deal” and Trump and Xi are expected to sign it off at a likely meeting at the APEC Summit in Chile in mid-November.

Trump said negotiations over phase two will start “almost immediately” after this partial agreement is signed off.  Phase two will be expected to cover the more contentious issues such as intellectual property protection, national security concerns around firms such as Huawei, state subsidies and enforcement mechanisms for any deal.  The US tariffs on $160b of Chinese consumer goods imports scheduled to take effect in mid-December remain in place, at least for now.  The hope would be that the renewed engagement and goodwill between the two sides will see those tariffs suspended in due course, although reaching a “phase two deal” will be a more difficult process. 

Equities and bond yields increased further on Friday as expectations for a US-China trade agreement grew over the course of the session.  The S&P500 ended the session up 1.1%, although it came off its highs towards the market close after US Trade Representative Lighthizer said there hadn’t been any decision made about the December tariffs.  The positive market reaction probably speaks to the low level of expectations for any kind of agreement as well as the possibility of the two sides making further progress at the Trump-Xi meeting expected next month. 

Positive Brexit developments were the other key driver of market sentiment on Friday.  Following a meeting with UK Brexit Secretary Steven Barclay described as “constructive”, EU chief negotiator Michael Barnier signalled that negotiations should intensify over the weekend ahead of the EU Summit that starts on Thursday.  The move follows a breakthrough meeting between UK PM Johnson and Irish PM Varadkar on Thursday in which Johnson reportedly softened his position on the Irish border.  The question is whether Johnson can maintain the support of both the Brexiteers in his party and the DUP if he changes his stance on Northern Ireland; DUP Deputy leader Nigel Dodds warned over the weekend that “Northern Ireland has to remain fully part of the UK customs union” although, encouragingly, arch-Brexiteer Jacob-Rees Mogg called for compromise.  The GBP was up 1.8% on Friday, bringing its cumulative rise since Thursday morning to 3.6% (its biggest two-day rise since 2008). 

The USD was broadly weaker on Friday, with the exception of the safe-haven Japanese yen and Swiss franc.  The BBDXY fell 0.4% and it is now close to its lowest level in two months.  In large part, the weakness in the USD is a by-product of the strength in other currencies - GBP (and to a lesser extent EUR) on Brexit and the CNY, EM and commodity currencies after this mini US-China trade deal. 

The NZD rose 0.3% amid the improvement in risk appetite, strengthening in the CNH and broad-based weakening in the USD.  The NZD reached a 4-week high above 0.6350 before easing back in the last few hours of trading as equity markets slipped.  While we haven’t changed our NZD forecasts, the odds of a re-test of the early October lows of 0.62 have receded a little amidst the brighter outlook for US-China trade relations (and hence the CNY). 

Global rates extended their moves from Thursday’s session.  The 10 year Treasury yield rose 6bps to 1.73%, bringing its cumulative rise on the week to over 20bps.  Fed rate cut expectations were pared back, with November now seen as around a 70% chance and 57bps of cuts priced-in by the end of 2020.  The US curve steepened, with the short-end supported by the NY Fed’s announcement that it would purchase Treasury bills from mid-October until at least the second quarter of 2019 at an initial pace of $60b per month. The Fed intends to maintain bank reserves at a minimum level in order to prevent a repeat of recent money market volatility. 

A stronger than expected University of Michigan consumer confidence index assisted the move in rates.  The market brushed off the fall in 5-10 year inflation expectations in the same survey to its lowest on record (the preliminary inflation expectations readings are often revised). 

NZ rates spiked higher on Friday, reflecting global forces, with the NZ 2 year swap rate rising 4bps to 0.89% and the 10 year swap increasing a chunky 11bps to 1.25%.  While these are large moves, they should be seen in the context of the sharp declines that preceded it (the 10 year swap reached an all-time low of 1.1% earlier in the week).   Additionally, present levels of long-term interest rates embed a relatively pessimistic economic outlook, leaving the market vulnerable to positive news (such as on US-China trade and Brexit, and the possibility that this could trigger an upturn in the global data pulse).  As of Friday’s close, the market continued to attach a small chance to a 50bp OCR cut by the RBNZ at the November MPS, although that had been pared back to less than 10%.  We continue to think the chance of a 50bp OCR cut in November is very low, especially if non-tradables CPI inflation picks up to 3% when the data is released this week. 

In domestic data, the PMI released on Friday signalled the manufacturing sector remained stuck in contraction, for the third consecutive month.  The PMI index was unchanged at 48.4 in September, although there were small lifts in new orders (to 50.4) and employment (to 50).  The weakness in manufacturing is very much a global theme at present, and the key issue is to what extent there are any spill-overs into services.  On that note, the PSI is released this morning.  After falling earlier this year, the PSI has increased back to near its post-GFC average over the past three months, despite the weakness in the PMI and overall subdued business sentiment.  

Domestically, NZ CPI is the highlight in the week ahead while, in Australia, the employment report and RBA minutes are released.  Our NAB colleagues expect the unemployment rate to remain at 5.3%, in line with consensus but way above the RBA’s estimate of NAIRU.  In the US, retail sales are the highlight data-wise.  The EU Summit starts on Thursday, with Boris Johnson hoping to secure a Brexit deal with the EU. 

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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