Equities and bond yields fall after reports that a US-China ‘Phase-Two’ agreement will be difficult. USD weakens sharply after Powell says the hurdle for Fed hikes is very high. NZ rates rise as market pares back November OCR cut pricing to 50%.

Markets have been traded with a risk-off tone overnight with equities falling, bond yields lower and the Japanese yen strengthening. This followed a Bloomberg report that a long-term US-China trade agreement would be difficult to achieve and a much weaker-than-expected Chicago PMI survey. The USD weakened sharply yesterday morning after Fed Chair Powell said the hurdle for hikes was very high and it has largely consolidated that move overnight. The NZD is back above 0.64, driven by the weaker USD and the market’s paring back of November OCR rate cut pricing, which is now around 50%.

Shortly after this report went out yesterday morning, markets reacted strongly to Fed Chair Powell’s comments in the press conference that suggested the hurdle for future Fed rate hikes is very high. Powell said the Fed “would need to see a really significant move up in inflation that’s persistent before we would consider raising rates to address inflation.” While the Fed clearly communicated that it intends to take a pause after the 75bps of cuts this year, the hurdle for easing still appears much lower than it is for hikes. Those comments led to around a 0.6% increase in the S&P500 (to a fresh record high), a 4bp fall in the 10 year Treasury yield (to 1.77%) and a sharp weakening in the USD.

Overnight, equity markets have largely reversed those post-FOMC gains, with the S&P500 down 0.6%, despite better-than-expected earnings results from Facebook and Apple after the close yesterday. Market sentiment has been affected by a Bloomberg report that Chinese officials were doubtful that a long-term US-China trade agreement was possible, given China’s reluctance to embrace big structural changes and an insistence on the removal of existing tariffs. It shouldn’t surprise anyone that the subsequent phases of trade talks will be more difficult than Phase One, but the report was still a reminder to the market that, despite the recent de-escalation in tensions, the key underlying issues are still unresolved. Trump later confirmed on Twitter that the two sides were finding a new location for his meeting with President Xi, where Phase-One is expected to be signed off.

The other key event overnight was a much weaker-than-expected Chicago PMI survey, which fell to 43.2 in October. With the exception of a one-off reading in December 2015, this was the lowest level of the survey since the GFC. The Chicago PMI can be volatile month-to-month, and there is the possibility that the ongoing woes at Boeing – which is headquartered in Chicago – have affected the index, but the data point to downside risks for the ISM manufacturing survey tonight. The market looks for a rise in the ISM to 49, after 47.8 last month. Payrolls is also released tonight. In other economic data over the past 24 hours, the official Chinese PMIs fell in October, with the Manufacturing index remaining below the 50 mark, while European GDP surprised slightly to the upside although, at 1.1%, it was the slowest annual pace of growth since late-2013.

US rates have extended their move lower overnight, with the 10 year Treasury yield falling another 8bps to 1.69%. The market has increased its Fed rate cut pricing on the back of the falls in equities and weaker Chicago PMI, with 40bps now priced-in by the end of next year. With Powell seemingly ruling out the prospect of rate hikes anytime soon, the market will continue to price the balance of risks around the next Fed move towards cuts, for some time at least.

The USD has largely consolidated overnight after its sharp move lower yesterday morning after Powell said that the hurdle for hikes is very high. The USD indices are 0.3% to 0.4% weaker than this time yesterday and are pushing up against the low-end of the trading range over the past three months. The JPY has outperformed amidst the sharp fall in US Treasury yields and risk-off backdrop and is 0.8% stronger (USD/JPY has fallen to a three-week low below 108). The Bank of Japan signalled an easing bias at its meeting yesterday, saying that it would keep rates at their present or lower levels, but this has had little impact on the JPY.

The NZD is back trading above 0.64, around 1% stronger than this time yesterday, supported by the broad-based weakening in the USD and rise in NZ rates yesterday. The NZD/AUD cross has appreciated from near 12-month lows to around 0.93. There was a material re-pricing of OCR expectations yesterday after Westpac changed its call on the RBNZ, forecasting no change in November. The market’s conviction in a November OCR cut had already been slipping in recent weeks, in-line with the decline in RBA and Fed rate cut expectations and the big upside surprise to non-tradables inflation in the latest CPI report. The probability of a November OCR cut has now fallen to 54% and, although there was less movement in subsequent meeting probabilities, the terminal OCR has shifted up to 0.7%. On balance, we think the RBNZ will cut the OCR by 25bps in November in light of weak activity indicators in NZ that point to growth well below the RBNZ’s forecasts. While market sentiment has improved in recent weeks, following de-escalation in US-China trade tensions, global economic data has yet to pick up and remains at subdued levels.

The NZ 2 year swap rate rose 4bps to 1.03% yesterday, its highest level since the August MPS, and despite a 4bp decline in the US 2 year rate. The curve flattened, with the 10 year swap rate 1.5bps higher at 1.42%.

Yesterday’s ANZ Business survey revealed a further (modest) decline in firms’ own-activity expectations, with the measure falling to its lowest level since 2009. It suggests GDP growth will continue to slow from its recent 2% pace, at least in the near-term. Other indicators were mixed, with a further fall in employment intentions but a small rise in investment intentions and profit expectations. Inflation expectations were unchanged, at 1.6%. There was no obvious market reaction to the survey given the small changes from last month. The next major piece of NZ data is the HLFS employment report next week.