US-China trade optimism drives Dow Jones to record high, global rates higher. NZ rates experience another big move higher yesterday. NZD consolidates about 0.64. RBA expected to keep rates on hold and maintain easing bias today.

US-China trade optimism drives Dow Jones to record high, global rates higher. NZ rates experience another big move higher yesterday. NZD consolidates about 0.64. RBA expected to keep rates on hold and maintain easing bias today.

Equities and bond yields headed higher overnight following more encouraging comments from US officials on Phase-One US-China trade negotiations. The USD regained some of its losses from last week but remains range-bound while the NZD continues to trade just above 0.64. NZ rates experienced another sizeable rise yesterday, with rates at the short-end reaching their highest level since the August 50bp OCR cut.

Market sentiment remains buoyant to start the week. Equities, bond yields, breakeven inflation and crude oil have all risen, pointing to greater market optimism around the global growth outlook. Comments from US and Chinese officials on trade negotiations remain upbeat, with Commerce Secretary Wilbur Ross saying yesterday that talks were “very far along” and he was “quite optimistic” that Phase-One would be signed off. The constructive dialogue between the two sides raises the prospect that the US might suspend the tariffs scheduled for December. As we reported yesterday, Ross said the US might not need to put auto tariffs on European imports, signalling a more generalised dialling down of trade hostilities by the US administration.

US equity indices are around 0.4%-0.5% higher overnight with the Dow Jones, which has lagged both the S&P500 and NASDAQ, making a new record high. The energy sector (+3.3%) again led gains on the S&P500 after an almost 2% rise in Brent crude oil prices. Earlier, European indices were up more than 1% with the Eurostoxx 600 reaching its highest since mid-2015. Chinese equities lagged the moves, with the CSI300 index up 0.6% yesterday. The CSI300 composite is up an impressive 32% year-to-date, although its recent gains have been muted and it remains significantly below the highs reached in April (before US-China trade relations soured).

The 10-year Treasury yield has increased 7bps to 1.78% and the yield curve has steepened, in-line with the improved market sentiment. There was no major economic data released overnight. The market’s focus is the non-manufacturing ISM survey, released tonight, for an updated read on the US services sector. The survey has slowed this year and last month hit a three year-low of 52.6, but it remains significantly more positive than the manufacturing equivalent. Minneapolis Fed President Kashkari, who has historically been one of the most dovish voices on the FOMC, told CNBC that he was “comfortable” with current policy settings and the message from the FOMC was that rates were "effectively on pause for a while.”

NZ rates had another big move higher yesterday. The increase in global rates, market nervousness about the likelihood of a November OCR cut and, almost certainly, unwinds of investor positions combined to push swap rates up 4 to 7bps across the curve. The 2 year swap rate closed at 1.06%, its highest level since the August MPS, as the market continued to price a November OCR cut at around a 50% chance. The terminal OCR is now close to 0.75%, indicating at the market now sees the most likely outcome being that the RBNZ cuts the cash rate just once more. Showing just how far market pricing has shifted, a month ago the market was pricing a small chance that the RBNZ could take the OCR to 0.25%.

The recent move higher in OCR expectations and NZ rates more broadly has occurred amidst similar moves in Australia, as the market has pared back its RBA rate cut expectations. Even a very weak Australian retail sales release yesterday did nothing to arrest the move higher in Aussie rates, with the 3 year yield ending 4bps higher at 0.83%. Australian retail volumes fell by 0.1% in Q3 despite $7.2b of income tax refunds that started flowing from July and the RBA rate cuts in June and July. The market expects the RBA to keep its cash rate at 0.75% at its board meeting today and retain an easing bias. Our NAB colleagues believe the new Policy Targets Agreement could potentially be released at the same time.

In FX markets, the USD has appreciated across the board, partially reversing the moves from last week (the BBDXY fell five consecutive days last week). The USD is around 0.2% stronger, in index terms, but remains near the bottom of its recent trading ranges.

The JPY (-0.35%) has underperformed amidst the risk-on backdrop and rise in US Treasury yields. The more positive comments on US-China trade talks have boosted the CNH to an almost two-month high (USD/CNH at 7.03). The appreciation in the CNH and increased optimism around global growth has seen commodity currencies (CAD, AUD and NZD) outperform, although they are still down slightly against the USD.

The NZD reached a 2½ month high of 0.6466 in the London morning before grinding lower over the remainder of the session to sit around 0.6420, close to where it was trading on Friday. We upgraded our NZD forecasts yesterday, in light of the reduction in global risks overhanging the market and a stronger CNH forecast assumption. We now expect the NZD to be anchored around 0.65 over the coming few quarters.

Finally, NZ and China announced an upgraded free-trade agreement yesterday evening, which will reduce tariffs on NZ wood and paper exports and introduce new rules that will make exporting to China easier and reduce compliance costs. Separately, the Regional Comprehensive Economic Partnership (RCEP) was agreed by 15 countries, including NZ, although India declined to participate at this stage. The RCEP is expected to be signed next year. The announcements weren’t market moving but are a reminder that the current protectionist tide that markets are obsessed with isn’t all one way, at least as far as it concerns NZ.

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So the OCR cut has had practically no effect on the currency at all .............