Increasing optimism on a US-China trade deal and a stronger-than-expected US non-manufacturing ISM index have driven markets, with a chunky rise in UST yields and more curve steepening. Higher US rates have supported the USD, and this dynamic has more than offset the positive news for the NZD, seeing it trade back below 0.64.
Through yesterday’s trading session the focus was on a number of media reports indicating how China was pressing the US to remove at least some of the punitive import tariffs to help seal a trade deal. The FT reported that China was asking for the US to eliminate tariffs on $110bn in goods that were imposed in September and lower the 25% tariff rate imposed last year on $250bn of goods. This demand goes further than just suspending the fresh tariffs due mid-December on $160bn of goods. In return, China could remove tariffs on a reciprocal amount of US goods, mostly farm products. There isn’t much more to add in overnight news on this topic other than it also looks like China will give Trump a “win” by cracking down on fentanyl smuggling, which formed part of the original trade deal a year ago that ended up scrapped.
The market took the optimistic view that Trump might actually agree to roll back some tariffs, or at least do enough to help seal a deal. USD/CNY traded below the 7 level for the first time since August, despite the PBoC reducing the cost of one-year funds to banks by 5bps to 3.25%, the first reduction since 2016 – a symbolic move that signals an easing of liquidity conditions.
The NZD trended higher, peaking near 0.6430 late last night, while the AUD pushed higher before meeting resistance just under 0.6930. Some support was evident after the RBA left its cash rate unchanged at 0.75% and maintained its easing bias. While the unchanged policy outlook was widely expected, the lack of any change got some nervous about their December rate cut calls. A rate cut next month looks increasingly unlikely but the market still prices in a better-than-even chance of a 0.5% cash rate in the first half of next year.
The worm turned close to midnight, when US rates and the USD tracked higher, with some follow-on price action after the US ISM non-manufacturing index recovered by more than expected from a 3-year low, with improvements in the key new orders and employment components. The recovery reduces fear that the recession in the manufacturing sector is spilling over into the services sector. In other economic news, the US trade deficit was in line with expectations, falling to a 5-month low of $52.5bn. The data highlight the impact of the trade war – in the 9 months to September US imports from China fell 13.5% while exports fell 14.6%, seeing a narrowing of the US trade deficit to China from $307bn to $266bn.
US rates rose across the curve, with 2-year Treasuries up 4bps to 1.62% and 10-year Treasuries up 8bps to 1.86%, extending the significant bond market sell-off and curve steepening evident over the past month or so. Traders of the 10-year rate will be eyeing the September high just above 1.90%. A break of that level would ease a path up to the 2% mark. To the extent that rising rates reflect a more optimistic economic outlook – a possible trade war truce and the message from the more positive yield curve – US equities continue to be well supported. Previously a 35bps sell-off in Treasuries might have seen equities fall substantially, but the S&P500 made a fresh record high yesterday and the overnight fall has been small.
The rise in US rates has supported the USD, seeing it make broadly based gains, with GBP, CAD and the AUD showing the smallest falls. While the other commodity currencies have only made small losses overnight and since this time yesterday, the NZD has been inexplicably weaker, trading at 0.6380 this morning. In overnight news, the GDT dairy auction price index rose by 3.7%, above our expectations for a 1-3% gain, driven by a 3.6% gain in whole milk powder and 6.7% gain for skim milk powder. QV house price data showed annual house price inflation nudging higher.
The softer NZD against a backdrop of higher NZ commodity prices obviously adds to the upside pressure for export receipts but also makes the currency look even cheaper on our fair value model. There may be some nerves ahead of some key labour market data today. We and the consensus see the unemployment rate rising to 4.1% in Q3, up from the decade-low reading of 3.9%, while annual wage inflation should show further upside pressure. The data will be important as the market has lost some conviction in whether the RBNZ will cut the OCR by 25bp next week, and further easing is now looking like a finely balanced decision. A material positive surprise would add to the reduced global risks and could see the market lose more conviction in the likelihood of further rate cuts, giving a little boost to the NZD and rates.
Yesterday the NZ rates market continued to see higher levels and curve steepening, with the 2-year swap rate up 1bps to 1.07% and the 10-year rate up 4bps to 1.50%, the highest closes since early August.