Further optimism on an imminent US-China trade deal has driven US equities up to a fresh record high and driven US Treasury yields up to a 3-month high. Higher risk appetite sees JPY underperform, but the NZD’s reaction has been inexplicably muted, lagging gains in the AUD and CNH.
Last night there was a notable market reaction to comments from China’s side that China and the US had agreed in principle to remove some of the punitive tariffs as part of a trade deal, going beyond just a freeze on new tariffs. A spokesman for China’s Ministry of Commerce said that “in the past two weeks, top negotiators…had agreed to remove the additional tariffs in phases as progress is made on the agreement. If China, US reach a phase-one deal, both sides should roll back existing additional tariffs in the same proportion simultaneously based on the content of the agreement, which is an important condition for reaching the agreement”.
These were specific comments that the market wasn’t willing to brush off easily, and it triggered a rise in S&P futures and another bond market sell-off that saw the US 10-year Treasury rate immediately rise 4bps to 1.85% and trend higher through the night. Resistance around 1.90% was broken and the sell-off extended an hour ago after Bloomberg reported that US officials had confirmed China's overnight comments that a phase one trade deal would include tariff rollbacks. The yield currently sits at 1.965%, up a chunky 16bps from the level prevailing at the NZ close. We await a more official source from the US to confirm China’s comments on the trade deal.
The S&P500 is up 0.6% to a fresh record high, buying into the view that a roll-back of tariffs will encourage a recovery in growth which will more than offset any valuation impact from higher rates. Expectations for further Fed easing have receded, with 11bps shaved off the 18-month-ahead Fed Funds rate. A 25bps cut is no longer seen as a better-than-even chance through much of the coming year. Further yield curve steepening is evident, with the 2s10s curve up to 26bps.
The reaction in currency markets has been a bit more muted. The yen has underperformed, falling about 0.6% since the NZ close, taking USD/JPY down to 109.50. CNH and AUD are stronger, with USD/CNH down 0.8% to 6.955, while the AUD is up 0.5% from the NZ close, back up through the 0.69 mark.
The NZD has inexplicably lagged the move, sitting at 0.6360, still down a touch from this time yesterday and barely higher from the NZ close. Traders appear reluctant to push up the NZD ahead of the RBNZ’s MPS next week. This sees NZD/AUD breaking down through the 0.9230 support level, to just above 0.92. The NZD’s underperformance against a backdrop of improving fundamentals (notably, higher risk appetite and stronger terms of trade) is making the currency look cheaper by the day. Obviously the rates backdrop hasn’t helped, with the swap curve down 3-5bps yesterday, and the market still inclined to believe that the RBNZ will deliver another rate cut next week.
In other news, the Bank of England voted to keep policy unchanged, but it wasn’t unanimous, with two of the nine members, Saunders and Haskel voting for a 25bps rate cut, citing threats to the outlook and signs that the labour market might be starting to deteriorate. The MPC signalled that a further deterioration could see more support for an easing. Governor Carney said that the risks to the outlook were “skewed to the downside”. The evident dovish bias of the committee saw the rates market price in a slightly greater chance of easier policy, although a 25bps rate cut is still not fully priced through the end of next year. UK rates have lagged the global selloff, with the 10-year rate up “only” 8bps to 0.79%, while GBP/USD is down 0.3% for the day to 1.2820.
Following hot on the heels of yesterday’s positive factory orders data, German industrial production fell by slightly more than expected, down 0.6% m/m in September, confirming that the manufacturing sector was a big drag on the economy in Q3 and Germany’s economy was probably in technical recession. However the orders data suggest that the worst might now have passed. EUR is down 0.2% to 1.1040, seeing some spillover from a weaker GBP.
In the day ahead, the RBA’s statement on monetary policy is released which will contain new forecasts consistent with its on-hold policy decision earlier in the week alongside the continuing easing bias. Later today, China trade data will be watched for further signs of the impact of the trade war and recent ramp-up in tariffs. Overnight, the University of Michigan consumer sentiment index is seen to be relatively steady by the consensus.