Fed releases a surprise statement saying that it will “act as appropriate” – market prices 35bps of Fed cuts for March meeting. Chinese PMIs slump to record lows – should see NZD and AUD open lower this morning

There were massive moves across markets once again on Friday.  Equities fell sharply again alongside other risk assets before the Fed issued a surprise statement before the market close saying it would “act as appropriate”.  The statement caused a spike higher in equities and a fall in the USD as the market moved to price a chance of a 50bp cut this month from the Fed.  RBA watcher Terry McCrann said the RBA would cut rates this week and domestic markets now price around a 50% chance the RBNZ will cut later this month too (although those odds are likely to increase today).  The Fed Statement, and ensuing USD weakness, provided some support to the NZD, which closed the week just below 0.6250, near 10-year lows. 

The COVID-19 outbreak remains the source of market stress, with more countries (including New Zealand) reporting their first cases, and a further rise in new cases outside China.  A potential outbreak in Washington State in the US has led the Governor to declare a state of emergency, with one death recorded over the weekend in the state.   Other unexplained cases have been reported in California and Oregon.  The US now has 72 confirmed cases.   France has banned indoor gatherings of more than 5,000 people as the number of COVID-19 cases rose above 100 on Saturday while Italy’s jumped by more than 500 to 1,694.  The UK reported 12 new cases on Sunday, including one where the origin of the virus was unclear, taking its total to 35.  The WHO raised its risk assessment to “very high” but stopped short of declaring a global pandemic.  The global spread of the virus raises the prospect of further economically disruptive containment measures across a broad range of countries with likely spillovers to consumer and business confidence. 

In the Friday overnight session, global equity markets kept going where they left off on Friday morning – down.   The S&P500 fell as much as 4.15% on Friday night, bringing its cumulative decline since the 20th of February to more than 15%.  It was the worst week for the S&P500 (-13%) since 2008.  The VIX index of implied volatility almost touched 50, a level barely seen outside the GFC.  US high yield (i.e. “junk bond”) credit spreads increased almost 150bps on the week, to 5%, a sign that the market foresees rising bankruptcy risk amongst the most leveraged borrowers. 

The sell-off in equity markets was halted by an unexpected statement from Fed Chair Powell shortly before the US market close on Friday.  The brief statement reads: “The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.”  The S&P500 pared its losses on the day to ‘just’ 0.8% after the release of the statement.  MNI reports that BoJ Governor Kuroda, like Powell, is likely to issue a statement before the Japanese market open today outlining measures to stabilise markets. 

Global bond yields had been tracking equity markets lower throughout the Friday night session, and got a further push lower after the Fed statement, which market participants interpreted as a signal that the Fed will cut rates this month.  Some will argue that there’s not much monetary policy can do to combat a shock such as COVID-19, but the Fed will want to stop (or, at the very least, slow) the tightening in financial conditions, which has the potential to exacerbate the downturn in the economy.  As of the Friday night close, the market priced 35bps (i.e. around a 50% chance of a 50bp move) for the Fed’s meeting on the 19th.  If the aim of cutting rates is to support financial markets, then the Fed’s incentives are surely to err on the side of ‘doing more’ rather than less, which makes a 50bp cut seem a distinct possibility.  The market prices around 100bps in total for the Fed over the next 12 months. 

The 10-year Treasury yield closed the week at an all-time low of 1.15%.  The yield curve has steepened as the market anticipated a monetary policy response – the 2y10y curve increased 3bps on the day (and 11bps on the week) to 23bps. 

Before the Fed meeting, there are the RBA and Bank of Canada meetings taking place this week.  RBA rate cut expectations were fuelled by an article by RBA watcher Terry McCrann on Friday night which said a cut this week “can’t be avoided.”  The market has moved to almost fully-price a 25bp RBA cut for this week and the Australian 10-year bond future extended its rally on Friday night to reach an implied yield of 0.68%.  The market prices around a 75% chance of a cut by the BoC this week. 

NZ rates had a big move lower on Friday as the market started to contemplate the RBNZ cutting rates as soon as this month.  The 2-year swap rate fell 10bps to 0.85%, near its all-time low, while the 2y10y swaps curve steepened 3.5bps.  Despite RBNZ Assistant Governor Hawkesby saying as recently as Thursday that monetary policy was not best placed to deal with the economic fall-out from the virus, the market sees the prospect of monetary policy easing by the RBA and Fed this month as putting pressure on the RBNZ to follow suit (the RBNZ meeting is on March 25th).  As of the Friday night close, there was around a 50% chance of a March OCR cut priced-in.  But given the re-pricing in RBA rate expectations after the NZ market was closed on Friday night (the yield on Australia’s 3 year bond future is around 15bps lower than where it was when the NZ market closed), we’d expect to see another leg down in NZ rates when the market re-opens this morning.  We suspect the market will go close to pricing 25bps of cuts for the RBNZ’s March meeting.  Finance Minister Grant Robertson has said the government can loosen fiscal policy at the Budget in May if required, although the market’s focus for now is the potential for an RBNZ response. 

Economic data on Friday night had little impact on the market, with investors showing little interest in readings on economic activity pre- the spread of COVID-19.  Of note however, the Chinese Manufacturing and Non-manufacturing PMIs slumped sharply over the weekend.  The Manufacturing PMI for February fell from 50 to 35.7, its lowest level on record (below the 38.8 recorded during the GFC) while the Non-manufacturing equivalent fell from 54.1 to 29.6 (its low during the GFC was 50.8).  While the market understood that there would be a sharp (albeit ultimately temporary) hit to Chinese growth as a result of the containment measures implemented after the COVID-19 outbreak, the size of the falls in the PMIs are likely to see economists revise down their China Q1 GDP forecasts further.  With production restarting in China in recent weeks there should be a rebound in the PMI next month, although how fast production picks up is unclear. 

Currency moves reflected the risk-off backdrop, with the JPY appreciating 1.6% and the global-growth sensitive NZD and AUD falling 1% and 0.8% respectively.   The USD had been edging higher through most of the session but then fell back after Fed Chair Powell released his statement.  The BBDXY was 0.2% lower on Friday. 

Most of the fall in the NZD took place during local trading hours on Friday, as it broke below 0.63 and traded down to around 0.6250 at 4:30pm amidst rising OCR rate cut expectations.  The NZD traded lower in the overnight session (including a brief spike down to 0.6191) before the Fed statement generated broad-based USD weakness and added some support to the NZD.  The NZD closed the week just under 0.6250, near its lowest level since 2009.  The market’s growing nervousness around the risk of global recession is clearly NZD-negative and following the big falls in the Chinese PMIs on the weekend, its likely to open lower again this morning. 

Focus this week is likely to remain squarely on COVID-19, the response from authorities and timelier economic data (including the Caixin PMI today).  The RBA and Bank of Canada meetings will also be closely watched for how central bankers are responding to the shock.  Domestically, Statistics NZ will release some experimental trade data they have constructed for the 4 weeks to 23 Feb, which is to help people gauge early impacts from COVID-19 (and the drought).  The data is released at 2pm.  Provisional NZ visitor arrival numbers for the week to 9th February (which were released on Friday) showed total visitor arrivals were down 25.1% on a year ago, which those from China down 93.3%.