Equities rise on the prospect of globally coordinated policy response. RBA meeting today – market expects 25bp cut. NZ rates hit record lows as market prices 40% chance of RBNZ 50bp March cut

Risk asset markets have bounced back overnight after reports that G7 finance ministers and central bankers would have a conference call later today, raising the prospect of a globally coordinated policy response to the COVID-19 outbreak.  US equity markets are up around 2%.  The USD has weakened sharply amidst expectations of aggressive Fed easing.  The NZD and AUD opened lower yesterday morning after the shocking falls in China’s PMIs, but they have recovered those losses as risk appetite has improved.  There were big falls again in NZ rates yesterday, with the market now pricing a 40% chance of a 50bp RBNZ rate cut later this month. 

It feels like we have moved into the policy response phase after the recent equity market rout.  Fed Chair Powell’s unexpected statement on Friday night, in which he pledged that the Fed would “act as appropriate”, has been followed up by reassuring statements or comments from other major central banks, including the Bank of Japan, European Central Bank and Bank of England.  What has caught the market’s attention is the potential for a globally coordinated policy response.  French Finance Minister Le Maire confirmed yesterday that G7 finance ministers would speak on conference call this week, saying that there would be “concerted action” and it was important that the fiscal response was “as coordinated as possible”.  Bloomberg later reported that G7 central bankers would also join the call, which is expected to take place at 12pm GMT Tuesday (1am NZT tonight). The last time there was globally coordinated policy action was during the GFC. 

The prospect of a globally coordinated policy response – and, importantly, both fiscal and monetary policy – has helped stabilise markets and support risk appetite.  US equity markets are up around 2% on the day, with the market brushing off Chinese PMI data released over the weekend which showed activity had fallen to the lowest levels since the surveys began.  All sectors of the S&P500 are in the green, but defensive and high dividend stocks (so-called ‘bond proxies) have outperformed amidst the sharp decline in US Treasury yields. 

Of note, given it is arguably further advanced in its response to COVID-19, China’s CSI 300 equity market increased 3% yesterday and it is now within 3% of its recent highs.  Oil prices have recovered more than 3%. 

The market has moved to price imminent easing from the world’s major central banks.  The market almost fully-prices a 50bp rate cut by the Fed at its March meeting.  In fact, one-week and two-week US rates (that expire before the FOMC meeting) imply around 25bps of easing is priced to take place before the scheduled meeting – ie. the market prices a high chance of an intra-meeting cut.  The market fully-prices 25bp rate cuts for the Bank of Canada and Bank of England this month and an 80% chance of a 10bp rate cut by the ECB.  The market fully prices a 25bp rate cut by the RBA later today as well. 

In terms of COVID-19, recent trends remain very much intact.  The number of new COVD-19 cases in China continues to trend lower, with 202 reported on Sunday compared to 573 the day before.  But the number of new cases continues to rise elsewhere.  New York state confirmed its first case, while US Vice President Pence, who has been put in charge of the US government response, told Fox News that he expected “many more cases” in the US.  Moscow reported its first case, while the number of confirmed cases rose to 120 in Spain and 150 in Germany and to over 2,000 in Italy.  The OECD cut its 2020 global growth forecast to 2.4%, from 2.9%, due to the expected hit to Chinese growth from COVID-19.  It highlighted a scenario where the outbreak spread more widely throughout the world and growth slumped to just 1.5%. 

Market expectations of central bank easing has kept bond yields at very low levels, despite the recovery in risk appetite.  The US 10 year Treasury yield is at 1.09%, 6bps lower than Friday night’s close. 

Economic data again had little impact on the market.  The Global PMI slumped to its lowest level since 2009 (47.2 vs. 50.4 previously), mainly due to the fall in China’s PMI.  The ISM manufacturing survey was close to expectations, and remained just above the 50 level, but both the new orders and employment categories were weaker than expected.  The ISM survey largely predates the global spread of COVID-19 and was overlooked by markets. 

The USD has weakened broadly on rising Fed rate cut expectations, with the BBDXY 0.6% lower on the day.  The Fed has the second highest policy rate in the G10 and therefore more room to cut rates than most other central banks (especially the ECB and BoJ).  Markets expect that Fed rate cuts will erode the US interest rate advantage.  The EUR is the top performing G10 currency, up 1.3%, and near its highest levels of the year.  Short covering in the EUR likely aided its performance. 

The NZD and AUD opened lower yesterday morning after the weak PMI data but they have subsequently recovered amidst the broad-based weakness in the USD.  The NZD reached a low of 0.6180 yesterday morning but it has since bounced back to 0.6255. 

NZ rates (predictably) plummeted yesterday morning, catching up to the falls in Australian and US rates after the NZ market close on Friday.  The 2-year swap rate fell as much as 20bps at one point, helped along by a local bank calling for a 50bp easing by the RBNZ at the upcoming March meeting.  By the close of trading, the 2-year swap rate was 15bps lower (at 0.72%), with the 10-year swap rate falling 10bps (to 1.10%).  The steepening of the yield curve is consistent with the market expecting a monetary policy response from the RBNZ.  The market now prices the March meeting at 0.65% (implying a 40% chance of a 50bp cut), with May at around 0.5% and the terminal OCR priced near 0.4%.  Rates markets are likely to remain very volatile, and sensitive to COVID-19 developments and global central bank actions, for some time yet. 

Also of note domestically, there was a sizeable 5bp move in the 10-year ‘swap spread’ yesterday (the 10-year government bond yield increased by 5bps relative to the 10-year swap rate).  While day-to-day movements in the swap spread can be unpredictable, we interpret it as suggesting the market is starting to price the risk of greater government bond supply, with fiscal policy likely to respond to the COVID-19 shock. 

The RBA meeting is the focus for the domestic session today and then the G7 conference call of finance ministers and central bankers that is taking place at 1am tonight.