Oil price plunge causes carnage across markets; Fears of GFC II. Global equities down 5-10%; UST yields down below 0.5%. JPY the preeminent safe-haven

Financial markets have been melting down in response to the twin shocks of collapsing oil prices and the spread of COVID-19. Global equity markets are down in the order of 5-10%, bond markets are seeing a flight to safe havens (UST10s -26bps, Italy 10s +34bps), while JPY is proving once again to be the preeminent safe-haven currency. After flash crashes yesterday, the NZD and AUD are both stronger overnight.

As if dealing with the global spread of COVID-19 and its sharp economic impact wasn’t enough, financial markets now face another shock after oil prices collapsed. Brent crude slumped 31% on the open in Asia trading after the weekend report of the disintegration of the OPEC+ alliance and Saudi Arabia’s plans to ramp up oil production and slash prices to customers. While lower oil prices would normally be welcomed for many countries (the importers, of course), the crash in oil prices is expected to shake-up the US shale industry and exacerbate strains in high-yield credit, an area of current vulnerability. Financial markets are alert to this risk and potential spillover effects as we saw during the GFC.

Brent crude is trading this morning around USD36 per barrel (down 21% for the session) and WTI is at USD33 (down 20%). If these prices are maintained – likely for now and with some calling for a further sustained fall – then bankruptcies for oil producers will see investors’ losses, further pressure on fragile banking systems and so on. Energy sector bonds have been hard hit and even investment grade issuers are under pressure with Occidental Petroleum’s 30-year bond falling to 29 cents in the dollar, after trading above par just two weeks ago. The Market CDX North American Investment Grade Index jumped 45bps to 130bps in early NY trading, the biggest increase since the height of the credit crisis in September 2008.

The US S&P500 slumped by 7% in early trading, triggering an automatic 15 minute trading halt. The index is still down around 7% with the Energy sector slumping 19%. In rough terms the fall in global equity markets has been mainly in a 5-10% range.

Pressure is on the Trump administration to come up with a plan to deal with the looming economic fallout. Telling the Fed what to do hasn’t given the market any confidence to date. There are reports reports that the White House is trying to put together an economic package that might include temporary expansion of paid sick leave, and a menu of policy options including tax relief and cashflow injections to help companies facing disruption from COVID-19. Little confidence has been provided by EU leaders, with talk of discussing the impact of COVID-19 at the next summit on 26 March, far too late for action as far as markets are concerned.

The flight to safety and panic in markets has seen the US 10-year rate trade as low as 0.31% last night and as high as 0.60%, with the yield at 0.50% as we go to press, down 26bps for the day. The Fed Funds market is pricing in about 75bps of rate cuts by the time of the Fed meeting next week and the rate falling to about 15bps by year-end. Germany’s 10-year rate fell 15bps to a record low of minus 0.86%. The 10-year rate for the troubled peripheral euro area countries was higher across the board, with Italy up 35bps to 1.42%.

The drama finally made its mark on currency markets, with a flash crash yesterday afternoon. Japanese retail investors were rumoured to be active and triggering a hole in liquidity that saw the NZD plunge to as low as 0.6014 and the AUD down to 0.6313 in a matter of seconds before rebounding.   Both currencies have made strong gains since the NZ close, with the NZD up 1.8% to 0.6360 and the AUD up 1.3% to 0.6600. That the NZD has actually made a gain since the weekend close (+0.2%) is remarkable given the severe risk-off event. One might argue that the more positive terms of trade are at play, given the collapse in oil prices. But the more likely reason is the further collapse in US-NZ rate spreads that should ultimately be only short-term in nature, given that US rates can’t fall much further. With a global recession on the doorstep and GFC-like conditions in financial markets we find it hard to see a scenario where the NZD actually rises from here and the greater risk is an eventual move sub USD0.60.

We could write pages on the various milestones that currencies saw yesterday, but to keep it brief, JPY has remained the pre-eminent safe-haven currency, with USD/JPY down 3.2% for the day to 102.0. NZD/JPY was down as much as 8% to 61.3 during the flash crash, but is now down 3% at 64.9. Even with its recovery overnight, NZD/EUR and NZD/GBP crosses are lower for the day and at multi-year lows.  The collapse in oil prices has seen CAD underperform and NZD/CAD up 1.6% to 0.8660. The terms of trade effect has been in play on NZD/AUD, up 0.6% to 0.9640.

NZ rates fell to record lows yesterday, with NZ’s 10-year government rate down 9bps to 0.84%. The swaps curve saw a flattening bias, with the 2-year rate holding its ground around 0.72%, while longer term rates fell. Another RBNZ rate cut is well priced for 25 March, with some 46bps of cuts priced in for that meeting. BNZ officially called an economic recession for 1H20 in NZ and the RBNZ’s optimistic growth outlook is looking well out of the money.

In the day ahead, ANZ will be releasing some initial results from its NZ business outlook survey. Late responses in February showed a slump in own-activity and business confidence and we’d expect the results for early March to show another dive. That will be soon followed by Governor Orr releasing a speech on its high level principles around how it would assess and use unconventional monetary policy tools if ever needed. As previously advised, the speech will not discuss current economic conditions or the RBNZ’s outlook for the OCR.