GFC-like moves in markets – S&P500 falls sharply. RBNZ cuts OCR to 0.25%, signals QE. Government to announce Phase-1 fiscal response. Fed cuts rates to 0%-0.25% and restarts QE

Wild market moves continue.  There was more aggressive central bank easing yesterday, with the Fed cutting its cash rate by 1% and restarting QE, the BoJ doubling its ceiling for ETF purchases and the RBNZ cutting the OCR by 75bps.  This hasn’t done much to support risk asset markets though, with the S&P500 some 9% lower on the day (albeit off its intraday lows).  Rates are lower in NZ and the US, following the large-scale rate cuts.  The NZD initially fell below 0.60 yesterday morning, ahead of the RBNZ 75bp cut, but it has bounced back to 0.6060 after the Fed cut rates.  The NZD/AUD cross got close to parity overnight before easing back to 0.99.  The government announces its fiscal package to combat COVID-19 at 2pm today, and we’re expecting it to be very big.  

Where to start?  No sooner had we pushed send on this report yesterday that the RBNZ announced it would make an announcement at 8am, promptly followed by an emergency 75bp OCR cut, to 0.25%.  The RBNZ’s March meeting, originally scheduled for the 25th, has been cancelled.  The RBNZ said it would keep the OCR at 0.25% for the next 12 months (i.e. no further rate cuts).  It added that, if further easing was required, it would likely implement a Large-Scale Asset Purchase Programme (LSAP, other known as quantitative easing, or QE).  This would involve the RBNZ buying New Zealand government bonds in a bid to lower and flatten the risk-free curve.  The RBNZ appears to have changed its mind on negative rates for the time being, in part due to a lack of operational readiness in the financial sector.   RBNZ Chief Economist Yuong Ha told Bloomberg that the Bank want a QE programme ready to go by the RBNZ’s May meeting, or even sooner. 

Additionally, the RBNZ has postponed the planned increase in bank capital requirements for 12 months, to 1st July 2021, which the Bank estimates could free up to $47b in potential lending – a significant amount. 

At 2pm today, the government will announce Phase-One of its fiscal response to COVID-19 which is likely to be very big (we think something in the order of $15-$20b, or 5-7% of GDP).  The government’s fiscal response should be seen in the context of what we think is likely to be one of the sharpest drops in New Zealand economic activity in living memory. 

NZ swap rates were between 16 to 20bps lower across the curve yesterday (2 year: 0.63%, 10 year: 0.96%).  The market now prices the OCR falling to 0.15% by November.  While there is a chance the RBNZ changes its mind and cuts to zero, we think its proposal to do QE is credible and don’t expect further cuts over the next year, so shorter-dated rates are naturally running out of room to fall much further (any further falls would need to come from easing funding pressures and narrower BKBM-OIS spreads).

The NZGB curve steepened significantly, despite the RBNZ Chief Economist saying that the Bank would likely buy across the entire curve.  The 2023 maturity NZGB yield fell by 31bps while the 2037 yield fell only 7bps, an extraordinary move given that the swap curve flattened on the day.  The NZGB market remains wary of the likely deluge of government bond issuance ahead. 

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Global central banks are easing aggressively.  The Fed cut its cash rate yesterday morning by 100bps, to 0% - 0.25% and said it would restart QE, involving $500b of US Treasury purchases and $200b of agency mortgage-backed securities (MBS).  The Reserve Bank of Australia said it stood ready to buy Australian government bonds, offered extra liquidity and said it would announce further policy measures on Thursday.  The Bank of Japan kept its key policy rates unchanged but introduced a new lending programme, doubled its ceiling for ETF purchases to ¥12t and outlined plans to increase purchases of corporate bonds and REITs.  The Bank of Japan’s reluctance to cut rates further into negative territory (like the ECB), shows that global central banks are reaching the limits of monetary policy.   The Fed announced that it was extending existing FX swap lines with certain foreign central banks from 7 days to 84 days and lowering the pricing on accessing USD liquidity, in a bid to calm funding markets.  US FRA-OIS spreads – a barometer of funding market pressures – fell after the Fed’s action, although other markets (such cross-currency basis swaps) suggest that funding market pressures remain intense.  There is pressure on the Fed to restart its Commercial Paper Funding Facility, where it buys CP directly, amidst reports that this short-term funding market is ‘frozen’. 

Risk asset markets have been under significant pressure since the week began, despite the aggressive central bank easing and liquidity measures.  S&P500 futures hit their circuit breaker shortly after trading opened yesterday afternoon after falling almost 5%.  The S&P500 traded down as much as 11% after the cash market opened in the US, although it has pared that loss back to 9% as we write this.  The VIX is at an extreme level, above 75.  Market participants are concerned that major central banks are effectively out of ‘ammunition’ and can’t provide the degree of support to economies that would have done historically (the Fed would typically cut 5% or more during a recession).  The focus is really on the fiscal response – investors want a major stimulus package in the US, not the modest measures announced to date – and the rate of change in COVID-19 cases. 

Bond yields have fallen in the US, after the big 100bp rate cut and QE announcement, although yields are well off their intraday lows.  The US 10-year Treasury yield fell from 0.96% to 0.62% during Asian trading hours yesterday, but it is back up close to 0.7% now.  European bond yields are higher, especially in the vulnerable peripheral countries (Italy 10y +38bps).  Breakeven inflation rates, derived from inflation-linked bonds, have plummeted.  The US 10-year breakeven rate fell another 20bps overnight to just 0.7% while the equivalent measure in Australia fell to below 0.6%. 

Countries are taking further drastic measures to limit the spread of COVID-19.  New York City is closing bars, restaurants and gyms, similar measures to those announced a short while ago by Germany.  There are widespread school closures in the US.  The EU is reportedly considering banning all non-essential travel for 30 days.  UK Prime Minister Boris Johnson asked the public to avoid all non-essential contact and travelling.  On a more positive note, the Lombardy governor – the region in Italy which has the highest concentration of cases – said the growth in new cases in the region was no longer exponential.

Economic data is starting to filter through, showing the dramatic impact of the virus, and associated containment measures, on economic activity.  The Empire manufacturing index, based on firms in the New York region, experienced its biggest monthly fall on record, to levels last seen during the GFC.  In China, where the outbreak originated, there were larger-than-expected falls across all activity indicators (retail sales -20.5%, industrial production -13.5%), as foreshadowed by the PMIs earlier in the month.  But higher frequency Chinese data suggests activity is picking back up.

FX markets primarily reflect the heightened level of risk aversion and investor concerns about a severe global recession.  The safe-haven JPY is up 1.8% this week while the Swiss franc and euro have also seen gains.  Emerging market and commodity currencies – i.e. those sensitive to the global growth cycle – have fallen (the NZD being an exception here).  The BBDXY has extended its recent gains (+0.15%) and made a fresh 3-year high. 

The NZD/USD has been very volatile over the past 24 hours but, on net, is close to where it ended last week. The NZD initially broke below 0.60 yesterday morning in thin conditions ahead of the RBNZ emergency rate cut, but these losses were quickly erased after the Fed’s 100bp cut.  The NZD trades this morning at around 0.6060.  In terms of the outlook, we think it likely that the NZD/USD falls into the high 0.50s, with downside risk under more severe global recessionary scenarios, before recovering in the second-half of the year (assuming there is some levelling off in the rate of new COVID-19 cases and fiscal and monetary policy stimulus starts to filter through to global economic activity)

The NZD/AUD cross traded close to parity overnight, but it has since retraced and is back at 0.99 (still up around a cent from the end of last week).  We think there is a possibility that the NZD/AUD cross could trade through parity due to the plunge in oil prices (which is a negative terms of trade shock for Australia but a positive one for NZ).