Volatile markets continue – S&P500 rises 5%, US 10y higher as White House sets out big fiscal stimulus plans. Fed announces programme to buy commercial paper in a bid to help funding markets

Market volatility continues.  Policymakers have been jolted into action, with France and Spain announcing major fiscal support packages and the US administration looking at sending cash directly to Americans, which some have likened to a ‘helicopter money’ drop.  US equities are up around 5-6% while bond yields have increased on the prospect of large-scale fiscal stimulus and more government bond supply.  The Fed has restarted its Commercial Paper Funding Facility in a bid to ease strains in the funding markets.  The USD has experienced a big move higher, against all currencies.  The NZD and AUD are now both trading below 0.6, levels last seen during the GFC.  Yesterday, our own government announced a major fiscal support package which led to a big increase in domestic rates and, especially, government bond yields. 

Markets are still volatile and skittish.  A day after US equities recorded one of its worst days on record (S&P500 -12%), markets have bounced back overnight.  The S&P500 is currently 5% higher on the day as we write this, although it has eased back from its intraday highs (having been over 7% higher at one point).  European equity markets were up by 3% to 6%.  The VIX has fallen modestly but remains at crisis-like levels of implied volatility – expect these extreme moves to continue for some time. 

The baton is being passed from monetary policy (most developed market central banks are now close to ‘tapped out’) to fiscal policy.  US Treasury Secretary Mnuchin said the US administration would outline its fiscal plan today, with press reports saying that it would be between $800b to $850b (4%/GDP), although it could yet grow larger.  Trump reportedly wants to send checks worth more than $1,000 directly to US citizens, with Mnuchin saying he wanted to make it happen within the next two weeks.  Mnuchin also said that taxpayers could delay payments to the IRS for 90 days.  There will also be large amounts allocated for small business support ($250b) and the airline industry ($50b) according to Politico.  Trump’s fiscal proposal still needs to win the support of the Democratic-led Congress, but the market hopes that the extreme nature of the situation will lead to a bipartisan response. 

In Europe, French President Macron said the country was “facing an economic and financial war”.  France will outline fiscal measures at an emergency budget tomorrow, including €45b of new spending (2%/GDP) and €300b of loan guarantees.  Macron said that no French company would be allowed to collapse, raising the prospect of companies being nationalised.  Spain said it would provide €17b of direct subsidies to firms (1.5%/GDP) and €100b of loan guarantees.  The moves follow Germany’s announcement of its own “bazooka” earlier in the week, where the government will use state-owned KfW to provide potentially hundreds of billions of loans to German firms during this difficult time.  With the EU relaxing the fiscal rules amidst a huge economic shock, the governments are finally taking decisive action.  Separately, in the UK, PM Johnson said the government would do “whatever it takes” and new Chancellor Sunak outlined a plan to guarantee up to £330b of business loans. 

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Bond yields moved higher on the prospect of a big US fiscal stimulus package which, presuming Congress approves it, will generate a surge in government bond issuance.   The US 10-year Treasury yield is now trading up at 0.89%, some 17bps higher on the day, and the yield curve has steepened sharply.  The possibility of the US government sending checks to Americans directly, funded (in effect) by Fed purchases of US Treasury bonds will have some thinking this is a form of so-called ‘helicopter money’, a term originally coined by Milton Friedman.  A helicopter money drop, done in sufficient size, will always be inflationary, but the market doesn’t appear too perturbed – the US 10-year breakeven inflation rate has actually fallen on the day, leaving it at an extremely low 0.65%. 

In New Zealand, the government yesterday announced a major fiscal support package worth $12.1b (4%/GDP).  The package includes $5.1 billion for immediate wage subsidies (aimed at SMEs), $2.8 billion in business tax changes, a $600 million aviation package to ensure supply chains are maintained, a $500m cash injection to the health sector, and a $2.8 billion increase in benefit payments.  This is Phase-One of the government’s fiscal response with further measures to be outlined at the Budget in May.  The government fiscal package will help support the economy through what is going to be an extremely disruptive period. 

On the back of the fiscal announcement, New Zealand Debt Management (NZDM) said it would increase the bond programme for the current fiscal year to $13b, from $10b.  This implies NZDM will need to issue $5.1b of NZGBs in the June quarter alone, which will be one of the biggest quarters on record for gross issuance.  The government will announce further measures at the Budget in May and NZDM will likely increase the bond programme for subsequent fiscal years at that point (we expect the FY20/21 bond programme will increase from $10b to at least $15b).

There was a significant reaction in the NZ fixed income market, with both bond yields and swap rates heading higher.  2-year swap ended 7bps higher on the day and 10-year swap 23bps higher.  The market pared back its OCR rate cut expectations to just 2bps of cuts.  NZGBs underperformed swaps significantly (again), although this time at both the long-end (NZGB 2037 +35bps in yield) and short end of the curve (NZGB 2023 +21bps in yield).  The 2037 NZGB is now trading close to 50bps above the swap rate, indicating that the market is concerned about the forthcoming large increase in supply.  We would argue that the greater the increase in NZGB yields (especially if the market remains highly illiquid, as it is now), the greater the likelihood that the RBNZ brings forward QE. 

Offshore, there have been some positive developments on the funding market side.  The Fed restarted its Commercial Paper Funding Facility (CPFF) and will buy CP at 200bps over the OIS rate, helping to provide a backstop to this important short-term funding market.  The Bank of England also announced it would buy CP out to one year.  The BoJ conducted its first auction of USD liquidity, accessed through an FX swap line with the Fed, which attracted a large amount ($32b) of demand.  The USD/JPY 3m cross currency basis reached its lowest level on record this week, indicating Japanese financial institutions were finding it difficult to source US dollars, but this market has normalised somewhat since the BoJ’s operation.  Separately, eight of the largest US banks said they would access liquidity through the Fed’s discount window, a backstop liquidity source, in a bid to destigmatise the facility.   

In FX, the USD has surged higher over the past 24 hours, with the BBDXY experiencing one of its biggest percentage daily increases on record (+1.5%).  The BBDXY is at a fresh three-year high and is closing in on its highest level since at least 2005.  The move higher in the USD has been broad-based and indiscriminate between safe-haven and growth-sensitive G10 currencies.  The appreciation in the USD is being attributed to a funding/liquidity squeeze in dollars even though other measures of funding stress are well off their extremes. 

The NZD and AUD have both fallen below 0.6 amidst the broad-based USD strength.  The NZD trades this morning around 0.5960 while the AUD is at just below 0.60.  Both currencies are at their lowest levels since the GFC, with the improvement in risk appetite (as seen in the bounce in equity markets) not providing much support.  Overnight, the Global Dairy Trade auction revealed dairy prices fell 3.9% (whole milk powder -4.2%), which was less than we had expected. 

On COVID-19, there have been more reports of firms shutting factories and stores closing, with VW shutting down production in Spain, Portugal, Italy and Slovakia.  However, VW’s CEO said most Chinese factories have now resumed operations.  China, which was the first to enact widespread containment measures for the virus, is coming back online.  Yesterday, NZ King Salmon reported that its fresh salmon sales to China were up and running again.  In the US, the director of the US CDC said it was “possible” that virus cases would peak in 45 days.  Once the market can see the inflection point in the number of new cases around the world, it may start to front-run the economic recovery (just as it has front-run the pending recession). 

For now, economic data remains a second-order concern for markets and there wasn’t much reaction to a softer-than-expected US retail sales release.  The German ZEW survey plummeted in March, to its lowest levels since the European sovereign crisis.