Equity markets lower, but bond yields higher again. NZGB market coming under stress. Another huge USD rally with the NZD down to 0.5750, Oil falls to its lowest level since 2003

Equities have plunged again (S&P500 -9%), oil has fallen sharply (Brent -14%) and the USD has strengthened significantly (BBDXY +2.1%).  The GBP hit a liquidity vacuum a short while ago and fell as much as 5% to its lowest since 1985 while the NZD is now trading at around 0.5750.  These are huge moves.  Government bond yields have headed higher again despite the risk-off moves evident in other asset classes.  The NZGB market came under further significant pressure yesterday, with yields jumping sharply. 

It has been another bad night for markets.  The S&P500 is down 9% as we write this, reversing the previous day’s gains.  The S&P500 is now more than 30% off its record highs, which were reached last month.  COVID-19 cases continue to climb across Europe and the US as economic activity starts to grind to a halt amidst social distancing measures.  There are anecdotal reports of a surge in US jobless claims (the data covering the week ended 14th March is released tomorrow).  The market is pricing a deep recession, even with support from policymakers.  Market participants are deleveraging across asset classes. 

Against this risk-off backdrop, The USD has had another huge move higher.  The BBDXY reached its highest on record (the index was established in 2005).  The BBDXY has increased almost 8% in under 2 weeks and the movement overnight (+2.1%) was the fourth biggest daily move on record.  The USD is benefiting from its status as a safe-haven and pressures in USD funding/liquidity. 

There have been massive moves in other currencies.  The GBP had a ‘flash crash’ of sorts a short while ago, plummeting against the USD.  The GBP fell as much as 5% on the day against the USD to its lowest level since 1985 (lower than the levels seen in the aftermath of the Brexit referendum).  The GBP hasn’t even the biggest mover in G10 FX over the past 24 hours.  The Norwegian krona is over 8% lower against the USD amidst a 14% fall in Brent crude oil.  The JPY has predictably outperformed given the turbulent backdrop, but it too has fallen against the USD (-0.8%). 

In oil markets, Brent crude is 14% lower on the day, to under $24 a barrel.  That’s the lowest level since 2003.  The oil market is grappling with the hit to oil demand from what is expected to be a deep recession and the collapse of the OPEC+ agreement, which has led to a surge in supply.  Overnight, Saudi Arabia said it would to keep producing at a record high level “over the coming months”.  The appreciation in the USD is also not helping. 

The NZD is trading down at around 0.5740 (3.4% lower on the day).  The NZD/AUD cross rate briefly traded through parity for the first time in thin market conditions.  It is back to 0.9985.  Fundamentally, the oil price drop is a negative terms of trade shock for Australia and a positive one for NZ, but we’d be cautious about reading too much into the moves overnight. 

The fall in oil prices means there is no let-up for the battered US credit market, which has a sizeable weight towards firms in the energy sector (especially the high yield market).  The CDX index of US investment grade firms widened by 20bps, to 143bps, while the high yield CDX widened over 100bps, to over 750bps.  BBB-rated Occidental Petroleum’s 2½ year USD bond fell another 5 cents in the dollar to 77 cents, implying a yield of over 14%. 

Ordinarily, one would think that this kind of market panic would see investors flock to government bonds, as the traditional safe-haven.  This hasn’t happened, and yields have headed higher across the board.  After increasing 36bps yesterday, the 10-year Treasury yield has increased another 10bps overnight, to almost 1.2%.  Germany’s 10-year yield increased 20bps to -0.23% while the 10-year JGB traded at its highest yield since late-2018, at +0.08%.  We make some observations around why bonds are selling off now despite the market turmoil at the base of the email (for those readers that make it that far). 

Yesterday, the longest bond on the NZGB curve (the 2037s) increased another 28bps (16bps more than the equivalent swap rate).  For this bond, the so-called swap-spread (the difference between the NZGB yield and swap rate of the same maturity) has tightened an extraordinary 70bps this month alone.  NZ rates and NZGB yields are set to open higher again this morning. 

Policymakers are doing what they can.  The Fed has launched a Primary Dealer Credit Facility, which will provide funding for up to 90 days to the main dealers in US Treasury securities, providing certainty of funding.  Former Fed Chairs Bernanke and Yellen have written an op-ed in the FT recommending that the Fed should seek Congressional approval to buy corporate bonds directly, as the BoE and ECB already do.  In Canada, PM Trudeau outlined a stimulus package worth 3% of GDP. 

After rising more than 60bps initially, Italian bonds have outperformed significantly on the day amidst reports of significantly increased ECB purchases.  The 10-year Italy yield ended only 7bps higher on the day.  There are also reports that European policymakers are looking into whether a number of European governments (including Italy) should activate the European Stability Mechanism (ESM) fund.  This would then allow the ECB to make purchases through its OMT arrangement, allowing for potentially unlimited purchases.  Such a move would be politically contentious and represent an effective mutualisation of debt across the Euro zone, but the crisis appears to have opened the door for such a move. 

Why are bonds selling off (rates moving higher), despite the brutal losses across risk assets like equities?  We’d make the following observations.  First, the starting point was one in which yields on bonds were exceptionally low.  Long-end yields were at levels that implied little potential for capital gain on bonds (“return-free risk” one might say), and hence made them less useful as a hedge for risk assets.  This eroded demand as yields went lower.  Second, governments across the world have been outlining major fiscal stimulus plans over recent days.  This raises the spectre of much higher government bond supply across multiple countries simultaneously (notwithstanding central bank QE).  The US budget deficit was already around 5% of GDP before the crisis hit (due to the Trump tax stimulus of 2017), but add to this the increase in the deficit as the US economy goes into recession and the discretionary fiscal stimulus being reported in the press (another 5% of GDP) and this points to an absolute deluge of issuance ahead.  Third, there have been big losses incurred by some bond funds and ETFs, with redemptions out of these funds leading to forced selling across bond markets.  So-called risk parity funds (which lever up the bond exposure to generate the same volatility (risk) as other asset classes like equities) have also sustained big losses and it would be no surprise if the combination of investor redemptions and now much high market volatility has generated selling in bonds from these funds. 

In NZ’s case, we can add that, owing to the government’s major fiscal support package, government bond issuance here is going up materially from as soon as next month.  NZ is competing for global capital and NZGBs have cheapened significantly (NZGB yields higher) in advance of this supply hitting the market.