Markets show some tentative signs of stability. Central banks ramp up policy support. Fed sets up Money Market fund to ease funding strains, expands FX swap lines

Markets have shown some tentative signs of stabilising overnight amidst a barrage of emergency central bank policy measures.  The ECB, BoE and RBA all outlined new or enhanced QE purchase programmes while the Fed established a Money Market fund to ease funding strains.  US equities are modestly higher (S&P500 +1.5%) while the prospect of greater QE purchases by central banks has calmed bond markets (US 10y -15bps, Italy 10y -60bps).  NZGB yields increased sharply again yesterday in illiquid market conditions and we think there’s a growing risk that the RBNZ follows the path of global central banks and announces a QE programme imminently.  The USD has continued to rally, and the NZD and AUD fell as much as 5% yesterday afternoon.  But there has been a big turnaround overnight, with the NZD rising almost 6% from yesterday’s lows. 

Central banks are stepping up as the market maker of last resort to help restore some stability in financial markets.  Yesterday, during the Asian session, the ECB unveiled an expanded €750b QE programme to last until at least the end of the year.  The roughly €80b per month purchase pace is in addition to its existing purchases of €33b per month and is the fastest pace of bond buying ever for the ECB.  Additionally, the ECB said it might loosen its self-imposed limits on the programme (that it won’t buy more than 33% of a single issuer and that it will divide purchases across countries according to the capital key), which would open the door to larger purchases of vulnerable peripheral economies like Italy.  ECB President Lagarde said “there are no limits to our commitment to the euro” adding that the central bank would “not tolerate any risks to the smooth transmission of its monetary policy in all jurisdictions of the euro area.”  The ECB joined the list of central banks who will buy commercial paper (CP). 

This was the ‘bazooka’ the European bond market had been waiting for.  The Italian 10-year yield gapped almost 100bps lower when the European market opened before settled at 1.8%, still 60bps lower on the day.   It hasn’t done much for German bonds however (the market perhaps anticipating purchases to be skewed away from Germany this time), with the 10-year bund yield up 4bps on the day to -0.2%.  The announcement also provided some support to the beleaguered European credit market, with CDS indices tightening by 20bps (investment grade) to 30bps (high yield).  There were 10 new deals in the USD and EUR primary credit markets, an encouraging sign that the market might be starting to thaw. 

In the UK, the BoE cut rates by 15bps, to 0.1%, and restarted its asset purchase (i.e. QE) programme.  The BoE will increase its bond holdings by another £200b (to £635b), with the Bank saying it intended to complete them as soon as possible.  New BoE Governor Bailey described market conditions as “bordering on disorderly”. 

The announcements of large QE programmes has helped support government bond markets, which have come under intense pressure over the past few weeks.  The US 10-year US Treasury yield is back down at 1.05%, almost 15bps lower on the day.  Even media reports that the US Treasury was considering new 25 and 50-year maturity bonds to help finance the budget deficit didn’t prevent the fall in yields. 

Equities have also performed better overnight, with the S&P500 rising 1.5% and the NASDAQ up 3.5%.  European indices were around 2% higher.  The VIX remains at an extremely elevated level, implying markets are still worried about sustained high levels of volatility. 

On the funding market side, the Fed established Money Market Mutual Fund Liquidity Facility, which will help provide a liquidity source to money market funds.  Money market funds are a key investor in commercial paper, amongst other money market instruments, but redemptions from these funds (both actual and the concern there might be more to come) has hurt demand for CP.  US Libor-OIS remains at a very elevated level, above 90bps.  Separately, the Fed announced the expansion of its FX swap lines to more central banks, including the RBA and RBNZ.  This measure enables non-US banks to access US dollars through their local central banks. 

In Australia, the RBA unveiled a raft of policy measures yesterday.  It cut the cash rate from 0.5% to 0.25%, as expected, said it would buy government and semi-government bonds as part of a QE programme and established a term lending facility which provides banks with cheap, three-year funding - also at a 0.25% rate - if they lend to the real economy (especially small businesses).  The RBA said it would target a 0.25% yield for the 3-year government bond, which is meant to make its forward guidance more credible.  It will buy bonds across the entire yield curve, not just at three years, to assist in any market dislocations, but has not set yield targets for other maturity yields.  Separately, APRA (the Australian banking regulator) encouraged banks to use their capital buffers to support lending to the real economy and the Australian government is expected to outline further fiscal stimulus measures over the weekend. 

The RBA’s commitment to cap the 3-year bond yield at 0.25% generated a big fall in short-end Aussie yields, with the 3-year future now trading below 0.3%.  At the longer-end, the 10-year Australian bond yield briefly rose almost 100bps in the immediate aftermath of the announcement (highlighting just how extreme liquidity conditions have become) before reversing course and ending lower than where it started before the announcement. 

The NZ rates market remains in a state of extreme volatility with illiquidity high.  There was another huge steepening in the yield curve, with the 2 year swap up 10bps to 0.82% and the 10-year rate up 30bps.  The post-NZ close fall in Aussie rates will see the market open much lower this morning though, with 2-year swap trading back down to 0.72% in London. 

The NZGB curve experienced (another) big underperformance against swap after a very soft tender of $150m 2037 bonds.  The bonds cleared with a weighted-average yield 7bps higher than the prevailing mid-market yield at the time and the cut-off for successful bids was a further 8bps higher still.  The 15bp range amongst successful bidders was the widest since 2009.  To give readers some sense of the extreme moves in recent weeks, the 10-year NZGB yield has experienced its biggest 10-day increase (+71bps) since 1994.  NZDM’s funding requirement will increase significantly starting from April, setting the stage for potentially further volatility.  Against that backdrop, we think there is a growing risk that the RBNZ announces a QE programme imminently, to restore market function and the transmission mechanism of monetary policy. Elsewhere, NZD funding pressures remain evident in elevated levels of the short-term NZD FX basis. 

The FX market has been very volatile over the past 24 hours.  The USD is stronger again in index terms (BBDXY +1.3% to a new post-2005 high), but there has been some differentiation across currencies.  The EUR has fallen over 2% to its lowest level since 2017 following the ECB’s QE announcement.  USD/JPY is now trading above 110, a greater-than 2% move on the day.  In contrast, the CAD and Norwegian krone have made modest gains amidst a rise in commodity prices.  The Norges Bank said it was willing to intervene in the FX to support the krone, after its massive falls and huge volatility in recent weeks. 

The NZD and AUD got hammered during the Asian session yesterday, falling as much as 5% against the USD.  The AUD reached levels last seen in 2002 (0.5510) while the NZD traded down to around 0.5470, its lowest level since 2009. 

But there has been a big turnaround since the NZ market close yesterday, with both currencies rising significantly, both against the USD and on crosses.  The NZD trades this morning around 0.5770 and the AUD just above 0.58.  The improvement in risk sentiment overnight is likely to have sparked the recovery, from what appeared to be oversold levels.  The daily high-to-low ranges have been massive (almost 8% for both currencies, the 4th biggest daily range in the AUD since 1989 and the 5th biggest for the NZD). 

Economic data continues to be dismissed by markets.  US jobless claims spiked higher, consistent with anecdotes reported by state officials, while the Philadelphia Fed business survey experienced its biggest ever one month drop.  The reality is, however, that the market has already front-run the weakness in the data and is priced for a deep recession.