Fed takes central bank policy to its limit with new initiatives. But US equities weaker anyway, while USTs supported. Fed announcement sees NZD recover overnight. RBNZ QE policy drives NZ rates down significantly

The market is finding it hard to ignore the disturbing trend in the spread of COVID-19 and impact on the global economy, as an increasing number of countries go into lockdown. Risk assets have remained under pressure, even with new central bank and government support measures being announced on a daily basis. Global equity markets are lower while global rates are also lower, with central bank support more than offsetting the worries about increased bond supply. Currency markets have been fairly well behaved, considering the backdrop.

The new week go off to a bad start for risk assets after the negative news over the weekend that the spread of COVID-19 is accelerating and the economic impact is likely to be much larger than anyone imagined even a week ago. St Louis Fed President Bullard’s comments didn’t exactly inspire much confidence after he warned that the US unemployment rate could rise to 30% in the June quarter as GDP falls by 50%. Further not helping sentiment was that US lawmakers failed to agree on a $2Tn economic rescue package designed to soften the blow from the economic impact of widespread lockdowns to stop the spread of COVID-19. On a slightly more positive note, this morning Senate minority leader Schumer said that lawmakers are “very close” to reaching a deal on the stimulus bill and he wants to get the deal finished today.

The big news overnight was the Fed announcing a series of fresh measures designed to offer additional support to the financial system and lending facilities with a more direct channel to the real economy. Gone is the $700bn limit for purchases of Treasuries and mortgage backed securities, with the Fed looking to buy as much as needed (QE-unlimited). Amongst other measures, new corporate credit facilities have been introduced, alongside a new Term Asset-Backed Securities Loan Facility (TALF), which will see the Fed purchase investment grade primary and secondary market corporate bonds and bond ETFs. Even in the GFC, the Fed didn’t go as far as buying corporate debt, so the new programme exceeds the policy measures during that shock, and highlights the Fed’s determination to soften the economic blow, taking central bank policy to its absolute limits.

Germany formally abandoned its constitutional debt brake and signed off on taking on more than €750bn of new debt, with a €600bn rescue fund to provide troubled companies with loans and guarantees and taking on equity stakes if required. Another £156b will be set aside for social spending and company aid. Also, Bloomberg reported that Germany is ready to back a rescue plan to help Italy weather the crisis, with an emergency loan from the euro area’s bailout fund (with minimal conditionality). This could pave the way for unlimited purchases of Italy’s debt via the Outright Monetary Transactions (OMT) programme, designed during the GFC but never used.

In NZ, first thing Monday morning the RBNZ announced a QE programme whereby it will purchase up to $30bn of NZ nominal government bonds spread over the next year. The purchases will take place in the secondary market via an auction process. This is nearly 50% of the stock of nominal government bonds on issue, although if we add in the potential for some hefty net issuance, then ultimately the RBNZ could own about a third of the market. The RBNZ is effectively stepping up to fund the government’s ramp-up in spending, helping offset the upward pressure in yields that would occur in the absence of QE.

S&P futures were weak during the Asian trading session (limit down 5% for the first part of the session) and the S&P500 opened on a soft note and was down as much as 4.9%, even after the Fed’s announcement. Over the last hour or two, the market has tried to recover, paring the loss, while the Nasdaq index has been in positive territory.

The US 10-year rate has traded a wide 0.69%-0.87% range and is currently down 11bps for the session to 0.73%.  The Fed’s QE policy will support the Treasury market, but investors are also weighing the upcoming surge in supply. The peak in yields overnight occurred after the Treasury Secretary pledged to issue a lot of long-term financing. Credit markets still look pretty mixed, even with the forthcoming support from the Fed. CDX indices show narrower spreads, but cash bonds look wider, with the US investment grade spread up 6bps to 357bps, and the high yield spread up 39bps to 1073bps.

The RBNZ’s QE announcement supported a strong rally across bond and swap markets alongside curve flattening, with the 10-year government rate down 48bps to 0.96% and the longest bond (‘37s) down 68bps to 1.62%.  The 10-year swap rate fell by “only” 37bps to 1.0%, indicative of the significant swap-bond widening and we think the RBNZ’s actions can support another 15-20bps move on this spread. The credit market (both high-grade and bank debt) remains strained.

In currency markets, the NZD traded on a weak note yesterday after the RBNZ’s QE announcement, going sub-USD0.56, and the government’s announcement of a forced (minimum) 4-week self isolation period for most citizens didn’t help sentiment either. The NZD has rebounded after the Fed’s move overnight, to trade back above 0.57. The AUD has followed a similar pattern, down to 0.57 yesterday and back up to 0.58 this morning.

Of the other majors, EUR is on the strong side, while GBP is on the soft side. In these volatile times, we’ll give up on trying to explain the moves.  With so many moving parts – such as different policy responses, varying spread of COVID-19, and pockets of liquidity pressures – it is hard to frame a coherent theme. The stronger EUR sees NZDEUR back down to 0.53, while NZDGBP is up nearly 1% to 0.4950. JPY is also on the soft side, seeing NZD/JPY up 0.4% to 63.5.