Equities, bond yields lower despite US $2 trillion fiscal stimulus package. Bank of Canada cuts -50bps, announces first QE program. USD weakens again

Equity markets and bond yields fell on Friday, despite Trump officially signing the $2 trillion fiscal support package into law.  Still, equities were up significantly over the course of what was a very volatile week.  The USD experienced another big fall, leaving the NZD trading back above 0.60 by the end of the week. 

Volatility remains very high across asset classes and it is likely to remain that way for quite some time.  The market is trying to gauge the ultimate severity and duration of the coming global recession, which depends in part on how long COVID-19 containment measures are kept in place and how effective the massive, globally coordinated fiscal and monetary stimulus is.  In terms of the former, the UK’s Deputy Chief Medical Officer said overnight that it could take more than six months for UK life to get back to ‘normal’, although that didn’t mean the country would stay in complete lockdown for that long. 

On Friday, the US Congress passed the $2.2 trillion (10%/GDP) fiscal stimulus package and Trump signed it into law.  The package includes $500b in loans and other help for big business (including airlines, states and cities), $350b for small businesses, direct cash payments to low-and-middle income households (by way of a cheque for $1,200 for adults and $500 for children), and enhanced unemployment insurance.  The size of the stimulus dwarfs the $800b Obama package that was signed off during the GFC.  Additionally, the WSJ reported that the Trump administration was weighing up whether to suspend import tariffs for three months, although firms would still need to pay at a later date (there is no suggestion the COVID-19 crisis will lead to more permanent changes to overall tariff/trade policy). 

Equity markets ended last week on a soft note, despite the passing of the stimulus bill.  Equities had risen significantly over the previous trading sessions in anticipation of the bill being passed, so it was probably ‘in the price’ already.  The S&P500 was down 3.4% on Friday, following declines of 3 to 5% in Europe.  It gained more than 10% last week but remains 25% off its recent highs.  Market participants are asking themselves whether the recent bounce in equities is just a ‘bear market rally’ which will ultimately give way to steeper declines, or is justified based on the unprecedented fiscal and monetary measures being thrown at the economy and markets. 

Stimulus measures continue to be rolled out in other countries.  Xinhua reported that the Chinese Politburo had agreed to increase the fiscal deficit and would allow local governments to increase their issuance of infrastructure bonds, to fund more investment and support the economy.  In Canada, the Bank of Canada cut its cash rate by 50bps, to its effective lower bound of 0.25%, in an unscheduled decision on Friday and announced its first QE programme.  The BoC will buy a minimum of $5b government bonds per week initially (an annual run-rate equivalent to almost 50% of the current stock of the bond market).  The BoC also established a Commercial Paper Purchase Program which will see it buy CP issued by businesses, municipalities and local governments.

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The USD fell again on Friday (BBDXY -0.6%), bringing its decline on the week to about 4%, in index terms.  This was the biggest weekly decline in the BBDXY since the index was established in 2005, albeit from what was a record (post-2004) high.  The fall in the USD has taken place amidst some signs of easing in USD funding pressures, including higher short-end EUR/USD and USD/JPY cross-currency basis swap spreads.   USD Libor-OIS remains very elevated at 130bps, but the market prices a sharp retracement over the coming quarters (to 30bps by the middle of December). 

The USD was generally weaker against developed market currencies and stronger against emerging markets.  The GBP increased more than 2% on Friday, to almost 1.25, despite PM Boris Johnson and Health Secretary Matt Hancock testing positive for COVID-19 and Fitch downgrading the UK’s credit rating to AA- (outlook negative).  The CAD and NOK underperformed amidst a 5% fall in crude oil prices as Russia and Saudi Arabia show no signs of compromising in their standoff over oil supply. 

The NZD was up around 6% last week, making it the fourth best week (in terms of percentage gains) since 1990.  The NZD ended the week above 0.60, the first time in almost a fortnight, 1.7% higher on the session.  The appreciation in the NZD last week can be attributed to the broad-based USD decline and some tentative signs of easing risk aversion (as evidenced by the 10% rise in the S&P500).  The AUD was up 1.7% on Friday and also around 6% on the week, to 0.6160. 

Central bank bond buying is starting to leave its imprint on the government bond market, with global longer-term yields falling significantly on Friday.  The 10-year Treasury yield fell 16bps on the session, to 0.68%, while the German 10-year bund yield was 11bps lower, to -0.47%.  The very short end of the US government curve (out to one-year) is mostly trading with negative yields, probably reflecting the amount of cash being parked in government-only money market funds.  The Federal Reserve will cut back its purchases of US Treasuries from Thursday to $60b per day, from $75b previously. 

NZ swap rates were modestly lower on Friday while NZGB yields ticked up.  The RBNZ has decided to increase its purchase amounts for its QE programme to $1.35b for the coming week, well-above the $750m pace that it said it would initially target.  The RBNZ has shown it is responsive to the market and we should expect further adjustments going forward depending on overall market function (in this instance, it has increased the overall purchase amount) and whether there are specific pockets of illiquidity that need addressing (in this case, purchases are skewed towards short-to-mid curve bonds). 

The market now awaits NZDM’s update (due before Wednesday), which will outline how it intends to go about raising $5.1b in government bonds over the coming quarter (for context, NZDM issued $7b in the entire FY17/18 and $8b in FY18/19).  Issuance will be maintained at a high level for quite some time, with Finance Minister Robertson saying over the weekend that the government’s fiscal support package will cost much more than the initial $12.1b announced ("We are probably somewhere around the $20 billion mark, but again, these are projections") and that he wanted to implement a big infrastructure / public works programme to help the economy recover from what will be a severe recession. There were further signs of a thawing in the global investment grade (IG) credit market on Friday, with more primary market issuance taking place.  On the week, there was a record $109b of US IG new issuance and around €75b in Europe, with corporates and banks rushing to take advantage of the reopening of the primary market to raise cash.  The primary market for high yield remains shut.  Despite strength in global credit markets the preceding night, NZ corporate and bank credit spreads were flat-to-wider on Friday and this market remains extremely strained.