Equity markets push higher. NZD and (particularly) AUD outperform on positive risk sentiment. More volatility in the oil market, but little impact to other markets

Equity markets have performed well over the past two sessions as countries look to ease up containment measures for COVID-19.  Offshore government bond yields have pushed a little higher.  Risk sensitive currencies have outperformed, especially the AUD.  The NZD/AUD cross has reached its lowest level since mid-November.  NZ is officially in in COVID Level 3 today. 

Since we last published this note on Friday morning, equity markets have performed well.   The S&P500 is 3% higher than Thursday night’s close (+1.6% overnight), leaving it at its highest level since the start of March.  It is now more than 30% above its recent lows.  The VIX measure of implied equity market volatility has fallen to 33, its lowest level since the start of March.  The unprecedented fiscal and monetary stimulus implemented by global authorities continues to provide support for risk assets.  Corporate earnings will come back in focus this week with 173 S&P500 companies reporting, including Amazon, Facebook, Microsoft, Caterpillar, Ford, GE and Chevron. 

The market continues to look through (mostly terrible) economic data and is more focused on the rate of growth in new COVID-19 cases (still broadly downwards in the US and Europe) and the prospect of easing containment measures.  Italy reported its lowest number of new cases since March 10th, France reported its lowest number of patients in intensive care due to the virus since March 29th and the UK reported its lowest virus-related deaths since March 28th.  There is some encouragement that Austria, the first European country to start re-opening its economy two weeks ago, hasn’t experienced an increase in new cases.  More countries have outlined plans to start easing containment measures.  Italy will allow construction and manufacturing firms to reopen next week, Germany will allow some children to return to school and hairdressers to reopen while New York state Governor Cuomo said he may look to ease restrictions after May 15th.  Some other US states have already outlined plans to start reopening. 

Equity markets have been unaffected by more volatility in the oil market overnight.  The June WTI oil futures contract has fallen more than 20% overnight (to around $13/barrel) after the largest US oil ETF said it would roll its positions in this contract to longer-dated maturities by the end of the week.  The ETF (known as the United States Oil Fund, or USO) is around $3.2b in size, and its activity in the futures market is one factor that is thought to have contributed to the extreme moves in oil prices last week (alongside the supply glut and lack of physical storage).  USO’s change should mean it leaves a less of a footprint on the market, by spreading its exposure over a greater number of contracts.  In contrast to the moves in oil, copper prices increased overnight, a sign that the moves in oil are largely idiosyncratic. 

Risk sentiment continues to be a dominant driver in FX markets.  The AUD and NZD have outperformed overnight amidst the rise in equity markets while the traditional safe-havens (JPY and Swiss franc) have underperformed.  The AUD is up 1.5% over the past 24 hours to around 0.6465, its highest level since mid-March.  It is now some 12% above its closing lows reached last month. 

The NZD hasn’t been able to keep pace with the AUD, but it has still managed a gain of 0.7% over the past 24 hours.  It trades this morning around 0.6060.  The NZD/AUD cross has fallen to its lowest levels since mid-November, at around 0.9370.  The relatively faster pace of RBNZ QE (compared to the RBA) is one reason we think the cross still has more downside potential.  On Friday, the RBNZ said it would maintain government bond purchases at $1.35b for this week, whereas the RBA has been gradually reducing its purchase pace.  NZ government bond yields fell by as much as 13bps on Friday, with the market seemingly anticipating a slow-down in the pace of RBNZ bond buying (which didn’t occur). 

NZ officially came off COVID Level-4 at midnight and the country is now on Level-3 alert.  The Prime Minister said there was a good chance the country could move to Level-2 if case numbers remained low (i.e. it wouldn’t require a complete stop to new cases).  NZ is due to spend two weeks at Level 3 before cabinet decides on what to do next.  Level 2 would entail a more significant opening up of the economy. 

In offshore government bond markets, yields have increased modestly over the past two sessions, in-line with the improvement in risk sentiment.  The Fed is reducing its purchase amount for US Treasury bonds to $10b a day for this week, down from $15b a day last week and $75b a day at its peak in March.  Yields remain at extremely low levels, with the US 10-year yield around 0.66% (+6bps overnight).

Italian bond yields have fallen sharply since Thursday night after credit rating agency S&P reaffirmed the country’s BBB rating.  The market had expected a ratings downgrade, but S&P said that the ECB’s bond buying had “backstopped this additional public borrowing.”  Italy’s 10-year bond yield has fallen more than 20bps from Thursday night, although the spread to the German 10-year yield is still wide, at about 220bps.  A downgrade to high-yield status remains a real risk of the coming year or two given the deterioration in Italy’s finances and its already-weak starting position.  

Yesterday, the Bank of Japan (BoJ) said it would make its Japanese government bond purchases ‘unlimited’ and more-than doubled its limit on corporate debt purchases (to ¥20 trillion, ~US$185b).  The change to an ‘unlimited’ government bond QE programme is purely symbolic because the BoJ operates a 10-year yield target of 0% and it has already committed to buying unlimited quantities of bonds to enforce that target.  It has finally gotten rid of its previous ¥80 trillion annual ‘target’ for government bond buying, which it has fallen well short of for several years now.  Tellingly, the BoJ again chose not to cut rates to more negative levels, a sign that it views the side-effects of such a policy as outweighing the benefits.  The BoJ also chosen not to increase its equity purchases (via ETFs).  There was little impact on Japanese government bond yields while the JPY appreciated slightly, suggesting the market was underwhelmed by the policy measures. 

Staying with central banks, the Fed and the European Central Bank (ECB) have their own monetary policy meetings this week.  Not much is expected of the Fed, given it has already unveiled a long list of policy measures of the past two months.  In Europe, a minority of economists expect the ECB to boost its QE programme this week, with most favouring such a move in September. The ECB announced last week that it would accept bonds from issuers downgraded to high-yield (so-called ‘fallen angels’) as collateral in its operations until at least September next year.  That could be a precursor to the ECB announcing this week that it will also buy these downgraded bonds as part of its QE programme (which would bring it into line with the Fed).