A more cautious tone overnight. Global rates lower, but NZD and AUD recover a little. Focus on RBNZ MPS this afternoon

Markets have taken on a slightly more cautious tone overnight, seeing US equities down moderately and lower global rates. Currency moves have been modest, with a hint of GBP weakness alongside a broadly softer USD.

US top health official Fauci appeared before the Senate and offered a fairly sobering assessment of the current state of play. He was concerned that some cities and states were re-opening too soon and that might trigger an uncontrollable outbreak of COVID19, turning the clock back for any economic recovery. He added that the number of US deaths from the virus was almost certainly higher than the 80,000 reported so far.

Republican Senator Graham introduced a China sanctions bill that would authorise President Trump to impose sanctions on China if Beijing “fails to cooperate and provide a full accounting of the events leading up to the outbreak” of COVID19.

These headlines see US equities trade on a more cautious note, with the S&P500 currently down 0.6%, after three consecutive days of gains.

In economic news, US core CPI fell by the most on record in April, down 0.4% m/m, taking the annual increase to 1.4% y/y, the weakest in nine years, driven by a number of one-off moves related to the lockdown. The market shrugged off the news, being well attune to the impact that COVID19 is having on both activity and inflation.

US Treasury yields tracked sideways, before moving lower after another successful bond auction. The US bond market is having no trouble absorbing the marked increase in supply this week, with strong demand for a record $32b of 10-year notes following on from yesterday’s strong 3-year auction, while the yield achieved was 1.2bps below market expectations.

A number of Fed speakers this week have pushed back on the Fed taking the policy rate into negative territory recently, including more overnight (Bullard, Kashkari and Harker) but that hasn’t stopped the market from pricing in that from mid next year onwards. Fed Chair Powell has the opportunity to push back on the idea tonight when he gives an update on current economic issues. The US 2-year rate is currently flat at 0.17% while the 10-year rate is down 3bps to 0.68%.

The Fed began its purchases of corporate bond exchange-traded funds to support credit markets, seeing decent gains in some of these ETFS. The Fed will also soon start buying corporate bonds in the primary and secondary markets.

In currency markets a slightly softer tone is evident in the USD, reversing some of yesterday’s gains, although GBP is at the bottom of the leaderboard for no obvious reason, down 0.4% for the day to 1.2280.

The NZD came under pressure lunchtime yesterday, in sympathy with the AUD, after the Australian newspaper reported on further signs of Australia-China trade tensions, hearing that China had suspended meat imports from some meat processing plants in Australia. Nerves were high after the weekend report that China might impose an 80% tariff on imported Australian barley. That currency move faded into the close and a rally to around 0.6535 overnight ensued, although it has now slipped back below 0.65. The NZD has followed a similar path, seeing some resistance just below 0.6125 and now back below 0.61.

In reality it was probably as much a USD move than necessarily related to down-under trade tensions. EUR also saw some weakness around the same time and has since recovered nicely, now up 0.4% for the day to 1.0855. ECB officials continue to defend the central bank’s bond-buying programme, disagreeing with last week’s German Constitutional Court decision that it might be illegal. Apart from the weaker EUR after the announcement last week, we haven’t really seen any market follow-through, despite some warning – including former German Finance Minister Schaeuble – that the ruling could put the existence of the euro into question because it opens the door for national constitutional courts to reject EU law.

The NZ rates market showed little movement yesterday. In the day ahead, focus turns to the RBNZ’s Monetary Policy Statement this afternoon. We expect the RBNZ to leave the cash rate unchanged at 0.25%. In March the Bank said that the OCR “will remain at this level for at least the next 12 months”. There will be keen focus on whether the RBNZ still holds this view, with the market pricing in lower rates this year. On our base case that the Bank doesn’t backtrack, NZ short rates can rise by 5-10bps and at the margin this outcome would be NZD-positive. But if the RBNZ suggests rate cuts are a real prospect before the end of the year there is likely to be a major fall in rates, with the 2-year swap rate perhaps falling by more than 20bps, alongside a short-term fall in the NZD. We expect the MPC will give the RBNZ headroom to increase its QE programme, raising the total programme from its current $33b to around “up to $60b” (which also happens to be lower than its current annualised rate of $70b).