Negative risk sentiment has extended into another trading session, with weaker equity markets and lower global rates. Safe haven currencies have showed some modest outperformance, taking the NZD sub 0.60, but with no further damage to most of the crosses overnight, after yesterday’s post MPS lurch lower.
Risk sentiment is negative after Fed Chair Powell gave a sobering outlook on the economy and a couple of big investing heavyweights have publicly expressed their bearish view of US equities. David Tepper called it the most over-valued market ever outside the bubble of 1999, after yesterday Stan Druckenmiller said that the risk-reward for stocks was the worst he’s seen in his career. The S&P500 is currently down over 2%, following a near-2% fall in the Euro Stoxx 600 index.
Fed Chair Powell suggested that “the path ahead is both highly uncertain and subject to significant downside risks” and the Fed will use its tools to the “fullest” until the recovery is well underway. He also encouraged further easing in fiscal policy, being “worth the cost”. On the key question of negative rates he reaffirmed the message that his Fed colleagues have been giving over the past week, that the committee’s view has not changed. He was well-prepped for the answer, saying that all FOMC members don’t see it as an attractive tool, the current tool kit works and evidence on negative rates is ambiguous, with a particular concern of its impact on bank profitability and hence the ability to lend. However that clear response has not stopped the market from pricing in a negative Fed Funds rate from mid next year.
US treasury rates are down slightly across the curve. As with the other large bond auctions earlier this week, the market didn’t have much trouble absorbing $22bn of 30-year notes. That sector of the curve has outperformed, down 3bps on the day, a greater fall than seen across shorter maturities.
Weaker risk appetite has seen JPY outperform and the USD make gains across all the other majors mainly in the vicinity of 0.2-0.4% in overnight trading. The NZD trades just below 0.60, with most of the damage coming in the hours after the RBNZ’s MPS.
The RBNZ reaffirmed its March guidance for the OCR to be held at 0.25% through to March 2021, and extended the QE programme up to a potential $60bn (and included inflation-indexed bonds in the programme). Both of these key policy decisions were in line with market expectations. The economic scenarios presented were sobering, although its baseline scenario was still more optimistic than our own view.
On future policy, the Bank left its options wide open with regards to further potential stimulus. As expected, negative rates were not ruled out but such a move, if desired, would have tocome after the March 2021 quarter, given the limitations in current trading bank systems. The Bank said it would weigh negative rates against its other unconventional policy options, including further QE, fixed term loans to banks and unsterilised FX intervention. These policy options have been raised before in the Bank’s paper on unconventional policy options. We see the Bank going down the track of printing money to buy foreign assets as only a remote possibility – highly unlikely – but there’s no harm in leaving that policy option on the table if easier monetary conditions is a current objective.
Surprisingly, the market took the free options left on the table as a green light to take the curve negative for the first time and sell the NZD. While the pricing of another OCR rate cut this year was moderated, the OIS curve now prices in a negative OCR from May 2021 through the rest of the 2021. This saw a significant rally across the rest of the curve, and new record lows set – 2-year swap down 11bps to 0.11%, 10-year swap down 13bps to 0.60% and long bonds rallying 12-16bps.
The lower rates dynamic drove down the NZD, which now sits down over 1% on all the key crosses. This was a significant market reaction for the rates and currency market to a Statement that met the expectations of the local trading banks. That the RBNZ hasn’t rejected the prospect of a negative OCR has been enough to get the market response, which the RBNZ will be happy with to the extent that it might take retail and business interest rates lower, something it wants to see.
In economic news overnight, UK GDP fell by 2.0% q/q in Q1, slightly better than expected, although still meaning that the UK economy has only shown positive growth in one of the past four quarters, with a bigger hit pencilled in for the current Q2. Euro area industrial production fell by over 11% in March, while US inflation indicators continued to paint a soft picture, this time the PPIs. As usual, none of these releases elicited a market response.
Today the focus turns to the NZ Government’s Budget release at 2pm. We see a fiscal deficit of 7% of GDP for the year ended June 2020, rising to 13% of GDP the following year and a deficits remaining over the rest of the forecast period, although moderating. These are our own forecasts, and it remains to be seen what assumptions Treasury comes up with. Net debt rises quickly to over 50% of GDP and we have pencilled in a $50bn bond programme for FY20/21. Ahead of that Australian labour market data will be of some interest, showing the first signs of the collapse in employment and surge in unemployment rate.
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