NZD and AUD make further decent gains against a backdrop where investors are backing a global macro recovery. Rates market well-contained by central bank policies

The NZD and AUD have extended their rallies, alongside emerging market currencies, as traders back the global economic recovery story. Global equity markets also remain well bid, while in the risk-on environment the global rates market remains well contained by central bank buying.

Newsflow has been light over the past 24 hours and familiar market trends remain in place – that is a rally in risk assets as investors look forward to the reopening of economies and global economic recovery out of the depths of recession.

The S&P500 is currently up 0.4%, following a 1.6% gain in the Euro Stoxx 600 index, led by a 3.75% gain in Germany’s DAX index –the market buoyed by the prospect of more fiscal stimulus as German Chancellor Merkel is trying to broker a second stimulus package for the economy worth as much as €100bn to help support the recovery. In the US, the rally is being led by cyclically-sensitive sectors, while small cap stocks continue to outperform, a classic sign of an improved macro outlook driving markets.

Markets are unperturbed by the recent escalation of US-China tensions, the prevailing thought being that if President Trump wants to win the November election, he can’t afford to rock the markets or the economy with a further ramp-up in import tariffs. Presidential betting odds have shifted sharply against Trump since the social unrest evident across the US. On that note, there is little good news to report, with looting and protests continuing. The FT’s lead story is the extension of the NYC curfew after a night of upheaval, with pictures of boarded up shops such as the Macy’s flagship shop and the Apple store.

The risk-on vibe sees commodity currencies continuing to be well supported.  The AUD was the best performing major currency we follow during April and May and looks on track to make the treble, as it leads the way through June. After tracking sideways through the NZ market time zone, it is up 1.4% since the NZ close to around 0.6880.

The RBA’s policy announcement was as expected, with Governor Lowe reiterating his recent comments that the severe damage to the economy from the virus could be less than earlier expected. The RBA’s QE policy remains on point, targeting a 3-year rate of 0.25% and its credibility is such that it hasn’t needed to do any bond buying for the past three weeks – a stark contrast to the RBNZ’s approach where the market doesn’t really know what sort of yields the Bank is targeting and it bought over $1b of bonds and still saw a significant sell-off in rates last week.

While the RBNZ didn’t get any bang per buck for its actions last week, some of that reflected the improved NZ outlook, as the country looks to have eliminated COVID19 and this is seeing different social behaviour and increased economic activity. Yesterday PM Ardern strongly hinted that a move to alert level 1 will be made early next week to take effect late-Wednesday, assuming case numbers remain near zero. This much earlier easing of restrictions than could have been imagined a month or two ago – which is likely to see only a closed border as the remaining restriction – will lead to economic forecast upgrades and reduce the need for the RBNZ to contemplate a negative OCR and support a dialling down of its QE programme.

The NZD has made strong gains overnight, up 1.2% since the NZ close to break up through 0.6360, reflecting the prevailing macro theme. The GDT dairy price index rose by 0.1%, near enough to our expectations of a close-to-flat result, with whole milk powder up 2.1%.

In our NZD weekly update yesterday we flagged upside risks to our conservative forecasts, as the currency approaches our year-ahead target (June 2021) of 0.65. Revisions to NZD crosses are mainly likely to be modest, reflecting that USD-weakness and its future vulnerability is the big story here. If this is the big USD correction that we, and others, have suspected would come one day – but have been uncertain about timing – then the NZD can appreciate a lot further. Overlay that with the macro backdrop of improving global growth – even if off a low base – and scope for risk appetite to recover further (our index remains well below average at around 22%) then it is not difficult to make a case for the NZD to make further substantial gains.

US dollar indices continue to push lower and after a nearly 3% fall in the DXY index over recent weeks, the USD remains some 18% above our long-term PPP fair value estimate. With currency markets the weapon of choice to convey a macro view at present, JPY has been the weakest of the majors overnight, seeing USD/JPY up over 1% to 108.70. Combine that with NZD outperformance, and NZD/JPY has surged over 2% to 69.1, back to the level last seen at the end of February.

EUR and GBP gains have been more modest, in the order of 0.3-0.4% for the day. GBP saw a lift after The Times reported that “Britain is expected to signal compromise on fisheries and “level playing field” trade rules if the European Union backs off from its “maximalist” demands on regulatory alignment and fishing access, according to senior Brussels sources”. A final round of negotiations has kicked off before a summit later this month which will decide whether a free trade agreement can be in place instead of WTO rules from next year.

The rates market remains fairly dull, with the lack of movement during the risk-on backdrop no doubt influenced by central bank backstops, with their various QE programmes. The US 10-year Treasury rate is currently up 2bps to 0.68%, while European rates generally nudged down a little. NZ government rates were up 1-3bps across the curve yesterday, while the movement in swap rates was even less than that.