NZD and AUD push higher. COVID19 outbreak in Victoria and AU/China tensions being watched closely. Likely pressure on NZ long rates ahead of long bond syndication

With US markets closed for Independence Day on Friday, financial markets saw a quiet end to last week. European equities and S&P futures were on the soft side, while the NZD and AUD ended the week on a positive note.

There wasn’t much news on Friday and what we did read looked to be negative, with a further negative flow of news over the weekend. US new daily case numbers of COVID19 broke up through the 50,000 mark towards the end of last week and on Friday reached a record one-day total, reflecting outbreaks across a number of Southern and Western states. Closer to home, Victoria in Australia recorded 108 new cases on Saturday, with lockdowns increased across Melbourne suburbs to contain the spread. Hopes for a Trans-Tasman bubble within a few months diminish by the day.

Bloomberg reported that ECB Governing Council members face a potential rift over how much their emergency-bond purchase programme should stay weighted toward weaker countries such as Italy. The capital key rule links bond buying programmes to the relative size of each economy, but recent purchases have been skewed towards Italy in response to the surge in bond rates for one of the worst-affected countries. The news story shouldn’t really surprise anyone who closely follows the ECB and there was little impact on markets. More important for the EUR over the next month or so will be whether EU members can agree on the terms of the Recovery Fund, which is required to inject some fiscal stimulus support for the region.

On Saturday, the WSJ reported that the US is sending two aircraft carriers to the South China Sea for some military exercises at the same time that China is holding drills in the area, a rare move. A US navy Commander said that they wanted to challenge what they called Beijing’s unlawful territorial claims. The military operation can only inflame the prevailing US-China tensions that already exist over the likes of trade and Hong Kong.

There has been little economic data flow. On Friday, Australian retail sales data for May were broadly in line with the weekly estimates, showing a strong rebound for the month. China’s Caixin PMI services index blasted up to its highest level in over ten years and was much stronger than expected. This was a stronger result than the official non-manufacturing index, with the Caixin survey biased towards smaller firms. The data provide some support to the view that China’s economic recovery is well on track.

S&P futures fell by 0.4% on Friday and, with no positive news over the weekend, risk assets might open the week on a softer note. The Euro Stoxx 600 index fell by 0.8%.

Currency market movements were small on Friday and despite weaker S&P futures, the NZD pushed higher in the overnight session, closing not far off its high for the week around 0.6530. AUD also pushed a little higher, closing the week around 0.6940. NZD/AUD remained above the 0.94 mark. Traders will no doubt be watching the COVID19 outbreak in Victoria and increased lockdowns as it has the potential to take the shine off the view that Australia’s economy is much better placed to recover than NZ, and thereby cause a reassessment of the NZD/AUD cross outlook.

Traders will also be watching Australia-China geopolitical tensions. The Weekend Australian reported that the Australian government expects further retaliatory tariff increases from China after PM Morrison’s offer of a safe haven to Hong Kong citizens. Following increased tariffs on barley and beef, other products such as milk powder might be included. The combination of Victoria’s COVID19 outbreak and further Australian geopolitical tensions with China could well underpin the NZD/AUD cross in the short term.

The NZ rates market was quiet, with a slight downside bias to the government and swap rate curves. The RBNZ announced that it would purchase $940m of government bonds this week in the LSAP, the same as last week, while it will taper LGFA purchases by $10m to $40m. The big event on the horizon for the NZ rates market is the pending syndication of the May-2041 government bond, scheduled for next week.  This will be the longest bond on the government bond curve, extending it by four years from the Apr-2037 bond.  Historically, government bond yields tend to increase immediately preceding new syndicated issues to incentivise investors to buy the deal, so we think the yield curve is likely to steepen over the course of this week.

The economic calendar for the week ahead is light. Tonight sees the release of the ISM non-manufacturing index in the US, which is expected to show further signs of recovery.