Risk appetite firmer, equity markets higher on positive results from COVID-19 vaccine trials, EU Recovery Fund hopes. EUR reaches highest level since March, NZD nudges up to 0.6570

Markets have traded with a risk-on tone overnight.  Sentiment has been lifted by positive trial results for a number of COVID-19 vaccine candidates and reports that EU countries are closer to a compromise solution over the proposed EU Recovery Fund.  Equities are higher and the USD is slightly weaker while global rates have again shown little movement.  The NZD has increased slightly.

There has been a flurry of announcements from pharmaceutical companies overnight on potential vaccines and treatments for COVID-19.  As foreshadowed by UK media last week, Oxford University and AstraZenica’s experimental vaccine showed positive results in their phase one trials.  The trials, covering 1,077 people, showed their vaccine generated both neutralising antibodies and so-called T-cells, which identify and kill infected cells, with no serious side effects. Oxford University/AstraZenica are seen as one of the frontrunners in the global race to find a vaccine.  Researchers are now underway with large-scale trials, which they hope to produce results on by Autumn, and AstraZenica’s CEO said he hoped they could start delivering doses of the vaccine by year-end.  Early recipients of the vaccine, if it is proven to be effective in large-scale testing, are likely to include health care workers and vulnerable people.  More widespread distribution is likely to take more time, after production has scaled up.

There were similarly encouraging results from Pfizer and BioNTech on their experimental vaccine and China’s CanSino, on its phase two trials.  Elsewhere, little-known UK pharmaceutical firm Synairgen saw its share price rise more than 400% after it claimed that its COVID-19 treatment drug reduced the rate of people in hospital needing intensive care.  AstraZenica’s US-listed share price actually fell modestly overnight, albeit from what were all-time highs.

Despite the encouraging news on potential COVID-19 vaccines, equity markets have been led higher overnight by tech stocks, which are less sensitive to the social distancing restrictions and reopening plans.   The NASDAQ is up over 2%, while the S&P&500 is up around 0.7% and the Russell 2000 index of small-cap stocks is down 0.3%.  The NASDAQ is on track to set a record high, on a closing basis, while the S&P500 is at its highest level since February.  Most sectors of the S&P500 are actually lower on the day, besides those with a big weighting to tech firms.  The VIX measure of equity volatility is close to its lowest level since February, at 24.5, but remains above its long-run average.

Also supporting market sentiment were signs that European leaders were edging closer to a compromise agreement on the proposed Recovery Fund.  Leaders have reportedly agreed to €390b of the €750b fund being allocated to grants to vulnerable countries, with the remainder being low interest rate loans.  The countries now need to agree on other issues such as climate change targets and a proposal to link payments to countries following the ‘rule of law’, which Poland and Hungary are opposed to.  European equity markets were up 0.5% to 1%.  The 10-year Italy-Germany bond spreads narrowed to around 155bps, its lowest level since February and indicative of less perceived credit risk in Italy.

The EUR has reached its highest level since March, although it is well off the highs of the overnight session.  It trades this morning around 1.1440, about 0.1% higher than the end of last week.

The USD is generally weaker, albeit modestly (BBDXY: -0.15%), and is close to one-month lows.  A stronger EUR, on the back of optimism around the EU Recovery Fund, narrower US interest rate differentials (especially for real, i.e. inflation-adjusted, rates) and improving risk appetite have all likely weighed on the USD over the past month.

The NZD and AUD are both up around 0.2% so far this week.  The NZD is trading around 0.6570, towards the top of the tight 0.65 – 0.66 range that has been in place over the past 2 weeks.

There has been little move in global rates overnight, with the 10-year Treasury yield continuing to trade just above 0.6%.  Since the nadir of the crisis in markets in March, there has been a broad-based recovery across equity and commodity prices, but no such bounce in global rates, which remain at exceptionally low levels.  However, market-based inflation expectations (so-called ‘breakeven inflation’) have continued recover.  The 10-year US breakeven inflation rate is back to where it was in early March, although it remains at levels (1.45%) which imply the Fed will continue to miss its inflation target. The NZ rates curve experienced a small fall yesterday, with the 10-year swap rate falling to its lowest level in over a month (-1bp to 0.69%).

In domestic data, the PSI (the services version of the PMI) bounced back into expansionary territory in June, just like the manufacturing PMI on Friday.  The headline index rose to 54.1 from 37.5 in May and a nadir of 25.8 in April.  There was strength in sales/activity (58.7) and new orders (59.6).  Like the PMI, employment stayed in contractionary territory (45.1), indicating that firms continued to shed staff, even as activity improved (from a low base).  At this stage, we think the recent run of better-than-expected domestic data (including housing, retail sales and these PMI surveys) and higher commodity prices argue for the RBNZ keeping its QE bond buying limit to stay at $60b at the August MPS.  Additionally, there is an argument that it makes sense to wait until after the Pre-Election Economic and Fiscal Update later in August, which will provide an update on the government bond programme.  Finance Minister Robertson said yesterday that $14b allocated towards the COVID-19 fiscal response at the Budget in May would be set aside, in case of a second wave of the virus for instance.  There is a risk that the bond programme is revised lower, in turn necessitating lower purchases from the RBNZ.

Finally, Republicans and the US administration have started talks over another US fiscal stimulus package, with Trump’s chief of staff saying they were looking at a plan in the “trillion dollar range.”  Republicans want to modify the enhanced unemployment benefits, which give an extra $600 per week until the end of the month, to ensure those claiming don’t receive more than they would earned from employment.  The administration is also proposing a payroll tax cut which is likely to meet heavy resistance from Democrats.  It remains to be seen whether the two political parties can agree a package over the next two weeks, before the enhanced unemployment benefits end and summer recess begins.