Risk sentiment higher. Equities up, bond yields up. USD underperforms although NZD, AUD rally fades

Risk sentiment is higher, with gains in US and European equity markets and higher US Treasury yields. The USD is the biggest loser for the day, although there has been little sustained progress in the NZD and AUD overnight.

Risk sentiment has been supported by hope that a US fiscal deal will be soon agreed, positive developments on the COVID19 front and positive US ISM services data. The S&P500 is up 0.7%, following a 0.5% gain for the Euro Stoxx 600 index. 

Negotiators for Democrats and Republicans on the next fiscal stimulus bill offered words of encouragement, with both sides indicating that some progress had been made and that they aim to reach agreement by the end of the week. However, US Treasury Secretary Mnuchin added that the two sides remained far apart on some key issues, but at least there was an agreement to set a timeline.

The 7-day rolling average of reported COVID19 cases in the US is still trending lower. Meanwhile, progress on vaccines and treatment looks good. The latest vaccine trial by Novavax reported a strong antibody response in patients. On the treatment side, a new US study showed that hospitalised patients who received blood transfusions rich with antibodies from recovered patients reduced their mortality rate by about 50%. Even if a vaccine is slow in coming, better treatment options should over time reduce the “fear” of COVID19 and therefore allow economic conditions to gradually normalise.

The US ISM services index rose to its highest level since early 2019 of 58.1, defying market expectations for a drop, continuing the run of stronger than expected data for key US economic releases. However, the employment sub-index fell slightly to 42.1, a level consistent with labour shedding, as the outbreak of COVID19 spread across the US, stalling the economic recovery.

On that note, the ADP payrolls figure was much weaker than expected, coming in more than 1 million lower than expected. However, this indicator severely undershot the more closely watched non-farm payrolls indicator over the past couple of months, by some 5.9m in May and 2.4m in June. The consensus for the July reading released at the end of the week for non-farm payrolls is at 1.5m, albeit a nearly 4m range covers the low-high estimates. One can understand the market not paying too much attention to the flow of data releases during these extraordinary times.

Global rates have picked up across Europe and the US. The US Treasury 10-year rate is up 3½bps to 0.54%, coming off the record low close yesterday. This comes ahead of a deluge of US Treasury issuance, with a record $112b of securities at next week’s quarterly refunding of maturing Treasuries. Investors are looking towards the Fed to increase its Treasury purchases at some stage, with further fiscal easing adding to the forthcoming supply.

In an interview with CNBC, Fed vice-chair Clarida was hopeful about the outlook, indicating that he expected the economic pick-up that began in Q2 to continue into the second half, despite the renewed outbreak of the virus, with another fiscal package helping. The Fed expected the review of the monetary policy framework to be completed in the near future. On that note, former Fed Chair Yellen suggested that instead of the Fed aiming for 2% inflation, she expected the review to conclude a desire for inflation to average roughly 2% over time.  This seem consistent with the view of some FOMC members that have spoken recently, suggesting that inflation is allowed to run above 2% for a time, before tightening policy. It plays to the run-up in market-implied breakeven inflation rates which have been behind a recent steady fall in US real interest rates, a significant drag on the USD of late.

In currency markets, broadly based USD weakness returned yesterday, and the BBDXY index now down 0.5% for the day. EUR has led the charge, albeit found some resistance just above 1.19, as it did at the end of last week and it currently sits at 1.1860.

The NZD pushed up to an overnight high of 0.6674, but has since fallen back to 0.6640, so now flat since the NZ close but up 0.5% from this time yesterday. There was little sustained reaction to the labour market data release yesterday. The data were unbelievable, largely due to measurement issues, but the finer detail gave a more accurate reading. Like the 6.2% unemployment rate measured in the final week of the June quarter, rather than the official 4.0% recorded for the quarter as a whole; and the 10.3% drop in hours worked. Much worse is to come, with the unemployment rate likely to climb higher into year-end towards 10%, with some 450k people rolling off the wage subsidy scheme which expires at month-end.

The NZ rates market was little moved by the data. There was a slight downside bias to rates for the day, reflecting some pressure from the offshore move the previous night.

The AUD has followed the same pattern as the NZD, trading as high as 0.7251 overnight, before losing that gain, now tracking below 0.72. NZD/AUD pushed lower, but found some support just above 0.92. The AUD continues to show no ill effect from the extended lockdown in Victoria, or renewed interstate border restrictions.

There’s not much to say about other NZD crosses, other than noting that the NZD/EUR cross has touched below 0.56 on EUR strength.

Finally, gold prices extended their mega upward run, supported by the weak USD and higher US inflation expectations, with the $2000 barrier proving little resistance. Spot gold traded as high as $2055 overnight, while the active future (Dec-20) traded up to $2070. 

In the day ahead, the RBNZ inflation expectations data shouldn’t move the needle, no matter the figure, while tonight sees the Bank of England release a policy update, with no changes in policy expected.