Risk appetite has improved overnight, with US equities making strong gains and on a cusp of a record high, while global rates track higher. The NZD has recovered its losses seen in the aftermath of the dovish RBNZ Monetary Policy Statement.
US equities are stronger, recovering after yesterday’s late sell-off after indications that fiscal talks were at a stalemate. It’s a new day, and there’s new-found optimism that a deal will eventually be reached. Biden’s choice of fellow Democrat Kamala Harris as his VP pick is seen as a “moderate” compared to other candidates, supporting market sentiment. To that we can add that the market is becoming more comfortable with lower new daily COVID19 case trends and vaccine developments. The S&P500 is currently up 1.5% and now within a few points of breaking the 19th February closing high. Unlike recent sessions, the IT sector is back in charge, with smaller cap stocks lagging.
In economic data, UK GDP slumped just over 20% q/q in Q2, broadly in line with market expectations and indicative of the more prolonged lockdown period compared to other nations. The monthly profile showed a jump in activity in June and timelier real-time data show further signs that the economy is now heading in the right direction as lockdown restrictions have eased.
US CPI inflation rose by much more than expected, driven by higher auto and apparel costs. The monthly increase in the core CPI of 0.6% was the biggest increase in almost three decades. Market reaction was contained to the extent that the jump in inflation was seen to be more one-off in nature, while annual core inflation remained low at 1.6%. There seemed to be little threat of any change the mindset of the US Fed, which is looking to accommodate a period of inflation running above its 2% target before even thinking about raising rates.
Following the CPI data, the US 10-year Treasury rate rose to as high as 0.69%, ahead of a $38b tender. But the sell-off encouraged good demand at the auction, seeing rates peel off back down to 0.66%, now little changed from the NZ close and up some 2bps for the day. Key European 10-year rates are up in the order of 3-4bps, so the move in US rates has lagged other markets.
The lack of upward pressure in US rates and risk-on backdrop sees the USD lower, with the BBDXY index down 0.3% for the day. GBP and JPY have been on the weak side, making no progress against a weaker USD backdrop, with the other European currencies and the commodity currencies showing overnight gains in the order of 0.7-1.0%.
The NZD shows no sustained impact from the dovish RBNZ MPS, with the TWI a touch higher since the release, NZD/USD higher and about half the key crosses higher, with global drivers in the box seat. In the aftermath of the MPS, the NZD touched a low of 0.6525 and in overnight trading it touched a high of 0.66, now back down to 0.6580.
On QE, the RBNZ expanded the Large Scale Asset Purchase Programme from a cap of $60b to $100b, and added a year to the programme, taking it through to June 2022. While it was just a matter of time before the RBNZ scaled up the QE programme, more surprising was (i) new-found research that gave the Bank confidence it could lift the limit on its holding of nominal NZGBs from 50% to 60% outstanding, before severely affecting market functioning, and (ii) the Bank would front-load bond purchases and it lifted next week’s LSAP tender of NZGBs and LGFA bonds by a total $160m to $1.13b.
On rates, while the commitment to retain the OCR at 0.25% through to March remained, in the suite of alternative monetary policy tools, the committee noted a preference for a negative OCR combined with a Funding for Lending Programme. We saw this as an increased probability of the Bank adopting a negative OCR next year, with the Bank potentially going down that track to offset any possible upward pressure on yields as it tapers its LSAP programme next year.
The message of a more expansionary policy stance, saw the money market pricing in a negative OCR by May (previously bounded by zero), and becoming more negative into the back end of next year. Swap rates moved lower across the curve, approaching the lows of May, with the 2-year swap rate down 7bps to 0.15% and the 10-year rate down 5bps to 0.63%. Against upward pressure on global rates, NZGBs significantly outperformed on a cross-market basis, seeing yields down 4-7bps across the curve, a move supported by more favourable future supply-demand dynamics. This was more evident in the linkers market, with inflation-linked bond yields down some 9bps.
Purchases of foreign assets were seen to be part of the alternative monetary policy toolkit, but Governor Orr noted that this was the least preferred of the range of options. We agree, and note that foreign exchange rate intervention by the RBNZ with the NZD currently “cheap” on long-term metrics and measured against NZ’s strong terms of trade would be futile.
The risk-on move overnight sees the AUD trading near its high for the session and currently around 0.7170. NZD/AUD is on track to close below the key 0.92 support level and sits around 0.9190, but up from the 0.9160 low seen yesterday. With support broken, the downside has opened up. Investors will continue judge the RBNZ’s money printing strategy and debasement of the NZD against the RBA’s more sensible yield curve control strategy and likely conclude that the NZD/AUD should head lower. We have our eye on the long-term support level of 0.88.
The day ahead might see some further positioning adjustments in the NZ rates market. Australian employment and US jobless claims data are the economic releases of interest.
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.