Risk appetite remains firm, with US equities heading higher again. US rates fall and curve flattens. USD recovers from a two-year low as ECB's chief economist says the EUR "does matter". NZD outperforms despite the market increasing OCR rate cut pricing

In overnight market moves, US Treasury yields have fallen and the curve flattened while the S&P500 has pushed higher.  The USD made a fresh two-year low but it has recovered over the past few hours and is now slightly higher on the day.  The NZD has outperformed despite a further increase in OCR rate cut expectations ahead of RBNZ Governor Orr’s speech today.

Risk appetite remains buoyant following the Fed’s shift to an average inflation targeting framework (meaning lower-for-even-longer rates) and as economic data supports a recovery in activity in major economies.  Tech stocks continue to power ahead, on little news, with the NASDAQ rising 1.3% overnight and making a fresh record high.  The NADSAQ is now more than 20% above its previous all-time high from earlier in the year.  Gains in the broader US equity market have been more modest, with the S&P500 increasing 0.6% (helped by the tech sector) and the Russell 2000 small cap index rising 0.7%. Credit spreads continue to grind tighter, with CDS indices on both USD investment grade and high yield (i.e. ‘junk’) debt reaching their lowest levels since late February.

Global rates have fallen overnight with curves flattening.  The 10-year Treasury yield is down 3bps, to 0.67%, back to where it was before Chair Powell outlined the Fed’s new average inflation targeting regime.  The 30-year yield is 5bps lower, at 1.42%, although it remains a few basis points higher than it was pre-Powell.  There has also been a reversal in market-based inflation expectations, with the 10-year ‘breakeven inflation rate’ down 4bps to 1.77%.  In a speech overnight, influential Fed governor Brainard said “in coming months, it will be important for monetary policy to pivot from stabilization to accommodation ”, potentially signalling a shift to more bond buying and firmer forward guidance from the Fed at its meeting later this month.  Brainard added that financial stability (i.e. concerns around asset bubbles etc) was an important part of the new mandate, albeit macroprudential and prudential tools were the “first line of defence” to deal with these issues.

Economic data has generally been better than expected.  The US ISM manufacturing survey rose to 56, its highest level since late-2018, with new orders reaching their highest level since 2004.  In China, the Caixin manufacturing PMI, which surveys a greater proportion of small and medium-sized firms than the official PMI, reached its highest level since 2011.  The data support the view that the global economy continues to recover from the huge hit earlier in the year.  Reflective of growing economic optimism, copper prices reached a two-year high overnight.

In currencies, the EUR touched 1.20 for the first time since 2018.  The gains didn’t last though and it has fallen back to just above 1.19, now 0.25% lower on the day.  The stronger US ISM survey, comments from ECB Chief Economist Lane on the exchange rate, and profit-taking in a market which is clearly positioned ‘long’ all contributed to the reversal in the EUR.  The ECB’s Lane observed that while the central bank doesn’t target the exchange rate, the EUR/USD still “does matter ” because of its impact on economic activity and inflation.  While the ECB doesn’t target an exchange rate, it knows its monetary policy actions affect it, and it could increase its bond buying programme to try combat disinflationary pressure.  Eurozone core inflation fell to a record low of 0.4% in August, with headline inflation falling in to negative territory, although the reading was impacted by one-off factors (i.e. delayed summer sales at clothing retailers).

The USD index made a fresh two-year low yesterday but it has recovered overnight to be now slightly higher on the session.  The GBP, AUD and JPY are all little changed from this time yesterday.

The NZD has outperformed over the past 24 hours (+0.15%).  The currency reached its highest level since July last year, almost 0.6780, although it has pared those gains over the past few hours as the USD has recovered.  The NZD trades this morning around 0.6740.  The outperformance in the NZD came despite the market increasing its OCR expectations yesterday and a slightly softer dairy auction overnight.  The GlobalDairyTrade index fell 1% while whole milk powder prices declined 2%.

OCR rate cut expectations continue to build, with the market now pricing the OCR to fall to -0.23% by mid-next year.  The market is also pricing more rate cut risk into the February 2021 meeting, which is now priced at 0.1%.  There was another marked shift lower in NZ swap rates yesterday, with the 2-year rate falling to a new all-time low of 0.04% and the 5-year rate falling 4bps to 0.15%.  The yield curve steepened beyond the 5-year point in both bonds and swaps, which is a normal reaction in the yield curve to expected cash rate cuts.

The move lower in NZ rates, which occurred despite little movement offshore, comes ahead of RBNZ Governor Orr’s speech at 12:30 today on the monetary policy response to COVID-19.  The Governor will no doubt recap the vast array of measures the Bank has taken since March, when the crisis erupted, but the market will be looking for any signals around the likely future course of policy.

The RBA kept its cash rate and 3-year yield targets unchanged, at 0.25%, at its board meeting yesterday.  However, it increased the size of its Term Funding Facility, allowing banks to borrow an additional 2% of their credit outstanding at 0.25% for three years.  Banks have drawn around $52b from the facility to date and the policy change brings the total allowance to around $200b.  The RBNZ is also looking into a long-term lending facility for banks, which it thinks will increase the pass-through from further OCR cuts (to negative) to retail interest rates.