US equities recover after further big falls on Friday. US rates increase sharply, curve steepens, after payrolls. Limited moves in currencies

There was another big sell-off in the S&P500 and NASDAQ on Friday before a sharp recovery late in the session pared losses to about 1%.  US Treasury yields ignored the weakness in equities and focused on a strong US employment report, which pulled rates up by 8-10bps at the long-end of the curve. The USD initially appreciated after the payrolls report but gave back those gains as equity markets recovered – currency changes, including for the NZD, were minimal.  The US bond and stock markets are closed tonight for Labor Day.

There was significant volatility again in equity markets on Friday, following the big falls seen on Thursday night.  The NASDAQ fell more than 5% within the first two hours of US trading taking its cumulative two-day decline to more than 10% at one point.  The sharp falls in tech stocks follow a rapid run-up over recent months which had pushed valuations to extremely high levels.  The FT reported that this previous run-up had been exacerbated by large-scale purchases of call options in single-name tech stocks by Japanese investor Softbank, which in turn led to buying of these stocks from dealers looking to hedge their exposures.  The S&P500 was down more than 3% at one point on Friday, dragged down by underperforming tech stocks.

But sentiment shifted late in the trading session, on no obvious news, with equities staging a major recovery.  The NASDAQ pared its loss to ‘just’ 1.3% while Apple, which had been more than 8% lower at one point, ended the day slightly higher.  The S&P500 closed the day down 0.8%.  The ‘buy the dip’ mentality remains intact for now, it seems, supported by ultra-low interest rates and expectations for a continued economic recovery.

The key event on Friday, albeit overshadowed by the volatility in tech stocks, was the US nonfarm payrolls release.  The US economy added 1.37m net new jobs in August, close to market expectations, but the big surprise was a large fall in the unemployment rate, from 10.2% to 8.4%.  The unemployment rate comes from a separate survey of households, which tends to be more volatile than the payrolls survey of employers, so it likely exaggerates the improvement in the labour market.  Job growth on the month was boosted by temporary government hiring for the census.  The US economy has now recovered around half the jobs lost in March/April although the pace of improvement has moderated over recent months.  Some commentators are concerned that recent strong employment reports may take some of the pressure off politicians to agree to a new fiscal stimulus package.

Fed Chair Powell, in an interview with PBS after the payrolls report, acknowledged the better labour market data but cautioned that “we do think it will get harder from here.”  Powell reiterated that interest rates would remain low for a long time (“it will be measured in years”), adding that “it’s likely we will need to [take more stimulus measures] over time.”  The Fed is not about to let down its guard if data turns out stronger than expected and its focus remains on getting inflation above 2% and the labour market back to full employment, both of which remain a long way off.

The payrolls report triggered a large steepening in the US yield curve.  While rates were little changed out to 2-years, consistent with the Fed’s commitment to keep rates lower-for-longer, yields on US Treasury bonds increased by 8bps, for 10-years, and 11bps, for 30-years.  The increase in rates on Friday reversed the moves over previous days, leaving the 10-year rate at 0.72%, unchanged on the week.  Heavy bond supply due this week ($108b of US Treasury bonds, including 10 and 30 year auctions, as well as an expected deluge of corporate bond issuance) likely added to the curve steepening pressure.

The USD initially rallied after the payrolls report before reversing lower as equity markets recovered.  The USD remains sensitive to risk appetite, tending to depreciate when risk appetite improves (i.e. equity markets increase).  The Bloomberg USD index ended marginally weaker on the day and remains in vicinity of two-year lows.

Outside the CAD (+0.5%) and Swiss franc (-0.5%), exchange rate changes on Friday were limited to just +/- 0.2%.  The NZD made a low around 0.6670 after payrolls before recovering to close the day at 0.6720 (+0.1%).

Commodities were mixed, with a sharp fall in oil (Brent crude -3.7%) but further gains in base metals (copper +2.2% to a fresh two-year high).  Over the weekend, Bloomberg reported that Saudi Aramco had reduced its oil pricing for October by more than expected, potentially signalling softer demand.

Domestically, the NZ yield curve flattened on Friday, in response to global forces.  The 10-year swap rate fell by 4bps and the 10-year government bond yield declined by 5bps.  Those moves should reverse today given the sharp sell-off in US Treasury bonds on Friday night.

The RBNZ kept its QE bond buying for this week unchanged, at $1.35b, and added the recently syndicated May-2041 bond to its purchase schedule.  The RBNZ continues to ‘frontload’ its bond buying in a bid to keep interest rates low ahead of the likely shift to a negative OCR early next year.

Governor Orr has written an op-ed in stuff.co.nz over the weekend.   There is nothing new in the article from a markets perspective, in which he reiterates that the Bank is preparing a package of measures, if required, including a negative OCR and a term lending scheme for banks.

Also over the weekend, Victorian premier Andrews said Melbourne’s lockdown would be extended for another two weeks, from 14th September.  From 28th September, restrictions would be eased in stages if new cases continued to decline.

It’s the Labor Day holiday in the US tonight so markets are likely to be quieter than usual.  US jobless claims and CPI are the data highlights this week but the real focus for markets is the FOMC meeting next week.  The ECB meeting is on Thursday night where the central bank is expected to maintain a dovish tone while refraining from adding more stimulus.  In New Zealand, there are more partial Q2 GDP indicators and the preliminary version of the ANZ business survey on Wednesday.