Equity markets tumble again but with little spillover into bonds and currencies. BoE flags the possibility of negative interest rates

Equity markets have had another big fall overnight, mainly tech stocks, but without much impact on other asset markets.  US Treasury yields are marginally lower than yesterday’s close and FX changes against the USD are all within +/-0.2%.  The GBP has underperformed, albeit not by much, after the Bank of England flagged that it would consult with the banking regulator on negative rates, as a possible policy tool.   Yesterday’s NZ GDP data confirmed that the economy suffered an enormous hit in Q2, but it was close enough to expectations to cause little reaction.

Equity markets have extended their post-FOMC declines overnight, with falls of 1.4% for the S&P500 and 1.8% for the NASDAQ.  Yesterday morning’s FOMC meeting confirmed the Fed’s intention to keep the cash rate on hold until at least 2024, although investors were evidently disappointed by the absence of new easing measures (such as increased bond buying).  Tech stocks have underperformed again, with the NASDAQ sitting near its recent low and some 10% off its all-time high, set earlier this month.

Ordinarily, such declines in equity markets would spark a rally in bonds and a safe-haven bid to the USD, but there has been less movement in these other asset classes.  The US 10-year Treasury yield fell as low as 0.64% in the New York morning, but it has since rebounded back to 0.68%, close to yesterday’s close.  The USD was bid through yesterday’s Asian trading session, with the EUR briefly breaking below support at 1.1750, but those moves have unwound overnight.

Economic data has had little influence on markets.  US initial jobless claims fell slightly last week although the pace of improvement has clearly levelled off.  The Philadelphia Fed business survey matched market expectations, but the underlying details of the report were robust, including higher new orders and employment components, pointing to some further recovery in the ISM survey next month.  US housing starts and permits data were a bit softer in August, but the underlying trends remain higher, with the housing market a bright spot for the US economy.

Some more encouraging noises around US fiscal stimulus negotiations have emerged over the past few days.  Trump implored Republican senators to “go for the higher numbers”, rather than sticking to their very modest stimulus requests.  Democrat leaders, who rejected a compromise $1.5tn proposal recently put forward in the Senate by a bipartisan group of lawmakers, said they were “encouraged” by Trump’s comments.  The Democrats still want a $2tn+ stimulus package but, if Trump can sway Republicans to soften up their demands, then a compromise deal may still be possible. White House Chief of Staff Meadows said he is “probably more optimistic about the potential for a deal in the last 72 hours than I have been in the last 72 days”, adding that he wanted to see a deal done in the next week to 10 days.  Politico reported that Senate republicans were still sceptical about a larger stimulus package, so Trump and his team have some work to do to win them over.

The Bank of England left all its policy settings unchanged at its meeting overnight (cash rate: 0.1%, asset purchase programme £745b) but flagged that it is looking seriously at negative interest rates, as a possible policy tool.  The minutes to the meeting explained that the MPC had been briefed on how negative interest rates might be implemented effectively and the Bank was planning a “structured engagement” with the banking regulator over operational aspects of negative rates later this year.  The discussion in the minutes is the clearest sign yet that the Bank would consider negative rates, if the recovery falters, and interest rate markets shifted to price in greater rate cut risk.  There is around 20bps of rate cuts priced-in for the Bank by the end of next year, which implies a cash rate of -0.1%.  Given the looming risk of a no-deal Brexit and the recent resurgence in COVID-19 cases in the country, investors are also taking the possibility seriously.  The UK gilt curve bull steepened, with 2-to-5 year rates falling by 5bps, but little movement at the longer-end of the curve.  The New Zealand curve has also come under steepening pressure since the RBNZ signalled, at the August MPS, its intention to cut the OCR to negative next year.

The negative rate discussion in the BoE minutes caused an immediate 0.9% fall in the GBP.  But the move hasn’t been sustained and it is back to 1.2960, essentially unchanged on the day.   On Brexit, the EU Commissioner said “I am still convinced [a trade deal] can be done” but said it was up to the UK to withdraw its controversial Internal Market bill to ensure the success of negotiations.

The USD was initially stronger in the aftermath of the FOMC meeting, on disappointment over the lack of additional bond buying.  The Bloomberg USD index (BBDXY) reached an intraday high yesterday afternoon as S&P500 futures fell by more than 1%.  But it has been a swift turnaround overnight, on no particular news, and the BBDXY is now down 0.2% on the day and back near two-year lows.

Net changes in other currencies have been reasonably modest, albeit in the context of reasonably wide trading ranges.  The EUR has recovered almost 1% from its intraday lows yesterday afternoon, below 1.1750, and is now 0.25% higher on the day, at around 1.1840.  The JPY is 0.2% stronger despite BoJ Governor Kuroda’s pledge to ease further if labour market weakness impacted the inflation outlook.  The AUD is around flat over the past 24 hours, underperforming most other currencies, despite a very strong labour market report.  The data showed Australian employment surged 111k in August (consensus: -35k) and the unemployment rate dropped from 7.5% to 6.8% (consensus: 7.7%).  Hours worked rose a less impressive 0.1%, weighed down by the ongoing lockdown in Victoria.  With the number of new COVID-19 cases in Melbourne now tracking within the expected range, the city looks set for an easing of restrictions towards the end of this month.

The NZD tracked the EUR and AUD lower yesterday afternoon as equity markets declined, reaching a low below 0.6680.  But it has recovered all those losses, and then some, overnight, bouncing back to around 0.6750.  The NZD/AUD cross has risen back to near its recent highs, towards 0.9240, despite the stronger Australian data.  Crowded positioning among speculative investors in the cross may be one explanation for the surprising rise overnight.  We still think the cross will ultimately head lower in due course; we have pencilled in 0.89 for year-end.

The NZ GDP release yesterday revealed the huge hit to the economy during Q2, as the country entered lockdown.  Stats NZ estimated the economy contracted 12.2%, which was remarkably close to market expectations (-12.5%) and caused little reaction in markets.  The breakdown revealed big, but unsurprising, declines in those sectors where work-from-home wasn’t an option, including mining (-43.8%) and construction (-25.8%).  We expect an equally large (+13.5%) bounce-back in growth in Q3 but the sobering reality is that the economy will still be about 5% below its pre-Covid peak by the end of the year, according to our forecasts.

In other local news, the RBNZ announced the results of its bank stress tests, which are a check on how far banks’ capital levels would fall under hypothetical ‘downside’ scenarios.  The results showed banks’ capital levels remained above the regulatory minima under a 1-in-50 to 75 year event but fell below in the more extreme 1-in-200 year event.  Importantly, the RBNZ flagged the possibility of a further delay to the implementation of the new capital requirements (which will significantly increase the amount of high-quality capital banks need to have), with a decision expected at the Financial Stability Report in November.

NZ government bond yields fell another 2-3bps yesterday, a day after New Zealand Debt Management announced a reduction to its bond issuance programme for this year.  There was significantly greater demand for long-maturity bonds in NZDM’s tender than in the previous two, which helped bond yields fall by around 3bps more than swap rates.  The RBNZ announces its planned bond buying schedule for the week ahead at 2pm today although its highly likely to be maintained at $1.4b for the fifth week in a row.  The MPC will have the opportunity to provide guidance to RBNZ staff on the weekly purchase pace when the committee meets next week.