It has been a better session for risk assets overnight, with US and European equities rising by 0.5-1.5%. The USD has strengthened to an almost six week high, despite the recovery in risk appetite, while US rates are little changed. The AUD has underperformed after RBA Deputy Governor Debelle reiterated the possibility of further easing measures. The RBNZ Monetary Policy Review takes place at 2pm, although we’re not expecting any major surprises.
Risk asset markets have traded with a more positive tone overnight. The S&P500 is up 0.8%, reversing most of the previous night’s 1.2% fall, while the NASDAQ has outperformed for the second day running, rising 1.4%. There hasn’t been an obvious catalyst for the turnaround in sentiment other than what looks like opportunistic dip buying from investors.
Fed Chair Powell’s testimony to the House Finance Service Committee delivered few surprises, although he took the opportunity to reiterate to Congress that more fiscal support would helpful. Prospects for a new fiscal stimulus package appear have diminished after Republicans signalled their intention to fast-track confirmation of a new Supreme Court justice, before the upcoming election, following the recent death of Ruth Bader Ginsburg.
Besides the ongoing fiscal stalemate in the US, investors remain concerned about the second wave of COVID-19 cases in Europe, which could lead to the reintroduction economically damaging restriction measures. Overnight, UK PM Johnson described the current juncture as a “perilous turning point” and asked people to work from home if they could. The government also announced, amongst other measures, that pubs and restaurants would need to close at 10pm and Johnson warned these measures could last for six months. While governments have been reluctant to go back to nationwide lockdowns, like those implemented earlier in the year, even more moderate restrictions will likely slow the path of the economic recovery.
In currencies, the USD has strengthened again, with the Bloomberg DXY reaching an almost six-week high. The BBDXY is 0.5% higher over the past 24 hours, extending its gains from the previous two sessions. Comments from Chicago Fed President Evans, in which he said it was possible the Fed could raise rates before inflation reached 2%, provided support to the USD. We wouldn’t read too much into the comments, which appear go against the thrust of the Fed’s new ‘average inflation targeting’ framework and comments from other Fed officials. Tellingly, there was little reaction in the bond market, with Treasury yields unchanged on the day (US 10yr: 0.67%). Evans highlighted that Fed officials needed to discuss the practical details of the new framework.
In the UK, BoE Governor Bailey pushed back the near-term prospect of negative interest rates. Market speculation that the BoE could cut its cash rate to negative intensified after the minutes to last week’s meeting highlighted that BoE staff had briefed the MPC on negative rates and said the BoE was planning a “structured engagement” with the banking regulator on the topic in Q4. Bailey said negative rates were “in the toolbag but it doesn’t imply anything about the probability of us using negative interest rates at the moment. ” Bailey added that the technical preparations for negative rates would take time, implying the tool is unlikely to be used imminently. UK gilt yields rose sharply after his comments, with the 2-year yield up 7bps and the 10-year up 5bps. The GBP has been volatile overnight, rising in the wake of Bailey’s comments before slipping back to near the lows of the day, as the USD strengthened across the board. The GBP is down 0.6% overnight, to around 1.2730.
In other currencies, the EUR has fallen 0.6% to its lowest level since early August, just above 1.17. The resurgence in COVID-19 in the continent and stretched long positions among speculative investors have likely played a part in its recent reversal from near 1.20. In more positive news, the populist League party performed poorly in Italian regional elections, leading to a 5bp fall in the Italian 10-year yield to its lowest level since February.
In his widely anticipated speech yesterday, RBA Deputy Governor Debelle reiterated that the RBA could ease policy again “should the Reserve Bank Board decide that is warranted” . Our NAB colleagues interpret Debelle’s comments as suggesting action in imminent – at either the upcoming October or November meetings. They now forecast 15bp cuts to the cash rate, 3-year bond yield target, and three-year term lending facility for banks, all to 0.1%. Further, they expect the RBA to enact an RBNZ-style QE bond buying programme, focused on the 5-10 year sector of the curve, to assist in getting rates and, they hope, the AUD, lower. Debelle reiterated the RBA’s sceptical stance on negative interest rates, observing that the empirical evidence was “mixed .” The prospect of further incremental easing by the RBA is not completely unexpected, having been foreshadowed by an AFR article early last week.
The AUD fell immediately after Debelle’s speech and there has been further follow-through overnight as the market digests the likely policy implications. The AUD is down 0.8% over the past 24 hours, to around 0.7070, its lowest level in a month. Australia’s 3-year yield fell to a new record low of 0.2%, below the RBA’s current 0.25% yield target, suggesting the market sees a reasonable risk that the RBA does indeed follow through with easing.
The NZD has fallen 0.5% overnight, reflecting the stronger USD, while the NZD/AUD cross has pushed back up to 0.9260. We ultimately think the cross will head lower in due course, with the RBNZ’s more aggressive bond buying and likely shift into negative rate territory next year exceeding the RBA’s incremental easing measures.
NZ rates were little moved yesterday, with falls of 1-2bps in government bond yields and up to 1bp in swaps. However, the fall in Australian rates post the NZ market close may put some further downward pressure on NZ rates when trading opens this morning.
The focus today is the RBNZ Monetary Policy Review, which comes out at 2pm. We expect the Bank to hold the OCR at 0.25% “in accordance with the guidance issued on 16 March”, which was that the OCR would remain unchanged for at least a year. In the unlikely event that the RBNZ omitted or adapted this forward guidance, there would be a sharp fall in short-term interest rates and market expectations of a negative OCR would be brought forward to February. As noted in the August MPS, the Bank is still working on a package of additional monetary instruments and we don’t expect any news on this front. We’re not expecting any sustained market reaction from the RBNZ statement this time.
The other event to highlight locally today is New Zealand Debt Management’s regular update on bond tender issuance for the month ahead, which is released at 8am. Following the reduction to this year’s bond programme that was announced alongside PREFU, from $60b to $50b, we expect NZDM to reduce the volume of bonds it offers in the weekly tenders, from $950m-$1b to possibly around $750m. For context, the RBNZ is currently buying $1.35b of government bonds per week under its QE programme, thus gradually chipping away at the free-float of bonds in the market and pushing down on interest rates.
The European PMIs are the focus tonight.