Big falls in equity markets (S&P500 -2.5%) on COVID-19 concerns, deadlocked fiscal stimulus talks. US 10-year yield falls back below 0.8%. Currency moves modest in comparison - NZD slightly lower to start the week

It has been ‘risk off’ start to the week with investors focusing on the resurgence in COVID-19 in Europe and fiscal stimulus talks stalling.  The S&P500 is off more than 2% while US Treasury yields have fallen back below 0.8%.  The USD has gained a little ground, albeit from what was its lowest closing level since May 2018.  The NZD has been fairly resilient, despite the risk-off backdrop, with the NZD/AUD cross pushing towards 0.94 for the first time since July.

There have been some chunky falls in equity markets overnight, with the S&P500 down 2.5%, the NASDAQ down 2.4% and the Eurostoxx 600 1.7% lower.  Meanwhile, the US 10-year Treasury yield has slid back to 0.79%, having reached its highest level since June on Friday night (at 0.87%).

The number of new COVID-19 daily cases has set records across multiple European countries and the US in recent days, raising the prospect of another wave of economically damaging restriction measures.  Over the weekend, the Spanish government announced a state of emergency, introducing a nationwide curfew between 11pm and 6am.  In Italy, the government said all bars and restaurants would need to close at 6pm.  Both countries are keeping schools and most workplaces open for now, conscious of the economic hit that another full lockdown would bring, but the resurgence in the virus is still likely to lead to more caution among businesses and households.  On that note, German software company SAP’s share price plunged over 20% after the firm lowered its revenue forecasts and said the new wave of COVID-19 was leading to less spending on software updates as businesses rein in costs. The German DAX was off 3.7%.

Adding to the negative sentiment, fiscal stimulus talks between the White House and House Democrats stalled over the weekend, with both sides accusing each other of “moving the goalposts.”  Treasury Secretary Mnuchin and Democrat leader of the House Pelosi are due to talk by phone today but with barely a week to go until the election, the chances of a pre-election fiscal deal look close to zero.  The fate of another fiscal stimulus package now rests mainly on a Democrat ‘clean sweep’ at the election.

Betting markets put around a 65% chance of Biden winning the election, while prediction site fivethirtyeight gives Biden an 87% chance of winning, similar odds to a week ago.  The battle for the Senate, which is crucial to Democrats’ fiscal plans, is expected to be tighter.  Betting markets give the Democrats around a 60% chance of regaining the Senate while fivethirtyeight is at 74%.

On a more positive note, the FT reported on encouraging results from the experimental vaccine being developed by Oxford University and AstraZeneca.  According to FT, early results had shown “robust immune responses” amongst older people, which is considered crucial given the vulnerability of this section of the population.  The US regulator gave Oxford University and AstraZeneca the green light to resume phase three trials on Friday (trials had previously been paused after a participant experienced an unexplained complication).

FX market moves have been reasonably contained compared to those in equity and bond markets.  The USD has experienced a broad-based, albeit relatively modest, appreciation to start the week.  The Bloomberg DXY index is up 0.35%, having closed at its lowest level in 2½ years on Friday night.  The USD typically appreciates during periods of heightened risk aversion.

The NZD has drifted slightly lower this week amidst the risk-off backdrop, falling 0.2% to around 0.6675.  The NZD was the second-best performing G-10 currency last week, gaining 1.35%.  In other currencies, the AUD and EUR have fallen 0.3% and 0.4% respectively so far this week, while the JPY is off 0.15%.

The NZD/AUD cross continues to tick up ahead of the RBA Board meeting next Tuesday, where it is expected to announce a 15bp rate cut to the cash rate, 3-year yield target and term lending facility (all to 0.1%) and a QE programme in 5-to-10 year bonds.  The cross traded around 0.94 overnight for the first time since July.  Our NAB colleagues look for a QE programme in the region of A$140b.  Their assessment is that the market is already pricing a programme between $150-200b and thus see the market as vulnerable to disappointment if the RBA initially launches a more conservative QE program (which would likely translate into some retracement in the NZD/AUD cross).  News that the state of Victoria has announced a more comprehensive re-opening from 11:59pm tonight is good news for the Australian economy but has had little impact on markets.

There was little market reaction to NZ CPI release on Friday.  CPI rose 0.7% in Q3 (+1.4% y/y), undershooting both market (+1.7% y/y) and RBNZ expectations (+1.8% y/y).  The RBNZ is focused on the medium-term outlook for inflation and employment, and the downside risks it sees to these, but the lower-than-expected CPI reading plays to the view that the RBNZ will add more stimulus.   The RBNZ has signalled it will ease policy later this year by introducing a Funding for Lending Programme (FLP) – a long-term term lending facility for NZ banks at concessionary rates – and we still expect it will follow this up with a negative OCR next year.  Market pricing for the OCR next year continues to oscillate between -0.2% and -0.25%.

In offshore economic data, the only notable release overnight has been the German IFO business survey, which was close to market expectations and down a touch from last month’s level.  This followed the ‘flash’ European PMIs on Friday night which showed a further recovery in manufacturing but softness in the services sector, with the latter having been hit much harder by the second wave of COVID-19 in the region.  Of note, the German manufacturing PMI hit 58.0 in October, its highest reading since April 2018, buoyed by China’s post-pandemic economic recovery and related demand for German exports.

We should see flattening pressure on the NZ rates curve this morning with 10-year US Treasury and Australian government bond yields having moved 5-6bps lower since the Friday afternoon close in NZ.  The NZ 2s10s swap curve reached its steepest level since the start of September on Friday, at 53bps, while the 10-year NZ government bond yield made a one-month high, at 0.6%.  The RBNZ said on Friday it would keep its bond buying unchanged for this week, at $900m, after tapering the previous four weeks.

There is little on the agenda in the day ahead, with markets likely to remain focused on the upcoming US election and resurgence in COVID-19 in the US and Europe.