Equities increase further on vaccine optimism, global rates tick higher. NZD flat on Friday, but up more than 1% last week. Brexit in focus this week as talks reach crunch time

Markets traded with a positive tone on Friday, with equities increasing further and global rates edging higher.  The Russell 2000 small cap index made a new all-time high, with investors looking past the surge in COVID-19 cases in the US and instead focusing on the potential for economies to reopen next year as a vaccine(s) becomes available.  The NZD rose more than 1% last week, the top-performing G10 currency, as the market priced-out negative rates for the RBNZ.

Optimism around Pfizer’s COVID-19 vaccine, which was found to be more than 90% effective, was the key driver of markets last week.  Investors can finally see light at the end of the tunnel, where economies reopen more broadly at some point next year.  The S&P500 increased 1.4% on Friday, taking it to a new all-time high on a closing basis.  Investors poured a huge $44.5b into equity funds in the week ended Wednesday according to EPFR data, the largest inflow in more than 20 years and symptomatic of positive market sentiment.

Small cap stocks and those that have been most affected by social distancing restrictions, such as airlines, continue to outperform.  The Russell 2000 small cap index rose 2.1% on Friday, with the index finally breaking above its previous record high set in August 2018.   The sectoral performance of the S&P500 last week paints a similar picture, with energy (+16%), financials (+8%) and industrials (+5%) leading the way while the IT and consumer discretionary (heavily weighted to Amazon) sectors fell.  The sectoral moves last week are almost the mirror image of those seen year-to-date which had, up to last week, shown huge outperformance from tech firms which had benefited from the stay-at-home environment.  The NASDAQ managed a 1% rise on Friday but was still down 0.5% over the course of the week.

For now, optimism around a vaccine is trumping growing concern around the acceleration in COVID-19 cases in the US, which saw almost 180,000 new cases on Friday, a new record.  Numerous states have announced new restrictions in recent days, targeting restaurants and bars, gyms and limiting gatherings of people.  The city of Chicago announced a 30-day stay-at-home advisory to residents on Friday.  Interestingly, two recently appointed COVID-19 advisors to Biden said they didn’t favour a full US national lockdown, preferring targeted measures instead.

In Europe, the growth in new cases looks like it may have peaked, but only because most countries have implemented targeted lockdowns.  Over the weekend, Austria announced a stricter lockdown, closing schools and mandating working-from-home for all but essential businesses for at least 2½ weeks.

In politics, Trump’s campaign team has suffered several legal defeats in its attempt to contest the election result.  Trump appeared to acknowledge in a tweet over the weekend that he lost the election, although he hasn’t yet officially conceded.  The market safely assumes that Biden will become President early next year, with more interest in the upcoming Senate run-offs in Georgia on January 5th, which will determine which party gets control of the Senate.

Global rates ticked higher on Friday’s session, with the 10-year US Treasury yield bouncing 2bps higher, to 0.9%.  It had reached an eight-month high of 0.98% earlier in the week in the wake of Pfizer’s vaccine announcement.  Like equity markets, the bond market is starting to incorporate a more positive medium-term growth outlook.  The Georgia Senate run-offs are key for the bond market, because if the Democrats defy the odds and win both, they would gain control of the Senate, allowing the party to unleash another big fiscal stimulus.

In currencies, the USD came under renewed downward pressure from the risk-on backdrop.  The BBDXY index fell 0.35% on Friday, cutting its gain on the week to 0.4%.  The USD remains just 0.5% above its recent 2½ year low.  We expect further USD weakness next year.

The GBP was the top-performing G10 currency on Friday, rising 0.5% to around 1.3190.  UK PM Johnson reportedly sacked his key advisor Dominic Cummings, one of the architects of Brexit, on Friday.  The market took the news positively, interpreting the move as clearing the way for Johnson to compromise on a trade deal with the EU, despite a UK government spokesperson refuted the suggestion.   Crunch talks take place this week, with the two sides working towards a 19th November deadline, the date of the upcoming EU Summit, although this deadline may slip to the 23rd according to media reports.

The NZD was broadly flat on Friday, ending the week just below 0.6850.  The NZD was the top-performing currency last week, gaining over 1%, after the market priced-out negative rates from the RBNZ after the November MPS.  The NZD/AUD cross slipped 0.4% to 0.9420, a day after reaching a seven-month high of 0.9480.  There was no market reaction to Thursday’s revelation that there had been an unexplained community COVID-19 case discovered in Auckland, nor Friday’s announcement from the government that the case had been traced back to an existing case and so the country would remain at Alert Level 1.

NZ rates consolidated on Friday after the big moves from earlier in the week.  The 2-year and 10-year swap rates fell 1bp, to 0.19% and 0.8% respectively.  The 2-year rate rose 15bps last week, as the market priced-out negative rates for next year, while the 10-year rate rose 25bps, with upward pressure on global rates after the Pfizer vaccine news adding further upward pressure to the long-end.

There wasn’t much economic data to speak about on Friday.  The University of Michigan consumer confidence survey fell almost 5pts, to 77, well below economists’ expectations.  The decline in consumer confidence may reflect the resurgence in COVID-19 in the US as well as disappointment among Republican voters around the election result.  In NZ, the Manufacturing PMI fell back in October, although it remains in expansionary territory and the employment index posted its strongest reading since April 2018.

Markets will be watching vaccine news closely this week with Moderna expected to report Phase 3 results imminently and Pfizer/BioNTech potentially applying for an emergency use declaration by the end of the week.  Hopes are high that Moderna will announce favourable results given it had developed its vaccine using similar technology to Pfizer.  Chinese activity data is released this afternoon, with the market likely to focus on retail sales activity.  In the US, the highlight is the October Retail Sales report, which is expected to reveal further 0.5% growth after last month’s very strong 1.9% jump. There’s only second-tier data released in NZ this week.