UK and EU agree to keep Brexit talks going amidst reports of compromise. Subdued moves in other asset markets on Friday. RBNZ pushes back on suggestion house prices be included in monetary policy remit

Market moves were subdued on Friday.  Equity markets and bond yields ended slightly lower while, in currencies, the USD and JPY outperformed.  The NZD made a new post-2018 high on Friday, before retreating.  Over the weekend, the EU and UK have agreed to extend trade talks (again), which may raise hopes that a no-deal Brexit can be averted.

Brexit is back in focus for the market.  Friday’s trading session was dominated by gloomy assessments of the state of negotiations, with investors starting to seriously contemplate a no-deal scenario.  On Friday night, European Commission President von der Leyen told European leaders that a no-deal Brexit was the “higher probability” scenario while UK PM Johnson later warned that a no-deal exit was “very, very likely.”  The GBP fell by as much as 1.2% before paring about half that loss.  The GBP was the clear underperformer last week, losing 1.6% (the second-worst performer, the Norwegian krone, was down 0.2%).

Sunday was supposed to be the make or break deadline where Johnson and von der Leyen decided whether or not a deal could be reached.  But, not for the first time, the outcome from that call has been that the two sides have agreed to keep talking.  Johnson later cautioned that the “most likely” scenario was still a no-deal outcome.  But UK media have taken a more optimistic interpretation amidst reports that compromises had been made on the longstanding issue of “level playing field” conditions.  The Telegraph quoted EU sources as claiming that “genuine progress” had been made in weekend negotiations.  The GBP should open higher this morning, although a deal is by no means certain yet.

There was some limited spill-over from Brexit concerns on Friday to other key asset markets.  After the EC’s von der Leyen was reported as saying a no deal scenario was more likely, S&P500 futures dipped as much as 1.2% while the US 10-year Treasury yield fell from 0.91% to 0.88%.  European equity markets mostly fell between 1% to 1.5%.  But the risk-off moves faded as the session wore on, with the S&P500 eventually closing only 0.1% lower on Friday and the 10-year Treasury yield ending 1bp lower, at 0.9%.

The other key market focus as present is US fiscal stimulus negotiations.  Negotiations between Democrats and Republicans are still stuck on the issues of state and local government funding (a key Democrat demand) and liability protection for employers (a key Republican demand).  If the ~$900b fiscal stimulus can be agreed, it will be attached to a full-year spending bill, which needs to pass by Friday to avert a government shutdown.

In other news, the US FDA formally approved emergency use authorisation for Pfizer and BioNtech’s Covid-19 vaccine over the weekend.  Distribution of the vaccine is expected to start today in the US (it has already commenced in the UK), with the head of the Operation Warp Speed unit saying over the weekend he hoped 75% to 80% of the US population could be vaccinated by June.  Moderna is expected to receive emergency use authorisation for its Covid-19 vaccine by Friday.  The vaccine can’t come soon enough, with Germany over the weekend announcing a ‘hard’ lockdown.  In Germany, the government announced schools will close, most shops will shut and gatherings will be restricted to no more than five people between December 20 and January 10.

In economic data, the University of Michigan consumer confidence index bounced back in December, possibly due to recent vaccine-fuelled gains in the stock market, although it remains well below its levels from earlier in the year.

Currency moves were reasonably muted on Friday.  The EUR traded above 1.2160 early in the London morning before falling back to 1.2110 (-0.2% on the day), in sympathy with the weakness in the GBP.  The EUR remains close to its highest level since April 2018.  Likewise, the AUD made a new post-2018 high during Asian trading, above 0.7570, although it later gave back those gains to close unchanged on Friday.  The JPY outperformed amidst the softer tone to equities and US Treasury yields, rising 0.2%.  The Bloomberg USD index was up 0.25% on Friday although it continues to hover around 2½ year lows.

Like the AUD, the NZD made a new post-2018 high on Friday afternoon, above 0.71, before turning lower in London hours (-0.2% on the day).  Despite the moves on Friday, the NZD was still the second-best performing G10 currency on the week, gaining 0.5%.  The AUD was the top performer last week, rising over 1.5%, buoyed by surging commodity prices (especially iron ore).  The NZD/AUD cross made a one-month low on Friday and ended the week around the 0.94 mark.

The RBNZ released its detailed response to the Minister of Finance on Friday on whether house prices should be included as a formal consideration in setting monetary policy.  The RBNZ said changing the monetary policy Remit, as per Finance Minister Robertson’s suggestion, was not its preferred option.  In the response, the RBNZ noted, amongst other things, that it could make the goal of monetary policy confusing and that, in any case, it would be unlikely to result in significant monetary policy changes, because the MPC’s primary objectives of stable inflation and maximum sustainable employment would be unchanged.  Instead, the RBNZ suggested that house prices be included as a consideration in setting financial stability policy and specifically requested the government consider allowing it to implement debt-to-income rules.

There wasn’t much market reaction to the RBNZ paper, which largely fleshed out Governor Orr’s initial response to the Finance Minister in more detail.  The NZ 2-year swap rate was unchanged on Friday and barely moved at all last week, with the market starting to settle into holiday mode.  The 10-year swap rate fell 1bp, to 0.91%, responding to global forces.

In domestic data, the Manufacturing PMI bounced from 52.5 to 55.3 in November, above its long-term average of 53.  There were strong gains in the key new orders (57.6) and production (55.4) indices while employment fell back to 51.5 (albeit still in expansionary territory).

While Christmas is fast approaching, it’s still a big week ahead with key domestic and offshore events looming.  Domestically, Q3 GDP is released on Thursday and we are looking for an above-consensus 14% increase over the quarter (consensus +12.8%, RBNZ +13.4%).  The government’s Half-Year Economic and Fiscal Update (HYEFU) is on Wednesday and we expect it will be accompanied by a further reduction to the bond programme.  The Services PMI (PSI), final release of the ANZ business survey for December, and consumer confidence are also released.

Offshore, markets will remain focused on Brexit and US fiscal stimulus negotiations.  The Bank of England meeting on Thursday night will be closely watched for policy guidance, given the uncertainty surrounding Brexit.  The Fed meeting takes place on Thursday morning amidst speculation that it could tilt more of its bond purchases towards the longer-end of the curve, in an effort to keep a lid on long-term interest rates.  The market also expects the Fed to set out the conditions for how long it will continue to buy bonds.