The key market development since we last wrote this report was the Democrats’ unexpectedly victories in the two Senate run-off races in the state of Georgia. The results give the Democrats 50 out of the 100 seats and, with VP-elect Kamala Harris having the casting vote, overall control of the Senate, albeit with a wafer-thin majority. The Democrats’ control of both the House and Senate gives President-elect Biden greater ability to pursue his policy agenda, including more fiscal stimulus.
On Friday, Biden outlined his plans for a huge $1.9 trillion stimulus (~9%/GDP), comprising another round of cheques for households ($1,400 for most Americans), $400 per week in additional unemployment benefits through September, and greater funding for state and local governments, health care and education. Biden is seeking the support of some Republicans in the Senate to push through the stimulus (60 votes are needed to avoid the filibuster), so the proposal might yet get watered down during negotiations. Biden is expected to outline his plans for a second fiscal stimulus, focused on longer-term issues such as infrastructure and climate change, next month.
The Georgia Senate results have had a material impact on the rates market, given the read-across to growth and inflation as well as bond supply. The US 10-year Treasury yield broke above the psychologically important 1% level in early January and is now trading just below 1.1%, around 15bps higher than it was around Christmas. The US 2y10y yield curve reached its steepest level since mid-2017, above 100bps, although it has retraced some of that move over the past few days. Market-based inflation expectations have also continued to increase, with the US 10-year ‘breakeven inflation’ rate rising above 2% for the first time since 2018. The increase in inflation expectations means that US real yields have barely moved higher (the US 10-year real yield is still below -1%). This goes some way to explaining the continued strength in equity markets and downward pressure on the USD despite the back-up in nominal yields. Yields have moved higher, but by much less, in other major markets such as Europe and the UK.
Late last week, Chair Powell pushed back against the notion that the Fed might taper its QE bond buying any time soon. He added that rate rises will happen “no time soon.” But the market narrative has subtlety changed from one in which investors were asking whether the Fed would increase its QE purchases or buy more longer-dated bonds in December to now one in which investors are starting to ask whether tapering is possible this year.
It’s been a good start to the year for equity markets, albeit with some reversal late last week. The three main US benchmarks are up 0.3%-1% year-to-date with larger rises seen elsewhere (especially in emerging markets). Small cap and cyclical stocks continue to outperform (Russell 2000 small-cap index +7.5% YTD) on expectations that widespread vaccination and fiscal stimulus will boost the economy. US earnings season started last week, with JPM, Citi and Wells Fargo reporting on Friday. The three banks released a combined $5b in loan loss reserves, a sign that they think loan losses will be less severe than previously anticipated, although their share prices still fell on Friday.
Currency movements have been relatively modest in comparison to bonds. The USD has strengthened modestly this year (BBDXY +0.5%, DXY +0.9%) albeit from what was an almost three-year low. Commodity and global growth-sensitive currencies have generally outperformed, with the NOK, AUD and CAD essentially unchanged against the USD this year. The NZD has been the laggard in the commodity currency space, falling 0.7% year-to-date. The EUR is down 1.1% this year, but remains above 1.20, while the JPY has fallen 0.6%.
The NZD is trading around 0.7130, having reached a high of 0.7315 early in the New Year. We remain bullish the NZD predicated on continued weakness in the USD and broad strength in commodity prices, amidst expectations for a broadly-based global economic recovery in 2021. Our year-end target is 0.76 although, as we pointed out in early December, a path to 0.80 is not particularly onerous.
The NZ curve has continued to steepen, consistent with the increase in longer-term US and Australian rates since Christmas. The NZ 10-year swap rate is now trading at 1.1%, while the 2-year swap rate has barely moved, as the market still sees the RBNZ keeping the OCR on-hold for the foreseeable future. The RBNZ announced on Friday that it would buy $650m of government bonds this week, down from $800m the last time it bought bonds in December. The tapering is a technical adjustment to the lower pace of bond tender issuance this month (which was also lowered by $150m) and had no impact on rates on Friday (government bond yields fell by up to 4bps).
Recent economic data has been generally weaker. The non-farm payrolls report showed the US lost 140k jobs in December while jobless claims moved higher last week, a sign that recent Covid-related restrictions are starting to impact the labour market. Meanwhile, US retail sales data on Friday was much weaker than expected which will likely trigger downgrades to economists’ US Q4 GDP estimates. In contrast, the US ISM manufacturing index reached 60.7, close to its highest level since 2004, while the ISM services index is also at a robust level. So far, the market has been content to brush off weaker economic data because it assumes that widespread vaccination and more US fiscal stimulus will support growth ahead. There hasn’t been much released in NZ, except for data indicating the housing market remains very strong.
In terms of the week ahead, the QSBO business survey is released tomorrow while NZ CPI is out on Friday (we look for annual headline inflation to fall to 1%, from 1.4%, but we will be keeping a close eye on the core inflation measures). Offshore, highlights include Chinese GDP (with annual growth expected to bounce back above 6%), the European PMIs and the Australian employment report. Biden is inaugurated on Wednesday (the 20th). Today is a public holiday in the US (Martin Luther King Jr Day) so trading activity is likely to be subdued over the next 24 hours.