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Global reflation trade the predominant force, drives US equities higher, supported by a dovish Fed. UST10s stretch to 1.43% before wave of buying ensues. NZ rates push higher and add risk to tightening cycle beginning next year

Global reflation trade the predominant force, drives US equities higher, supported by a dovish Fed. UST10s stretch to 1.43% before wave of buying ensues. NZ rates push higher and add risk to tightening cycle beginning next year

The global reflation trade continues with the US 10-year yield up to a fresh high of 1.43% overnight, before falling back down. US equities were initially perturbed by that move, but have since pushed higher, with Fed Chair Powell again in the background doing his best to sound dovish. The NZD has made further post-MPS gains, hitting the 0.74 mark, while other commodity currencies have also outperformed.

The bounce-back in US equities seen yesterday after Fed Chair Powell reiterated his overtly dovish stance has gained further legs overnight. Powell is at it again, with a second day of questioning in front of lawmakers. Some of the headlines that got our attention were Powell suggesting it “could take more than three years to hit the 2% average inflation target” and “asset prices are somewhat elevated”. While none of this is new, like yesterday, it is another friendly reminder that the Fed will be slow to remove monetary stimulus, helping stoke up real asset prices further.

On cue, commodity prices have been driven up further, with copper now at its highest level in a decade. Oil prices are up more than 2%, with Brent crude taking a look above USD67 per barrel and WTI through USD63, despite the EIA reporting inventories of crude up 1.29m barrels last week. There’s a story on Bloomberg titled “Whispers of $100 oil return as crude shakes off COVID’s clasp”, which outlines the bullish case for oil.

The S&P500 is currently up 0.9%, gaining ground after a soft open after investors initially seemed concerned that the US 10-year Treasury yield had extended to a fresh high of 1.43%. However, there were reports of that level of yield attracting real money investors, and a swift fall in the rate back down to 1.37% saw equities gain ground. Further supporting sentiment, the FDA reported that J&J’s single-dose COVID19 vaccine was 66% effective and appeared safe, paving the way for its approval as early as this weekend. The vaccine also appeared effective against the worrisome South African strain of the virus.

The tailwind of the global reflation trade sees commodity currencies continuing to lead the way. The NZD is up 1% from this time yesterday, cracking the 0.74 mark within the last hour or so. It was always going to be tough for the RBNZ to hold back a post-MPS rise in the NZD, despite the Bank’s valiant effort to sound dovish.

The RBNZ kept all its policy settings unchanged and delivered the widely expected dovish missive along the lines of other central banks. While acknowledging a number of positive developments since its November update, the Bank claimed that the outlook remains highly uncertain. The MPC agreed to maintain the current stimulatory monetary settings until it was confident that CPI inflation will be sustained at 2% and that employment is at or above its maximum sustainable level, something that “will necessitate considerable time and patience”. 

That said, underlying the Bank’s projections was a clear sense that the easing cycle was over, with the Bank admitting that the recent resilience in the domestic economy implies that no significant additional stimulus is required. The Bank’s projected “unconstrained” OCR troughed in the September 2021 quarter, with the model projecting higher rates thereafter, with about 15bps of tightening by Q1 next year, not inconsistent with the market’s thinking that tighter policy looks appropriate from early next year.

The Bank displayed no disdain for the value of the NZD, simply noting the strength of the TWI provided some offset to higher global commodity prices for NZ exporters, and noting that many of the export-oriented firms the Bank had spoken to have still benefited significantly – a welcome change from the sort of messaging we used to hear before Governor Orr took the helm, with prior Governors ready to talk down the NZD at the first whiff of any upswing. 

The market took the occasion to price in a little bit more tightening risk from early next year onwards. About 9bps of tightening is now priced into the curve from February 2022, with almost a full 25bps hike priced by August 2022. The 2-year swap rate closed the day up 3bps to 0.42% while the 10-year rate rose by 10bps to 1.81%. The 10-year NZGB yield rose by 6bps to 1.69%, the heavy Australian market a contributing factor alongside the upward pressure from monetary policy considerations. Since the NZ close the implied yield on the Australian 10-year bond future has risen by some 6bps, setting the scene for higher NZ rates on the open.

As we go to print, positive NZD momentum continues, with 0.7410 the high so far, a fresh three-year high. During 2016 to early 2018, the 0.74-0.7550 mark proved to be a key resistance zone, but ultimately we think it can break higher in time. As we’ve previously noted, the path to USD0.80 isn’t particularly onerous, and we could already justify that sort of level given the strength of NZ’s terms of trade.

The NZD is higher on all the key crosses, with NZD/AUD up to 0.9325, recovering the loss seen over the past couple of weeks. The AUD itself is slightly higher, near 0.7940 but just short of the three-year high of 0.7945 posted yesterday afternoon.

Soon after the RBNZ MPS there was a short squeeze on GBP which saw it spike up to 1.4237. The liquidity vacuum has since been filled and the currency has settled down towards 1.41. EUR has largely tracked sideways around 1.2150. The risk-on backdrop sees JPY the weakest of the majors and NZD/JPY up through 78.4, its highest level in over two years.

Today, the updated ANZ NZ business outlook survey for February is released, with the preliminary survey showing a sharp increase in selling price intentions.  The key releases tonight are US durable goods orders and jobless claims.

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