Market moves subdued on Friday. Fed ends temporary capital exemption for US Treasury bonds - US 10-year ends week at 1.72%. Turkey central bank Governor fired after only three months - could lead to more emerging market volatility

After a hectic week, market moves were more subdued on Friday.  The S&P500 was flat, the US 10-year yield continued to hold just below 1.75% and currencies were range-bound.

The main news from Friday was the Fed’s announcement of an end to the temporary exemption for US Treasury bonds, under the so-called Supplementary Leverage Ratio (SLR), on March 31st.  The exemption was put in place during the crisis last year and, in effect, reduced banks’ capital requirements for holding Treasury bonds (as well as cash balances at the Fed).  Some market participants believe the ending of the exemption might dampen banks’ demand for Treasuries going forward and could exacerbate volatility.

The US 10-year yield shot up from around 1.7% to 1.75% after the announcement was made, before settling back at 1.72% (near where it closed the previous session).  The Fed said that, while it was ending the temporary exemption, it would consult with banks and market participants on a longer-term solution.  All the major banks are compliant with the rules even without the exemption in place, but the Treasury market, and banks’ cash balances at the Fed, are expected to significantly increase this year.

After their heavy falls on Thursday, on the back of a big rise in bond yields, equity markets steadied on Friday night.  The S&P500 was broadly unchanged, although banks were notable underperformers (KBW banks index -1.7%) after the Fed announcement on the SLR.  The S&P500 remains less than 2% below its all-time high.  There was some relief for recently battered tech stocks, with the NASDAQ gaining 0.8% (partially recovering from its 3% decline the previous session).

The market seemed to largely brush off news that more European countries were considering tighter lockdown restrictions amidst a renewed pick-up in Covid-19 cases in the region.  Germany’s Chancellor Merkel said it was likely the country would need to apply the “emergency brake”, re-imposing tighter lockdown rules, rather than easing restrictions in April as previously planned.  Italy imposed a tighter lockdown last weekend while Paris entered a month-long lockdown on Friday night.  The stuttering vaccine rollout in Europe means it will be slower to exit lockdown conditions and its economic recovery will lag countries like the UK and US, which are more advanced in vaccine distribution.  European equity markets were down around 1% on Friday while 10-year bond yields were around 3bps lower.

Currency moves were muted on Friday night.  The USD saw broad-based, albeit modest, gains.  The EUR closed the week around the 1.19 mark while USD/JPY finished just below 109, near its highest level in 9 months.  The BoJ’s monetary policy review (see more below) had little market impact, with the central bank announcing only incremental changes to its framework, most of which were reported the previous day by the Nikkei newspaper.  The NZD was little changed on Friday night, closing the week at around 0.7165.  The NZD has remained contained within a relatively tight 0.71 to 0.73 range for most of this year.

There were no ground-breaking changes from the Bank of Japan’s review of its monetary policy framework.  The BoJ clarified that it would set a range of +/-25bps around its 10-year yield target of 0%, a marginal increase from the current 20bp range.  In effect the BoJ will tolerate the 10-year yield rising to 0.25% (it was little changed at 0.11% after the announcement).  The BoJ said it would now only buy equities when the market experienced instability, rather than its current policy of buying at a steady pace through all market conditions.  The Nikkei fell 1.4% after the BoJ said that it would only buy the broader Topix equity index going forward.  Finally, the BoJ unveiled a new concessionary loan facility in an effort to try convince market participants that it can cut its cash rate more negative.  The upshot is that, short of extreme options, the BoJ is reaching the limits of its monetary policy toolkit, which the market already knew.

Two days after the FOMC meeting, Fed Chair Powell released a WSJ op-ed, reiterating a number of messages from the Fed statement.  The dovish punchline was “but the recovery is far from complete, so at the Fed we will continue to provide the economy with the support that it needs for as long as it takes”, but there wasn’t much market reaction.

Elsewhere, Turkey’s President Erdogan fired the central bank Governor just three months into his term and days after he raised interest rates by more than expected.  Emerging market currencies have started to come under pressure recently, as the USD has strengthened and US bond yields have climbed, which can precipitate capital outflows from emerging markets.  Erdogan’s intervention will see a big fall in the lira when trading opens tonight, which could cascade into other emerging market currencies and potentially broader risk appetite.

Yield curve steepening was the main feature of the domestic rates market on Friday, reflecting the big offshore bond market selloff the preceding night.  The 10-year swap rate increased 3bps, to almost 2%, while the 2-year swap rate edged down to 0.52%.  The yield curve between the 2 and 10-year wholesale rates is close to its steepest level since 2013, at almost 150bps.  The RBNZ announced that it would keep its bond buying for this week at $630m, unchanged from the previous two weeks but up on the $550m/week pace before that.

There are few major events for the market to get excited about in the week ahead.  The highlights include Fed Chair Powell and Treasury Secretary Yellen’s joint appearances in front of the House and Senate on Tuesday and Wednesday evenings.  The European flash PMIs are the highlight in an otherwise quiet week for economic data.  There is only second-tier data in NZ, but the government is due to announce a package of measures aimed at combating speculation in the housing market.  We also await an announcement on the proposed Trans-Tasman ‘bubble’, which media have reported could potentially be up and running in April.