It was a ‘risk-on’ trading session on Friday night, with equities and bond yields higher and the USD broadly weaker. The NZD was back at 0.70 by the end of the week. The RBNZ announced a reduction to its QE bond buying pace on Friday, which drove an increase in NZ government bond yields.
Equity markets ended last week on a positive note, with solid gains across both US and European indices. The S&P500 was up 1.7%, with broad-based gains across sectors, but led by cyclicals (such as Energy and Materials). Most of the day’s performance came in the last hour of trading and left the S&P500 at a new all-time high on a closing basis. Global bond yields also moved higher on Friday, with the US 10-year yield increasing 4bps, to 1.67%, and European government bond yields up 3-4bps.
There weren’t any major new developments to explain the price action, but market sentiment remains buoyant on expectations that the global economy will experience a very strong recovery this year. Commentators have pointed to the impressive vaccination drive in the US (President Biden this week increased his target to 200m Americans being vaccinated in his first 100 days of office) as supportive of ‘reflation trade’ narrative. More fiscal support is anticipated, with the WSJ reporting that Biden will outline his plans for a big infrastructure package this week. And despite the stumbling vaccine roll-out in Europe and concern around a ‘third wave’ of Covid-19 in the region, European economic data has proved stronger than expected. On Friday, the German IFO business survey increased to its highest level since mid-2018, with the manufacturing sector leading the way.
Market-based inflation expectations continue to grind steadily higher, supportive of higher long-term yields. The US 10-year ‘breakeven inflation’ rate increased 4bps on Friday, to 2.36%, its highest level in almost eight years. Inflation is low at present, with data on Friday showing the Fed’s preferred core PCE measure of inflation was just 1.4% higher than a year ago. But the market perceives growing inflation risks ahead on the back of what is expected to be a turbocharged economic expansion, once Covid-related restrictions are removed. Inflation pressures are coming from other angles too, with the continued disruption to the Suez Canal expected to lead to greater freight costs and likely to exacerbate supply-chain issues. 5-10 year inflation expectations from the University of Michigan’s consumer sentiment survey have picked up to 2.8%, their highest level since 2015.
The USD was broadly weaker amidst the risk-on market backdrop. The BBDXY index was down 0.2% on Friday, trimming its gain on the week to 0.7%. Even with the pullback on Friday, the BBDXY remains close to its year-to-date highs. Speculative investors continued to reduce their net short position in USDs last week according to CFTC data.
Commodity currencies outperformed on Friday. The NOK was up 0.9% (helped by a 4% gain in Brent crude oil), making it the top performing G10 currency, while the AUD and NZD were up around 0.75%. The NZD, which had briefly traded below 0.6950 on Friday morning, ended the week back at 0.70. Still, the NZD was the standout underperformer last week, down 2.3%, as the market pared back OCR rate hike expectations in response to the government’s new policy measures to clamp down on property investors.
The EUR was up a more modest 0.3% and closed just below 1.18. Safe haven currencies underperformed, with the JPY falling 0.4%. USD/JPY is approaching the psychologically important 110 level which hasn’t been seen since March.
Turning to local developments, it was a volatile session in the New Zealand government bond market on Friday. It started at around 10am, when the RBNZ announced a change to its scheduled bond buying operation that morning, reducing the target purchase amount from $200m to $140m. This was the first time the RBNZ had amended a purchase operation at short notice like this and it caught the market by surprise. Government bond yields increased by as much as 8bps in the morning even while swap rates were barely changed.
At its 2pm announcement, the RBNZ formally announced a $200m reduction to its pace of bond buying for this week, from $630m to $430m. The $200m reduction to QE, which is greater than the $150m decline in issuance this week, is perhaps a recognition from the RBNZ that its buying had started to overwhelm the market. The RBNZ will still be buying more than bond issuance this week ($420m QE vs. $300m issuance of nominal bonds) but, in terms of duration (i.e. interest rate risk), the two sides are now quite closely matched.
By the end of the day, the 10-year government bond yield was 5bps higher, at 1.63%, while the 10-year swap rate was 4bps lower, at 1.77%. Both government bond yields and swap rates were significantly lower on the week, mainly due to the government’s announcement on housing.
It’s a busy week ahead for economic data overseas. Nonfarm payrolls is released on Friday and the market is looking for a ~650k gain in employment in March and a 0.2% fall in the unemployment rate, to 6%. The ISM manufacturing survey, which is close to its highest level since the mid-1980s, is the other highlight in the US. The Chinese PMIs are also released this week. Domestically, the final release of the ANZ Business Survey comes out on Wednesday. The preliminary version of the survey showed a pullback in confidence and own activity expectations but record high pricing intentions.