After two straight down days, equity markets have rebounded overnight, with the market still seemingly in ‘buy the dip’ mode. There has been little change in global rates and the USD. The big outperformer overnight has been the CAD, after the Bank of Canada tapered its bond buying and said it expected the conditions for rate hikes would be met in H2 2022. The CAD is up almost 1%, dragging the NZD and AUD higher. There was no market reaction to the NZ CPI data yesterday which came right in-line with expectations.
Market sentiment appears to have perked up a bit over the past 24 hours, although without any obvious drivers. The S&P500 is up around 0.6% and the NASDAQ 0.7% while small cap stocks have outperformed, with the Russell 2000 index 2% higher. Netflix’s disappointing earnings report, particularly its subscriber numbers, hasn’t had much impact on the broader tech sector, although its own share price is down some 7% overnight. In general, earnings results have been overwhelmingly positive, with the more than 70 S&P500 companies to have reported so far having beaten analyst expectations by more than 20% on average.
Covid-19 cases remain very high in some countries, notably India, but the market remains optimistic that the vaccination rollout is making progress in major advanced economies, clearing the pathway for the removal of restrictions over the coming months. In France, the government confirmed it was planning to lift its nationwide travel ban in early May, with schools reopening in the coming weeks and bars and restaurants allowed to open for outdoor dining from mid next month. In contrast, the German government passed a new law allowing it to override regional governments and put in place social distancing restrictions in those areas where cases are running high.
At its monetary policy meeting overnight, the Bank of Canada announced it would taper its bond buying, from $4b/week to $3b/week. The tapering announcement was in-line with expectations and reflected “progress made in the economic recovery” . But what caught the market’s attention was the BoC’s statement that it expected the conditions for raising its cash rate, namely that the economy has fully recovered and inflation is sustainably at 2%, would be met in the second half of 2022, earlier than previous forecasts. (Those conditions will sound familiar to RBNZ watchers). The market, which was already pricing the BoC to start raising its cash rate in 2022, modestly bumped up its rate hike expectations in response. The market now prices an almost 50% chance the BoC will raise its cash rate this time next year. The increase in Canadian yields was led by the 5-year point (+3bps), with the yield curve flattening beyond that. The CAD has appreciated almost 1% overnight and is trading close to its highest level since early 2018.
Outside of Canada, there has been little movement in global rates. The US 10-year rate is trading at around 1.57% currently, close to yesterday’s close, while European rates were little moved ahead of the ECB meeting tonight.
Like global rates, movements in the major currencies (the EUR, JPY and GBP) have been small overnight. The EUR briefly dipped below 1.20, but it has since recovered to 1.2030, unchanged on the day. There was little reaction to news that Germany’s Constitutional Court had made a summary judgement that allows the German government to participate in the €750b European recovery fund. The USD is down marginally overnight, in index terms, mainly reflecting the appreciation in the CAD.
The strength in the CAD has spilled over into the NZD and AUD, which have increased 0.5% and 0.3% respectively overnight. The NZD was trading around 0.7180 prior to the BoC meeting but it has now pushed up to 0.7210.
NZ CPI was right in-line with market (and our) expectations, with headline inflation increasing 0.8% in Q1 and 1.5% on a year ago. In terms of core inflation, CPI ex food and energy fell to 2%, from 2.1%, while the RBNZ’s Sectoral Factor Model of core inflation increased to 1.9%, from 1.8%, its highest level since 2010. Unlike most other countries, like Australia for example, core inflation is already reasonably close to the RBNZ’s 2% target (as it was before the Covid crisis hit). We continue to think headline inflation will push up towards the top of the RBNZ’s 1-3% target range in the coming quarters, in part due to favourable base effects. The RBNZ has pledged to look through temporary factors so it is unlikely to be phased, unless inflation expectations and core inflation start drifting above the 2 target.
Market reaction to the data was minimal. The market continues to price around a 50% chance of a 25bp OCR hike by mid-2022 and a full hike by the end of the year. NZ swap rates were lower on the day, with the 10-year rate down 4bps, to 1.79%, but this reflected global moves from the overnight session. Rates in NZ, like those overseas, appear to have entered a consolidation phase after a sharp run-up earlier in the year.
Long-term government bonds outperformed swaps yesterday with the RBNZ finding it increasingly hard to source long-term bonds in its QE operations at present. The RBNZ’s buyback of $30m 2033 maturity bonds met with only $40m of offers and cleared some 5bps below secondary market yields at the time. The lack of selling interest in long-term government bonds comes ahead of what will be some large duration extensions for the domestic bond indices in the coming weeks (which would typically lead to bond buying from fund managers). Given the apparent lack of selling interest at present, we suspect the RBNZ will reduce its bond buying pace again next week.
The ECB meeting will hog market attention in the session ahead. The central bank is expected to keep all its policy settings unchanged with a decision on the pace of asset purchases likely to be deferred until the June meeting, when its economic projections are updated. The ECB announced a ‘frontloading’ of its asset purchases in March and is expected to pare this back at some point.