Market sentiment recovers from the tapering talk in the Fed minutes. Equities bounce back, USD and bond yields lower. NZ Government announces expansionary Budget yesterday

Risk sentiment has rebounded over the past 24 hours with investors seemingly deciding that the tapering talk in yesterday’s Fed minutes won’t translate into action any time soon.  Equities have recovered strongly while the USD and bond yields have fallen, largely reversing their moves yesterday.  The NZD is back to around 0.72.  Yesterday, the NZ government outlined an expansionary Budget alongside higher-than-expected bond issuance and plans to issue a 30-year government bond for the first time, but the market was unmoved.

There has been very little news to speak of overnight, with only second tier economic data (discussed below) released.  The market has now had time to reassess the discussion within yesterday’s Fed minutes, which said “a number” of participants thought it may be appropriate to “being discussing” a tapering of its bond buying in the upcoming meetings.  Given the Fed meeting preceded the shockingly low May payrolls report, and key Fed officials, including Chair Powell, have reaffirmed their dovish stance in the interim, the market appears to come to the view that it’s still to early for the tapering discussion to begin.

Market movements are a mirror image of those yesterday, with equities higher and the USD and bond yields lower overnight.  The S&P500 is up more than 1%, with tech stocks outperforming (NASDAQ +1.7%), while the Eurostoxx gained 1.3%.  The US 10-year Treasury yield has drifted back down from 1.67% to 1.63%, still comfortably contained within its recent 1.50% – 1.70% trading range.

Economic data overnight has been second tier and not market moving.  US jobless claims continue to trend lower, a sign that the US labour market continues to recover as states remove Covid-related restrictions.  The Philadelphia Fed business survey fell by more than expected, albeit from a 48-year high and to a level still consistent with very strong economic activity.  Supply-side inflation pressures were still evident in the survey, with the prices paid index reaching its highest level since 1980 and firms reporting that they intended to raise prices by 5% over the coming year.  Central banks continue to argue these current inflation pressures are temporary, with ECB chief economist Lane saying overnight that the recent increases in input prices have “ nearly zero connection” to underlying economic trends and the ECB has “a lot of work to do” to reach its inflation target.

In currencies, the USD is under pressure again and trading near multi-year lows.  The Bloomberg USD index has fallen 0.4%, reversing most of yesterday’s appreciation.  The improvement in risk appetite overnight and the market’s apparent reassessment of the tapering talk in the Fed minutes look the likely drivers behind the overnight move.

The G10 currencies, except for the NOK, are all up between 0.3% and 0.6% against the USD over the past 24 hours.  The EUR is trading near its recent highs, back above the 1.22 level.  Likewise, the AUD has pushed up from 0.7720 to around 0.7770 this morning.  There was little market reaction to yesterday’s Australian labour market report with the market brushing off the surprise 30k fall in employment in April (+20k expected) as down to seasonal adjustment issues.  Our NAB colleagues expect further improvement in the Australian labour market, including a further decline in the unemployment rate, going forward.

The NZD has appreciated 0.4% over the past 24 hours, largely tracking the broader USD move.  It trades this morning just below 0.72.  There has been little movement on the key crosses.

Turning to domestic developments, at the Budget yesterday, the government announced, amongst other things, a significant increase in infrastructure spending and “the biggest lift in benefit payments in more than a generation”.  The infrastructure spending is likely to put further pressure on the already capacity constrained construction sector, and therefore broader inflation pressures, while the lift in benefit payments is likely to support consumption.  We see the fiscal stimulus as supporting our view that the RBNZ will start raising the OCR from mid next year, although the policy announcements have likely come too late to be formally incorporated into the RBNZ’s MPS forecasts.  The MPS is next Wednesday.

On the bond issuance front, the surprise was that the bond programme was kept unchanged for the coming fiscal year, at $30b, contrary to our (and market) expectations for a reduction.  The $30b bond programme forecast is consistent with an increase in nominal bond tender issuance from the current $300m/week to around $500m/week from July onwards.  We can’t see the RBNZ increasing its QE purchase pace (currently $350m/week) to match, so the market will likely need to start absorbing bond issuance on a weekly basis from this point forward.  This will probably put some modest upward pressure on interest rates, although other factors, like global trends and the OCR outlook, will remain the dominant drivers.  There was minimal market reaction to the Budget yesterday, with interest rates marginally lower across the curve.

Separately, New Zealand Debt Management said it intends to issue a 30-year nominal bond before the end of December, which will be a first for the government (Auckland Council issued a 30-year bond last year).

The focus in the session ahead will be the ‘flash’ European PMIs, which provide a timely barometer of economic activity in the region.  The market expects the PMIs to show an improvement in services sector activity while manufacturing activity is expected to remain at historically high levels.