After last week’s massive positioning upheaval in financial markets a modicum of sanity has returned. A reversal of sorts has begun, with US equities rebounding, the US Treasuries curve steepening and the USD showing a broadly based fall. The NZD and AUD have made gains in the order of 0.8%, with the former knocking on the door of 0.70.
As regular readers will know, last week’s price action in financial markets was fairly dramatic with some nerves and fear heading into the key US FOMC policy update and those fears being realised when the Fed delivered a more hawkish outlook than expected, as the median committee member brought forward the timing of expected rate hikes to incorporate two rate hikes in 2023. This caused a significant re-evaluation of the global reflation trade, seeing a big upheaval in asset prices, including widespread falls in commodity prices, significant interest rate curve flattening, sector rotation in equity markets and a strong rebound in the USD.
The new week has begun with a mini reversal of those pricing dynamics, even as a chorus of speakers overnight has sung a similar tune, that the time has begun for some normalisation of US monetary policy.
Two of the (non-voting) hawks on the FOMC, Kaplan and Bullard outlined their case in a joint webinar. Kaplan said that for some time he has been a fan of taking “our foot gently off the accelerator sooner rather than later so that we can manage these risks” around the recovery process, in a bid to “avoid having to press the brakes down the road” with a more abrupt shift in monetary policy. Bullard said that the debate is open and appropriate on tapering asset purchases, particularly for mortgage backed securities in a strong housing market where “there’s a good question there about whether it’s time to retire our intervention” into housing finance.
Other notable folk with similar views and reported overnight include billionaire investor Ray Dalio and ex US Treasury secretaries Summers and Mnuchin.
Last week’s price action only makes some sense if one believes that the Fed is now well ahead of the curve and its actions will drive much weaker global growth. That seems laughable when the outlook remains one of significantly depressed real interest rates for an extended period of time. In our view, Fed policy normalisation is still so far off that we can’t see how this derails the global reflation trade for any great length of time.
The obvious conclusion is that last week the market wasn’t ready for the Fed to begin talking about talking about policy normalisation and a positioning wipe-out ensued. Such market corrections can be considered healthy. Overnight, a small reversal has taken place, but markets are likely to remain on edge over the short-term.
The equity market was one of the least affected markets during last week’s upheaval. The S&P500 is currently up 1.3%, reversing the loss seen on Friday and with a rotation back into the favoured sectors of the reflation trade, Energy, Financials Industrials and Materials.
In the US Treasuries market, last week’s significant curve flattening has given way to some significant steepening. Last week the 30-year bond fell 17bps and fell another 9bps during Asian trading to as low as 1.925%, but has since sharply reversed course, up some 18bps from that low to 2.10%. The 10-year rate traded down to as low as 1.35% an hour before the NZ close and now trades up to 1.48%, while the 2-year rate has been flat at 0.25%. The Australian 10-year bond future is up some 7bps in yield since the NZ close, so that will set the tone for early trading domestically.
In currency markets, the USD BBDXY index is down 0.4%, the blow softened by a lack of movement against the yen, with USD/JPY flat at 110.30. The NZD has trended higher since the NZ open and currently sits just under the 0.70 mark, up 0.8% since last week’s close. The lack of time spent below the March low of 0.6940 reinforces that level as a line of technical support, with the first line of resistance at the previous support level of 0.7100. The AUD has also showed a nice recovery and, pushing up to 0.7540.
Alongside its commodity currency brethren, CAD shows a similar percentage gain. Of the other majors, GBP is up 0.9% to 1.3935, while EUR has been the laggard, only up 0.4% to 1.1915. Overnight, ECB President Lagarde noted to lawmakers a brightening in the outlook for the economy as the pandemic situation improves but also highlighted the differences between the US and Eurozone, saying “they’re in a different situation in terms of the cycle, they’re in a different situation in terms of inflation, and they’re in a different situation in terms of inflation expectations.”
Yesterday the domestic rates market was pushed around by global forces that saw a significant flattening of the curve, but this is looking to reverse course in the day ahead. But for the record, the 2-year NZGB rose by 5bps while the 10-year rate fell by 5bps to 1.74%. The swaps curve also showed a 10bps flattening for 2s10s, with the 2-year rate up 4bps to 0.73% and the 10-year rate down 6bps to 1.84%.
The key focus tonight will be on Powell’s testimony to Congress on the economy. The market will be looking for confirmation of the Fed’s new confidence in the economic outlook that resulted in a bringing forward of the beginning of policy normalisation. Ahead of his testimony, another two FOMC members, Mester and Daly, will be offering their perspective.
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