Friday saw a complete turnaround from the risk-off moves the previous night. The US 10-year rate, which hit 1.25% on Thursday night, rebounded to 1.36%, while the S&P500 and NASDAQ closed the week at record highs. Market sentiment was boosted by the PBOC’s announcement that it would cut reserve requirements. The NZD bounced back to around 0.70 amidst a weaker USD and higher commodity prices. It’s a big week ahead, with the RBNZ MPR and NZ CPI the domestic highlights.
As foreshadowed earlier in the week by China’s State Council, the PBOC formally cut reserve ratio requirements (RRR) for Chinese banks on Friday by 0.5%, which will free up an estimated ¥1tn in liquidity. The policy move came earlier than some analysts had expected and is effectively an across the board RRR reduction, rather than a targeted measure to support certain sectors. The PBOC described the move as a liquidity management exercise, in the context of upcoming maturing central bank loans, rather than monetary easing, but the market still interpreted the move as confirmation of a shift in direction in China’s policy stance. The PBOC has not run monetary policy nearly as easy as developed market central banks and China also has no evident consumer inflation problem at the moment, with CPI released on Friday barely above 1%, giving the PBOC the policy leeway to support growth amidst some signs of a slowdown.
Separately, Chinese credit growth for June was much stronger than expected and its highest monthly reading since January, seemingly confirming that Chinese policymakers have pivoted to supporting the economy through credit easing. Chinese Q2 GDP is released Friday.
Whereas Thursday saw markets fret about a possible slowdown in global growth (with talk of easing in China seen by some as validating those concerns) and the spread of the Covid-19 delta variant, Friday saw a complete turnaround, with the PBOC’s RRR cut contributing to a broad based risk-on move across asset classes.
The EuroStoxx 600 equity index was up 1.3% while the S&P500 and NASDAQ both gained around 1%. Cyclical sectors led the rebound in equities, with commodity producers and financials leading the charge, the latter also helped by the steepening of the yield curve, which is perceived as supportive of bank net interest margins. The share prices of big tech firms largely shrugged off an executive order from Biden that would target an alleged lack of competition in certain industries, including tech. Both the S&P500 and NASDAQ ended the week at record highs.
Commodity markets were also universally stronger on Friday on expectations that China would support growth. Copper was up more than 2% while Brent crude oil increased 1.4%, reversing most of its falls from earlier in the week. Despite the risks from the likes of the delta variant, which is now the dominant Covid-19 strain in the US, we still think it’s reasonable to expect a very strong global expansion this year with both monetary and fiscal policy set to remain extremely expansionary for some time yet.
US Treasury yields also experienced a big turnaround on Friday. The US 10-year rate, which hit a 4½ month low of 1.25% on Thursday night, rebounded to close the week at 1.36%. The move was led by the inflation expectations component (so-called ‘breakeven inflation’) which increased 6bps at the 10-year point, to 2.29%. That leaves the 10-year real rate (i.e. inflation-adjusted rate) still at ultra-low levels, around -0.95%.
The USD was broadly weaker on Friday (BBDXY -0.4%) amidst the improvement in risk appetite and still ultra-low US real rates. Despite the pullback, the BBDXY remains in the upper end of its trading range for this year. After topping the currency leader board on Thursday, the safe haven JPY and Swiss franc underperformed on Friday (-0.4% and +0.1% respectively) while the EUR only saw modest gains (+0.25% to 1.1875).
Likewise, commodity currencies reversed some of their losses from earlier in the week as risk sentiment improved. The AUD, which printed a year-to-date low on Friday afternoon, was up 0.8% to around 0.7490 while the CAD was also up strongly on Friday night, supported by a stronger-than-expected Canadian employment report. Analysts interpreted the Canadian employment report, which saw +230k new jobs in June, as sealing the deal for a further tapering by the Bank of Canada when it meets this week. Still, on the week, commodity currencies were the laggards (AUD and NZD -0.4%, CAD -1%), reflecting some emerging jitters about the global growth outlook.
Like the AUD, the NZD made a fresh year-to-date low on Friday afternoon, just under 0.6925, but it was one-way traffic after that point as it trended up to around 0.70 (+0.6%). The rebound in the NZD confirms the 0.6920-0.6930 zone as key support. The NZD was down for the second consecutive week and the five out of the last six weeks. We still see NZD as fundamentally undervalued compared to its typical historical drivers which point to fair value above 0.73.
In Australia, a further 77 Covid-19 cases were reported in NSW yesterday, with the State Premier saying she expected daily cases to top 100 soon, raising the prospect of an extended lockdown in the city. This implies some downside risk to the economic outlook, although markets have been little affected so far.
In the domestic rates market, swap rates edged slightly higher (10-year +2bps to 1.76%) while government bond yields continued to push lower (10-year -2bps to 1.66%). The NZ 10-year bond yield fell 16bps last week, although there should be some reversal this morning, reflecting the moves in global rates on Friday night.
The RBNZ kept its bond buying unchanged for this week, at $200m, despite evident signs of strong investor demand for New Zealand bonds (as reflected in the sharp rise in swap spreads last week). The market will be looking for guidance from the RBNZ on its bond buying at its Monetary Policy Report this Wednesday.
It’s a big week ahead, both in NZ and offshore. The RBNZ MPR is on Wednesday while CPI is released on Friday, where we are looking for a 0.7% quarterly increase, taking the annual rate to 2.7%. The market will also closely watch the core inflation figures, which were already around the 2% target midpoint last time and are surely biased higher. In Australia, our NAB colleagues look for a slightly below-consensus 10k increase in jobs in June, after May’s blockbuster 115k increase. China’s monthly activity indicators and GDP are released on Friday, with consensus for the latter at +1% q/q growth in Q2. In the US, CPI and retail sales are released, Chair Powell testifies to the Senate and House and corporate earnings season gets underway. Meanwhile, the Bank of Canada meets, with the market looking for it to taper its bond buying from $3b/week to $2b/week.
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