Equity markets, industrial commodities rebound as Dallas Fed President Kaplan (a 'hawk') hints he is open to delaying tapering. NZD stabilises on Friday but still down heavily (~3%) on the week

Risk asset markets recovered on Friday, after what had been a rocky week.  Equity markets were higher in the US and Europe, industrial commodities rebounded, and the US 10-year rate nudged up, to 1.26%.  The shift in market sentiment appeared to follow comments by Dallas Fed President Kaplan, one of the ‘hawks’ on the committee to this point, who said he was openminded about delaying tapering if there was evidence the Delta variant was dampening demand.  The NZD and AUD stabilised on Friday but were still heavily down on the week.  OCR expectations were pared back on Friday, despite further hawkish messages from RBNZ Governor Orr, as the market focused on rising Covid-19 cases numbers and the growing list of high-risk locations of interest.

Dallas Fed President Kaplan has been one of the more hawkish voices on the Fed for several months, having been the first on the committee to make the case for tapering back in April.  So, markets paid attention when he told Fox on Friday that he was open to a delay in tapering if the Delta variant was shown to be hurting demand in the economy.  To be clear, Kaplan’s current view is that the Delta variant is mainly hampering the supply side of the economy, for instance by delaying the return to work of those worried about getting Covid-19, with little evidence that it is hindering consumer demand.  But he called the Delta variant the "the big imponderable" to the outlook and said he was open to changing his view that it is mainly a supply-side problem, one that QE can do little to solve.

Equity markets reacted positively to the hint that one of the more hawkish Fed members was open to delaying tapering.  S&P500 futures, which had been down around 0.5% before Kaplan’s comments, quickly turned higher, with the index eventually ending up 0.8% on the day, while the NASDAQ gained 1.1% and the Eurostoxx 600 index was up 0.3%.  Friday also saw a recovery in some of the recently beaten-up commodities, with copper bouncing back 1.6%, while Singapore-listed iron ore futures rising around 5% from their closing levels on Friday morning, although they were still down some 13% on the week.  Oil prices bucked the trend, with the Brent crude oil spot price down 1.5% on Friday, taking its loss on the week to 5.6%.

Despite the gains on Friday, equity markets were down across the board last week (S&P500 -0.6%, Eurostoxx -1.5%) due to concerns around slowing Chinese and global growth, related in part to the spread of the Delta variant, and apparent nerves around the Fed’s plans to taper back its QE bond buying.  Asian equity markets saw big falls last week, among them the Hang Seng (-5.8%) which fell into bear market territory.  Markets remain wary about the regulatory crackdown by the Chinese authorities, with Xinhua reporting on Friday that a new data protection law had been passed, the latest in a string of regulatory actions aimed largely at the tech sector.

Movements in currency and bond markets were more subdued on Friday.  The US 10-year rate nudged 1bp higher, to 1.26%, having traded down at 1.23% earlier in the session.  The BBDXY USD index made a fresh 9-month high in the New York morning, but Kaplan’s comments appeared to trigger a reversal and it ended little changed on the day.  The BBDXY was up 1.3% last week, its third biggest week gain over the past 12 months.

Illustrating the lack of movement in FX markets on Friday, all the G10 currencies were within 0.2% of their closes from the previous session.  The NZD had a couple of forays towards the 0.68 mark, before recovering back to around 0.6830 at the end of the week.  On the week, the NZD and AUD were both down heavily (-2.9% and -3.2% respectively) amidst a stronger USD, weaker commodities, growing risk aversion and with both countries (a large part of Australia at least) now in lockdown.

NSW recorded more than 800 Covid-19 cases over both Saturday and Sunday, illustrating just how difficult the Delta variant is to contain, even after a lockdown in Sydney that is coming up on two months.  NSW’s Premier announced that Sydney’s lockdown would be extended until at least the end of September, with masks to be made mandatory outdoors and curfews put in place in parts of Western Sydney.

In New Zealand, community infections in the current Covid-19 outbreak are up to 72, with 21 new cases reported on both Saturday and Sunday.  The list of locations of interest continues to grow, including high-risk settings such as schools, hospitals, universities, churches, and corporate functions.  The government is due to provide an update around the alert levels this afternoon, with Auckland and Wellington almost certain to remain in Level 4 for some time longer.

Another hawkish interview from RBNZ Governor Orr fell on deaf ears on Friday, with another chunky (5bps to 7bps) fall in swap rates across the curve.  Orr told Bloomberg that October was a “live” meeting, that he wouldn’t rule out raising the OCR simply because of the lockdown and that it would require a significant shock to demand in the economy to prevent hikes.  He added that an OCR below 2% would still be stimulatory, given this was the RBNZ’s current estimate of the ‘neutral’ OCR.

The market remains unconvinced and continued to push back the expected timing of OCR hikes.  Pricing for the August meeting implies a roughly 50% chance of a rate hike, down from almost 80% after the MPS.  The market appears to be associating the timing of ‘lift-off’ with the likelihood of the Delta variant being brought under control and the country coming out of lockdown despite RBNZ Governor Orr stating this isn’t a precondition for hikes.

In other news, Bloomberg reported that Treasury Secretary (and former Fed Chair) Janet Yellen has backed the reappointment of current Fed Chair Powell for a second term.  Biden is reportedly deciding whether to reappoint Powell or promote current Fed Governor Brainard, seen as one of the most dovish members of the committee on monetary policy.

Finally, Pfizer’s vaccine is due to get full regulatory authorisation from the US FDA early this week according to Bloomberg.  The vaccine was granted emergency use authorisation late last year.

The highlight in the week ahead is the annual Jackson Hole symposium and especially Chair Powell’s keynote address on Friday night on the economic outlook.  The market will be watching closely for any further clues from Powell around the possible timing of tapering.  The ‘flash’ European PMIs for August are released tonight and are expected to remain at historically elevated levels, consistent with very strong growth in the Eurozone.  The focus domestically will remain on Covid-19 case numbers.