After a rocky couple of trading sessions, equities and bond yields have rebounded overnight. Volatility is high and sentiment fickle and much will depend on news on Omicron over the coming days and weeks. Currencies have seen limited movement overnight, with the NZD hovering just above 0.68. Yesterday saw a huge flattening in the NZ yield curve, with the gap between 5-year and 10-year swap rates shrinking to 0bps for the first time since the GFC.
Markets remain volatile and sentiment driven as investors grapple with the risks around Omicron. Shortly after this report was sent yesterday, there was a significant sell-off in US equities into the market close, with the S&P500 falling almost 3% from its intraday highs after news of the first Omicron in case in the US, in California. Another US case has been reported overnight in Minnesota in an individual who was recently in New York. Of course, Omicron was going to eventually find its way into the US, like other countries, but the market reaction speaks to heightened nervousness among market participants.
There has been a reasonable recovery in risk sentiment overnight, on no major news, with the S&P500 up around 1.5% and the NASDAQ 0.9%. Cyclical industries and those sensitive to Covid restrictions have led the rebound, with an index of airlines, hotels and cruise operators bouncing back over 3% overnight. Implied volatility remains elevated, with the VIX sitting just under 30.
Covid-19 cases have gone exponential in South Africa, where scientists first detected the Omicron variant, with around 8,500 new cases reported on Wednesday, almost double the previous day’s total. Doctors in the country have observed increased instances of people who have previously had Covid being reinfected with the new variant, a sign that Omicron might evade immunity generated by vaccines or prior infection. However, there is still hope that vaccines might provide protection against severe illness and death. Overnight, Pfizer repeated what its vaccine partner BioNTech had said earlier in the week, that it didn’t expect its vaccine would see a significant drop in effectiveness, while cautioning that we would need to wait for a week or two for confirmation from test results.
As Germany battles a surge in Covid cases, outgoing Chancellor Merkel announced new restrictions on unvaccinated individuals, banning them from restaurants, bars, and other non-essential shops. The measures have been labelled a ‘’lockdown of the unvaccinated”. Merkel also flagged that Germany might follow Austria in making vaccination mandatory from February next year as an “act of national solidarity”, with a vote in parliament likely to happen soon.
There has been a chorus of Feb policy makers overnight reiterating their openness to speeding up tapering, among them Daly, Quarles, Mester, and Bostic. An earlier end to QE opens the door to earlier rate hikes, with Fed officials now signalling they want the option to do so if inflation and employment are stronger than expected. If the tapering pace were doubled, from $15b per month to $30b per month, QE would end in March rather than June.
US Treasury yields are higher and the curve flatter on the back of improved risk sentiment and these hawkish comments from Fed officials. The market has brought forward the expected timing of the first Fed rate hike to June next year. The US 10-year rate is up 5bps since yesterday morning, at 1.46%, while the 2-year rate is 7bps higher, at 0.62%. The yield curve between 5-year and 30-year US rates was 5bps flatter, at 55bps, its lowest level since early 2019.
At its meeting overnight, OPEC+ announced that it would go ahead with its planned increase in oil supply in January (400k barrels per day). It added that it would “monitor the market closely and make immediate adjustments if required”, suggesting the cartel might quickly halt supply increases if Omicron leads to a major downturn in oil demand. Oil prices fell as much as 4.8% on the initial headlines, before rebounding to now be higher on the day (Brent crude +1.5%). This has helped market-based inflation expectations recover, with the 10-year breakeven inflation rate in the US rising 4bps to 2.47%.
Currencies have been relatively stable, with the NZD trading a narrow range between around 0.6800 – 0.6830 over the past 24 hours. Both the NZD and AUD remain close to their year-to-date lows and are trading around 0.6810 and 0.7100 respectively this morning. The BBDXY USD index is close to unchanged on the day, hovering near its highest level in 16 months.
In the domestic rates market, there was another huge flattening in the NZ yield curve yesterday. The 2-year swap rate was 7bps higher on the day, at 2.26%, while the 10-year rate was 5bps lower, at 2.62%, in a “twist” move. The spread between 5 and 10-year swap rates hit 0bps for the first time since the GFC and this curve segment might invert today, given the overnight flattening moves in global bond markets. An inverted yield curve is often seen as a sign that the market thinks the central bank might ‘overdo’ the tightening cycle, leading to a major growth slowdown in the future.
The fall in longer-term NZ rates yesterday is easily explained given the sharp falls in US and Australian 10-year rates on the session. The upward pressure at the short end of the curve is a little more puzzling considering the RBNZ’s message at the MPS of “considered steps”. The market is pricing the OCR to be around 2.40% by the end of next year, implying (almost) a hike at each of the seven meetings in 2022. We suspect mortgage-related paying in swaps and some profit taking among investors has caused the latest indigestion, with the market seemingly struggling to absorb the pay-side flows.
The nonfarm payrolls report should be the focus tonight. The market is expecting a solid 545k increase in jobs in November and anything in that ballpark should be sufficient for the Fed to announce an accelerated taper pace at its meeting in two weeks (unless Omicron developments get in the way). The ISM Services index is expected to pull back slightly, albeit to what would still be its second-highest reading on record.
Locally, Fonterra is scheduled to deliver a business update today, at which it might upgrade its forecast milk price for the 2021/22 season from the current $7.90 to $8.90 range. We are forecasting an $8.90 milk price once the season is all done, which would be a record, while NZX futures are at $9. Unlike the weakness seen in some other commodities in recent times, milk prices remain firm, reflecting, amongst other factors, constrained global supply.