Omicron fears continue to recede, driving risk sentiment higher. US rates higher with more curve flattening

Risk sentiment has recovered further, with a more than 2% gain in US and European equities, a 4% lift in oil prices and US rates pushing higher. Commodity currencies have outperformed although the NZD has lagged the movement in AUD and CAD again, with only a modest gain to 0.6775.

The positive turnaround in risk sentiment has extended into another session, with the market seemingly less concerned about the Omicron variant of COVID19 and the easing in China’s policy settings noted yesterday providing additional support.

The market is still awaiting hard confirmation from studies that Omicron, while likely more transmissible than Delta, does not lead to more severe health implications.  But emerging evidence firstly from South Africa, and across clusters in Norway and Denmark, still seems to point in that direction. The Norwegian Institute of Public Health said “The Omicron variant is unlikely to cause more serious disease in vaccinated people…vaccination will provide a high degree of protection.” Also on a positive note, GSK and Vir Biotechnology said their COVID19 antibody drug “sotrovimab” was slightly weakened by Omicron, but that the difference was not significant.

China’s troubled property developer Evergrande missed a payment deadline on some USD bonds, setting off the process for default and the beginning of a restructure that is widely anticipated to include the government’s help to limit contagion risk. The cut to the RRR for banks and indications that policies which curbed the property market will be eased a little, as noted yesterday, are all part of the process to support the economy through this difficult period.

Economic data released have been on the positive side. China export and import growth were both stronger than expected in November, the former pointing to still-solid global demand and the surprise 32% lift in imports was supported by a rebound in commodity volumes such as coal, iron ore and copper ore. The US trade deficit moderated in October, as suggested by the advanced estimate for goods. Germany industrial production rose a strong 2.8% m/m in October, a bounce-back from the notable contraction through August/September.

Less reassuring for the market was a US Conference Board survey of companies showing that companies are setting aside an average 3.9% of total payroll for wage increases next year, the most since 2008, with pay raises expected to be broadly based across different pay scales. The survey suggests that the recent acceleration in private sector wages is likely to carry over into next year and adds to the calls for the Fed to tighten monetary policy.

After a pause in the trend yesterday, the US Treasuries curve is back in a mood to flatten, with the 2-year rate up 5bps to a fresh high of 0.68%, while the 10-year rate is up 3bpa to 1.47% –  the latter up some 13bps from last week’s trough but still curiously low in in the context of rampant inflation, with some in the market picking annual CPI inflation printing as high as 7% at the end of the week.

The “buy-the-dip” mentality remains a feature of US equity markets, with the easing of Omicron concerns leading to a strong 2.1% gain in in the S&P500, taking the index within about 1% of the record high printed late last month, while the Nasdaq index is up over 3%. The Euro Stoxx 600 index closed up 2½%.

After yesterday’s meaty 4½% gain, Brent crude is up another 4% to USD76. After the 8% gain in iron ore in the previous session, it’s up another 2% for the day, taking it to $115 per ton, on expectations that China’s relaxation of property curbs will support demand.

The overnight GDT dairy auction price index rose by 1.4%, continuing the positive run in pricing, with price gains across all product groups. Whole milk powder prices rose by 0.6%, skim milk powder rose by 1.3%, cheddar rose by 1.0% and there were even larger gains across the remaining products, including a 4.6% lift in butter prices. Milk price futures continue to sit around $9 for FY22, while the lift in dairy prices alongside a weaker NZD have recently pushed up futures for FY23 to $8.75, representing expected mega payouts for dairy farmers for two years running.

The positive risk backdrop sees commodity currencies at the top of the leaderboard. The AUD and CAD show the strongest gains for the past 24 hours, up in the order of 1%, the former back up through 0.71 after briefly going sub-70 at the end of last week. The NZD has lagged the move, up a 0.4% gain since this time yesterday to 0.6775. EUR and GBP are both lower at 1.1240 and 1.3225 respectively and the yen is on the soft side as well. So while NZD/AUD has pushed down further to 0.9525, the NZD shows decent gains on the crosses, with NZD/EUR up to 0.6025, NZD/GBP at 0.5120 and NZD/JPY regaining 77.

The RBA policy update didn’t surprise, with its ongoing plan for QE through to February and subdued rates outlook, but the market read the minor tweaks in the Statement as more hawkish, with the Bank not seeing Omicron derailing the economic recovery and removing reference to its inflation and wages view from the final paragraph. The 3-year bond future has risen 12bps in yield since the Statement, even though the market has already priced in a number of rate hikes over coming years against the RBA’s sanguine view, while the 10-year rate is up 7bps in yield. Adding to the immediate post-RBA move was an article overnight by respected RBA-watcher McCrann, which talked about the potential for rate hikes next year.

The NZ rates market showed some dysfunction, with a notable narrowing of swap spreads, particularly at the short end of the curve, with the 2024-2025 bonds up 11bps in yield, against a 3bps lift in equivalent swap yields. This reverses some of the widening in swap spreads seen recently, but why the big move yesterday remains somewhat of a mystery. The 10-year NZGB yield rose 6bps to 2.35% against a 4bps lift in the 10-year swap rate. Given the lift in Australian rates since the NZ close, one would expect rates to jump higher on the open.

The Bank of Canada meets tonight and is widely expected to adopt a more hawkish tone, given the recent lift in inflationary pressure and last week’s blockbuster labour market report. The market is well priced for a long series of rate hikes beginning from about March next year, which should limit market reaction to a more hawkish tone.