Risk appetites rise ahead of US Thanksgiving holiday, expecting Fed pivot. China's pandemic spreads. Eyes on RBNZ

It has been an uneventful trading session overnight, on low volumes, ahead of the US Thanksgiving holiday.  Risk appetite is higher, with seemingly more weight put on the Fed dialling down its hawkish policy stance than the current COVID outbreak in China. US equities are higher, US Treasury rates are lower, and the USD is broadly weaker. The market has positioned itself for a hawkish policy update from the RBNZ today.

US equities are stronger, with the S&P500 currently up 0.8%, more than offsetting yesterday’s modest loss. US Treasury yields are lower across the curve with a mild flattening bias.  The 10-year rate is down 6bps to 3.77%, with a smaller fall for the 2-year rate and the 2s10s spread down to minus 75bps. Since St Louis Fed President Bullard’s hawkish presentation last week, where he said the Fed Funds rate needed to get to 5-5.25% “at a minimum”, the weight of Fed speakers has been much less aggressive. Mester supports a smaller rate hike next month, Daly talked of being “mindful” of the lags in policy and the cumulative effect of tightening and Bostic saying only 75-100bps of additional tightening would be warranted.

There remains some focus on China’s latest COVID19 outbreak, evidenced by this being the headline story in the FT at the time of writing.  New daily case numbers reached 28,000, just under the April peak when the Shanghai outbreak was the focus. There is a growing share (about 20%) of the country facing some sort of restrictions, with manufacturing centre Guangzhou at the centre of the outbreak and localised outbreaks in Beijing and Chongqing. Under the new government guidelines, the restrictions are more piece-meal and not city-wide. Yesterday a spokesman for the Health Commission said that localities shouldn’t be excessive on COVID controls, but they also shouldn’t loosen too much either.

We see reduced restrictions as the first steps towards an effective move away from the previous onerous zero-COVID policy. As we’ve seen elsewhere, Omicron is highly contagious and, once it has been unleashed in the community, there is a natural unstoppable process of infection. The near-term economic impact could well be greater than under a strict zero-COVID stance, but ultimately China’s medium-term growth outlook from this relaxation of policy is better.

There may be times of market angst when case numbers explode and there are some economic disruptions, but the strict zero-COVID policy was always unsustainable and the sooner China goes through what the rest of the world has been through the better.  That appears to be the market’s interpretation as well, with risk appetite higher despite the focus on China.

Oil prices have been choppy but stronger, trying to recover recent losses as speculation dies down that OPEC will raise production. The more likely change is a fall in production to re-balance the market, with near-term demand threatening to weaken as China battles against its latest outbreak of COVID19. Brent crude is currently up over 2% to USD89.50 per barrel.

The key economic release overnight was a lift in euro area consumer confidence to minus 23.9, a five-month high, but that is more a reflection of how deeply depressed confidence recently fell to than any hint of optimism.

Higher risk appetite sees a broadly weaker USD, with the DXY index down 0.4 for the day. The NZD and AUD are up 0.3% overnight, extending earlier gains, with the NZD at 0.6140 and the AUD at 0.6630. The other key majors have made modest gains but the NZD is higher on all the key crosses since this time yesterday as the market positions itself for a hawkish RBNZ policy update this afternoon.

That was also evident in the domestic rates market, with higher rates at the short end of the curve driving a flattening bias.  The 2-year swap rate closed 4bps higher at 5.06% while the 10-year rate fell 2bps to 4.42%. A flatter curve was also evident for NZGBs. The November meeting for OIS closed at 4.1875%, suggesting about 69bps worth of hikes priced for today or a 75% chance of a 75bps hike. The peak OCR rate is priced at around 5.15% for May next year, well above the RBNZ’s previous projected peak of 4.1% from the August MPS. Needless to say, the market is well priced for a hawkish update. The Bank’s projected path of the OCR is unlikely to be as high as current market pricing.

Global PMI data are released tonight, where the November figures are widely expected to show a fall in activity – further into economic contraction territory – for most. Ahead of the US Thanksgiving holiday, there will be a number of second-tier economic releases.