Market significantly reprices monetary policy outlook; easier policy back in sight for second half in the US. Treasury yields plunge, led by short end. Risk appetite weaker but NZD (+1.7%) outperforms, alongside AUD and JPY

Markets remain in turmoil following the collapse of SVB and closely followed by another much smaller crypto-focused bank. US Treasury yields have plunged, led by the short end and the USD has been whacked. Closing of positions have likely exacerbated moves. Some bank stocks have collapsed but US equities have been supported by solid gains for the rate-sensitive sectors. Risk appetite is weaker, but the NZD and AUD have been the two best performers this week.  What a mess.

Authorities moved quickly yesterday morning – or Sunday night NY time – to contain the contagion risk from the collapse of Silicon Valley Bank. A joint statement by the Treasury, Fed and FDIC was issued. It said the resolution of SVB would fully protect all depositors, alongside Signature Bank in New York (a main bank to the cryptocurrency industry) which was also closed down by regulators. Furthermore, the Fed would make available additional funding to banks to assure them of the ability to meet the needs of all their depositors, with no haircut applied to the necessary collateral.

Despite the government’s best intentions, the action is seen as a necessary but not a sufficient condition to prevent a possible financial crisis. In the US, investors have been looking into banks with the most uninsured deposits and deciding to sell them, in anticipation of a possible bank run. Of the 23 banks in the closely followed KBW Bank index, two banks have fallen by more than 50% (excluding the now-closed Signature Bank which shows 0% but is effectively down 100%), three are down 20-30% and another four are down 15-20%.

Increased fear has seen a further lift in the VIX index, peaking just under 31 last night, with credit spreads widening as well – US high yields spreads widening some 43bps and investment grade 13bps. The Euro Stoxx 600 index fell nearly 2½%, with its heavy weighting to bank stocks not helping. US equities have had a choppy session, down 1.4% early in the day, back up over 1% in afternoon trading and currently flat, with large sectoral variation – bond-sensitive sectors outperforming, financials whacked and cyclicals underperforming as well.

Yesterday afternoon NZ time, Goldman Sachs became the first bank reported to call that the Fed would no longer hike rates next week.  The market hasn’t entirely embraced that call but has moved significantly in that direction, with Fed Fund futures now priced at +17bps, compared to +33bps at Friday’s close and +43bps soon after Fed Chair Powell’s testimony to lawmakers last week.

More interestingly, just one full 25bps hike is now priced, before the market sees the Fed easing from the second half of the year – about 80bps of easing priced once the peak has been reached. The point is that the market sees financial conditions tightening as a result of the collapse of SVB, with banks needing to lift rates to attract deposits and adopting a more cautious stance on the asset side of their business. The need for monetary policy to play a role in additional tightening financial conditions has become unnecessary.

This turnaround in view has driven US Treasury yields lower, led by the short end.  The 2-year rate actually fell below 4% at one stage, or a low of 3.99%, a remarkable drop considering it peaked at 5.08 only a few trading days ago. As we go to print, the 2-year rate is down 48bps for the day to 4.10%, with the 10-year rate down 21bps to just below 3.5%. Closing of short positions have likely exacerbated the moves. The 2s10s curve is now only inverted by 62bps, from a peak inversion last week of 110bps.  Curve inversion is a harbinger of economic recession, and it is well known that in terms of timing, the actual inversion is not the best indicator, it is the subsequent steepening of the curve which gives the best signal on that. The fact that the entire Treasuries curve now sits below the Fed Funds rate has also been a good predictor of economic recession.

The move in US rates has spilled over widely to global markets, with 10-year rates for Canada, German and the UK all down more than 25bps on the day and short-end rates down even further. The ECB is the next major central bank to meet – later this week – and pricing has shifted down to +39bps.  Before SVB looked to be heading for collapse last week, a 50bps hike was almost a given. The doves on the committee will be arguing for some pullback in the scale of tightening given the turmoil in the banking sector.

In currency markets, the USD has been whacked again, with the DXY index down 1% on the day.  Closing of long positions will be a factor, as well as the larger fall in US rates compared to elsewhere acting as a drag, these factors more than offsetting the usual safe-haven flows seen in times of turmoil.

Interestingly the NZ has been the best performer since last week’s close (+1.7%) and overnight, rising up through 0.6260 and currently 0.6235. The strong link between risk appetite and the NZD over the past two years has been clearly broken over the past two trading session. The closing of positions isn’t a satisfactory explanation, as we didn’t think positioning was particularly short, at least compared to other majors. The AUD is up ‘only” 1.5% to 0.6675, seeing NZD/AUD extend its run further, up to 0.9340. The strong performance of the yen makes more sense to us, given the collapse in global rates and its safe-haven characteristics.  USD/JPY is down 1.5% to 133. EUR and GBP are up in the order of 0.9-1.2% to 1.0740 and 1.2175 respectively. Given its outperformance, NZD crosses are all higher.

Domestic rates showed notable falls yesterday, but the NZ market underperformed on a cross-market basis. NZGBs were down 10bps across much of the curve, with smaller falls at the longer end – the 10year rate down 8bps and the ultra-long bonds down 5-7bps. Swaps were 8-10bps lower across the curve. Rates will fall further on the open, with the Australian 10-year bond future down 20bps in yield terms since the NZ close.

There was some significant repricing of monetary policy expectations, but OIS rates still look too high, with the April meeting priced for a 33bps hike and the peak OCR at over 5.4%.  Against a backdrop of other central banks pulling in their horns, there will be less pressure on the RBNZ to tighten as well.  Given the significant mortgage repricing yet to come through the system and the economy on the verge of recession, if the banking crisis in the US means an earlier end to NZ’s official tightening cycle, then that might end up being a good thing.

Looking ahead, economic releases will play second fiddle to the focus on the US banking system, but there is still the small matter of the key US CPI release which comes out tonight. The market consensus is at 0.4% m/m for the ex-food and energy core measure. The breakdown will be important as well with Fed Chair Powell noting he was watching the core services index excluding housing, which to date has showed little downside momentum. But clearly the data release is less important now, following the collapse of Silicon Valley Bank.  The Fed should be treading carefully from here on further rate hikes, independent of the data.

Ahead of that REINZ housing market data are released where anything other than another depressing read on housing market activity and prices would surprise. UK labour market data tonight will also be of some interest.