USD has strengthened across the board, taking the NZD down to its recent lows in the process; implied volatility across a number of asset classes is at historically low levels

By Nick Smyth

After the passing of a number of significant event risks yesterday, markets have returned to calm, with volatility subdued.  The USD has strengthened across the board, taking the NZD down to its recent lows in the process.  RBNZ Governor Adrian Orr gave an interview with Bloomberg late yesterday in which he said the May OCR decision would be a difficult one.  

Orr’s interview with Bloomberg was released around 5:30pm yesterday.  He highlighted the competing forces that would weigh on their upcoming interest rate decision in May – a strong terms of trade and intense capacity constraints on the one hand versus below-target inflation and slower global growth on the other.  There didn’t seem to be a clear policy signal from the interview, but clearly the May decision is “live” and he said the RBNZ would watching the upcoming CPI release next week and the labour market report in early May. 

The market has pared back its OCR rate cut pricing over the past few weeks amid some improvement in the global data flow (something Orr acknowledged in his speech), RBA Deputy Governor Debelle’s failure to endorse near-term rate cuts in his recent speech, and some profit-taking in the short-end of the NZ rates curve.  The probability of a May rate cut was around 30% at the market close yesterday, down from around 50% in the immediate aftermath of the OCR Review.  A 25bp rate cut is almost fully priced by August. 

There was a marginal (around 10pip) fall in the NZD after the Orr interview was released, with the lack of reaction consistent with the lack of a clear policy signal from the interview.  The NZD has continued to track lower overnight, amidst a broad-based strengthening in the USD, and is sitting towards its recent lows, at 0.6725.  The NZD/AUD is marginally higher that this time yesterday, at 0.9445. 

In terms of that upcoming NZ data, we revised our Q1 CPI forecast higher after the release of food price data yesterday.  We now look for a 0.4% quarterly increase, taking the year-on-year rate to 1.8%, which is higher than the RBNZ’s 1.6% MPS forecast.  If we’re right on CPI, and especially if it were accompanied by an increase in core inflation, that might argue against a May OCR cut, although it’s uncertain how the RBNZ might weigh that up against other factors, such as slowing business confidence.  

In global markets, volatility is subdued after the passing (without incident) of a number of significant event risks over the past few days.  Implied volatility across a number of asset classes is at historically low levels, including FX, rates and equities – the lowest level in five years in the case of FX volatility (the CVIX).  With almost all major central banks on hold, inflation contained, and global growth showing signs of stabilisation, this low volatility environment could persist for some time. 

On the day, US equities are slightly lower (S&P500 -0.2%) while bond yields have moved higher - the 10 year Treasury yield is up 3bps to 2.5%.  The 10 year Treasury yield has traded an extraordinarily tight 7bp trading range since early last week. 

The USD has strengthened overnight, by 0.2% to 0.3% on the various USD indices, although it remains well contained within existing trading ranges.  The NZD and AUD have been the two weakest currencies over the past 24 hours, by 0.6% and 0.7% respectively.  In economic data overnight, US jobless claims fell to the lowest level since 1969, with the four-week moving average moving to a new cycle low of 207k.  The data might have been affected by timing issues around Easter, but it generally reinforces the view that the US labour market remains in good shape.  US PPI had no market impact, coming only a day after the more important CPI release.  

Yesterday morning the UK and EU agreed to a Brexit extension until the end of October, while granting the UK the option to leave earlier if it can pass a suitable deal through parliament before then.  There was no reaction in the GBP to the announcement, with an extension well anticipated by the market and market participants probably suffering from Brexit fatigue.  Cross-party talks between Labour and the Conservatives will continue, with Theresa May telling the House of Commons overnight that the two sides are not as far apart on the customs union as is widely perceived, but the likelihood is that the parliamentary impasse drags on for the coming months. 

Second-tier NZ data is released today, including the PMI, ECT spending, and net migration. 

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