US equities modestly positive and US rates slightly higher; NZD has only sustained a small fall after the RBNZ cut rates yesterday; GBP remains soft as hopes for a Brexit deal fade

US-China trade war news has dominated headlines overnight, with the market overall taking a complacent view of proceedings, seeing US equities modestly positive and US rates slightly higher.  The NZD has only sustained a small fall after the RBNZ cut rates yesterday.  GBP remains soft as hopes for a Brexit deal fade.

Late yesterday, Reuters ran a piece exploring why trade talks have broken down between the US and China, with sources stating China backtracked on a range of legal issues throughout the text of the proposed 150-page trade agreement, reversing the key points of agreement on US demands.  Seen in this light, it is understandable why the US side has become concerned about progress.  Overnight the US filed the necessary paperwork to ratchet up tariffs on $200bn of Chinese imports to 25% on Friday, while Trump taunted the Chinese with another tweet saying he was “very happy with over $100 Billion a year in Tariffs filling U.S. coffers...great for U.S., not good for China!”. Trump’s press secretary said that the White House has gotten an indication that China wants to make a deal, while China’s commerce ministry warned the government will “have to adopt necessary countermeasures” if tariffs are increase.

US equities and rates have been choppy on these news headlines, but the net result is that the market is still taking an optimistic view on the outcome. The S&P500 is currently up 0.3% after being down 0.4% in early trading. The US 10-year rate is up 2bps to 2.48%. We’d give a much higher chance of tariffs being ratcheted up at the end of the week than the market believes, causing more market turbulence.

Part of the lift in the US 10-year rate followed the announcement of a poor bond auction, which saw the lowest bid/cover in a decade and a long tail. An unusually low percentage of indirect bidders, which includes institutions like central banks, raises speculation that China didn’t participate in the auction as a result of the increase trade war tension.

Currency movements over the past 24 hours have been modest, with the NZD and GBP the biggest movers. The NZD sits this morning around 0.6570, trading a tight range overnight, after weakening post the RBNZ MPS.  The RBNZ cut the OCR to 1.5% as many in the market predicted, although most recognised it would be a close call and the market wasn’t convinced that the Bank would deliver a cut at this particular meeting.  The RBNZ’s projected OCR track showed a low of 1.36% in late 2020, indicating that the Bank saw some chance of another potential rate cut this cycle, although the text of the policy outlook statement was not overtly dovish – the Bank simply indicated that after the rate cut delivered there is now “a more balanced outlook for interest rates”.

This messaging meant that the market reaction was well-contained – the NZ TWI is down by only 0.25% since the announcement. The NZD initially plunged to a low of 0.6527 in a vacuum of liquidity immediately after the announcement, but much of the fall was retraced as the market digested the news that the Bank wasn’t overtly dovish about the policy outlook.  Similarly, rates plunged on the announcement, but moves were pared back over the rest of the trading session.  The 2-year swap rate fell to a low of 1.54% before closing the day just 3bps lower at 1.60%.  There was a slight steepening of the curve, with the 5 and 10-year swap rates ending the day little changed, and up 6-7bps from intra-day lows. The largest sustained moves were reserved for inflation-indexed bonds, which were 6-7bps lower on the day.

Before the announcement, the OIS market was pricing in just over 40bps of rate cuts this cycle through to early next year. That now sits at 46bps (including the 25bps cut) and explains the fairly modest reaction to the NZD and swap rates.  The market would need to be convinced of the likelihood of a series of rate cuts to exert any more downward pressure on the NZD. We think that there is a good chance of just one follow-up cut later in the year.  And as we’ve noted in our research, the global growth outlook will have more bearing on the NZD through the rest of the year than domestic monetary policy concerns. US-China trade war risks currently overhang the NZD and will be a key driver over the short term.

GBP is weaker, having a peek below 1.30 overnight, as Brexit deal hopes are pared, with sources suggesting Labour talks with the government on a formal Brexit compromise are close to being terminated. Despite the RBNZ rate cut, NZD/GBP is slightly higher for the day above 0.5050.  The NZD is lower on the rest of the crosses. The AUD is back testing sub-70 levels. NZD/AUD fell to 0.9325 at its nadir yesterday, but has recovered to 0.94.

The day ahead should be fairly quiet in the absence of any fresh trade talk news.  Things will get more interesting Friday night when US CPI data are released and we’ll see whether the US goes ahead with the ratcheting up of Chinese import tariffs.

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