Risk sentiment has continued to improve overnight, with equities making further gains and Treasury yields moving higher; USD has strengthened; NZD and AUD have continued to drift to new lows

Risk sentiment has continued to improve overnight, with equities making further gains and Treasury yields moving higher.  The moves came despite confirmation of US restrictions on Huawei.  The USD has strengthened, helped by better economic data.  The NZD and AUD have continued to drift to new lows, with a surprise rise in the Australian unemployment rate yesterday leading the market to price a better than even chance of an RBA rate cut next month. 

US equities have had another good session, the third day of gains in a row.  The S&P500 is up over 1% on the day and has now recovered from the sharp fall experienced on Monday after the Chinese retaliation to Trump’s decision to raise tariffs.  Better US data (see below) helped ease concerns about the US economy and contributed to the rise in equities and bond yields.  Better earnings from Cisco and Walmart added to the positive sentiment, with retail giant Walmart notably saying that higher tariffs would lead to higher prices. 

The move higher in equities has come despite confirmation yesterday that President Trump had signed an executive order aimed at restricting Huawei and other Chinese telecommunications company from selling their equipment in the US (as previously flagged by the FT).  Perhaps more significantly, the commerce department placed Huawei on its ‘Entity List’ meaning US firms will need to apply for a special licence to sell technology to Huawei.  This, in turn, may prevent Huawei from buying semiconductors and other US equipment it needs for its own products, including mobile phones.  Some commentators believe the US will grant the licences but keep the threat of their removal as leverage.  China slammed the decisions and said (again) it would take “necessary measures” to protect its companies, although it didn’t specify how. 

US Treasury yields have increased on the back of better than expected US economic data, with the 10 year yield currently trading at 2.4%, 3bps higher on the day.  It had earlier reached an intraday low of 2.35%.  Following on from yesterday’s stronger Empire manufacturing survey, the Philly Fed survey rose to 16.6, above market expectations and close to its highest level of the year.  The shipments and employment components rose, although there was a modest fall in new orders.  It’s been a good start to the month for the regional Fed manufacturing surveys, which bodes well for an improvement in the ISM survey released early next month.  Meanwhile, housing starts and building permits beat expectations, providing further evidence (alongside yesterday’s stronger than expected NAHB survey) that the US housing market is starting to pick-up again (probably in response to the previous falls in mortgage rates). 

Influential Fed Governor Brainard raised the possibility of “opportunistic reflation”, whereby the Fed tolerates a slight overshoot of its 2% target, in a speech overnight.  Interestingly, Brainard gave the example of an unexpected increase in core import price inflation, which seems entirely realistic given the threat of tariffs.  Brainard noted that “the Federal Reserve could use that opportunity to communicate that a mild overshooting of inflation is consistent with our goals.”  That certainly reinforces the view that the Fed will be far more focused on the growth implications of a US-China trade war than the inflationary side.  Brainard also said she thought the softening in US core inflation recently likely reflected at least some softening in the underlying trend, rather than being entirely due to “transitory shocks”.

The better US data has seen the USD appreciate across-the-board, with the USD indices around 0.3% higher.  Both the DXY and BBDXY indices are now approaching the upper-end of recent trading ranges. 

The GBP has again underperformed after embattled PM Theresa May announced a timetable to step down.  May said she will outline her plans to resign after a parliamentary vote on the withdrawal agreement in early June.  According to reports, if she loses that vote, she will resign immediately.  If she wins the vote, which will almost certainly require assistance from Labour and an agreement reached with Labour leader Corbyn, she will attempt to pass the bill into law before the end of July, after which she will stand down.  Arch-Brexiteer Boris Johnson confirmed what everyone already knew – that he intended to put his name forward for the leadership contest.  The GBP is 0.3% lower on the day, at 1.28, its lowest level since February. 

The AUD and NZD have been the two worst performing currencies over the past 24 hours – both down around 0.4%.  Australian rates and the AUD fell after yesterday’s surprise jump in the Australian unemployment rate (5.2% vs. 5% expected).  The rise in the unemployment rate, from an upwardly revised 5.1% in March, overshadowed the larger than expected increase in jobs growth over the month, and led the market to raise its probability of a June rate cut to around 75% (from around 40% pre-release).  The market now sees the cash rate bottoming out around 0.9%.  Our NAB colleagues now see the odds of a June rate cut as 50/50, and will be looking to Governor Lowe’s speech next Tuesday for further guidance. 

The AUD fell from 0.6920 to 0.6890 immediately after the labour market data.  After a recovery during the London morning, the AUD is again testing those lows, helped by a Terry McCrann article that an RBA rate cut at the June meeting was a certainty.  The magnitude of the fall in the AUD was probably tempered by the fact that two RBA rate cuts were already fully-priced, with most of the debate centring around the timing of when those might be delivered. 

There was a knock-on effect to the NZD, which fell to session lows of 0.6550 after the Australian data.  After a similar appreciation in the London morning, which saw the NZD trade up to as high as 0.6583, it’s been a steady move lower in the NZD since then to 0.6535.  Support comes in around the October lows at 0.6425.  There has been little movement in the NZD/AUD cross rate, which sits around 0.9480. 

NZ rates continued to move lower yesterday, with a 3bp parallel shift lower in the swaps curve and the market now pricing around a 50% chance of an August RBNZ rate cut.  But we should see some reversal today, and steepening in the curve, given the bounce in Treasury yields.  The PMI is released this morning. 

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