Global rates and equities moved sharply lower overnight; disappointing US data sparked a turnaround in the USD, which has weakened across the board; NZD has bounced back above 0.65; NZ rates continued fall yesterday

Global rates and equities moved sharply lower overnight, with heightened trade tensions continuing to weigh on sentiment and a much weaker than expected US business survey raising concerns about the US growth outlook.  The disappointing US data sparked a turnaround in the USD, which has weakened across the board.  The NZD has bounced back above 0.65.  NZ rates continued fall yesterday amidst growing global risks and the 10 year swap will break 2% today for the first time on record. 

It’s been a ‘risk-off’ session for global markets overnight, with equity markets a sea of red and bond yields sharply lower as markets anticipate another round of central bank easing.  The US-China trade stand-off continues to hang over market sentiment, with no signs either the US or China are willing to take steps to deescalate the dispute.   Indeed, rhetoric from China appears to be hardening, with two commentaries in the state-owned People’s Daily taking aim at the US, with one likening the recent restrictions on Huawei as the US making steps to start a “technology cold war”.  And China’s Ministry of Commerce spokesperson Gao Feng told reporters “if the U.S. wants to resume talks, they should show sincerity and correct their wrong practices” adding that “only on a basis of equality and mutual respect can the talks continue.”  Meanwhile, Trump announced a $16b aid package for farmers, to soften the blow from Chinese tariffs, suggesting that he is preparing for a drawn out conflict.  It’s hard to see what’s going to break the current standoff although Trump has form with executing sharp U-turns (i.e. from threatening North Korea with war to meeting North Korean leader Kim at summit).  The market might hope, but as we stand there is no sign either side is willing to blink first. 

Adding to the negative sentiment, the US manufacturing PMI fell to 50.6, its lowest level since 2009, and well below market expectations.  The market tends to place more weight on the ISM manufacturing survey (released early next month), but the large downside surprise to the PMI – led by the key new orders index – was enough to reignite concerns about the US economic outlook.  The Services PMI was also well below expectations, to its lowest level since mid-2016 and not far above the 50 level that divides expansion from contraction.  Respondents to the survey cited trade war worries and increased uncertainty.  European data didn’t provide much encouragement either.  Both the manufacturing and services PMIs slipped further, albeit not too far from market expectations, while the German IFO fell to its lowest level since late 2014. 

US Treasury yields had already been edging lower during the European trading session, but the US PMI data caused a further sharp fall.  The 10 year Treasury yield is now down 8bps on the session, to 2.3%, its lowest level since the end of 2017.  The closely watched 3m10y yield curve has inverted again, to -6bps, in a possible recession warning.  A 6% plunge in WTI crude oil prices has added to the downward pressure on rates via a 5bp decline in US breakeven inflation.  Meanwhile, expectations of Fed rate cuts continue to grow, with the market now pricing a 70% chance of a cut by September and almost 1½ cuts by the end of the year. 

Equity markets are down sharply amidst growing concerns about the global growth outlook and the US-China trade dispute.  The S&P500 is currently 1.7% lower as we write with the NASDAQ now down over 2%.  The energy sector has led declines (-4%), in response to the sharp fall in oil prices, followed by the China-sensitive IT and industrials sectors.   European equities had earlier fallen 1.5%-2% with China’s CSI300 1.8% lower.  Surprisingly, the VIX remains at a comparatively low 17.5. 

The USD was initially supported by the risk-off backdrop and made a new high for the year in the New York morning.  But the US PMI data, and growing expectations of Fed rate cuts, sparked a quick turnaround.  The USD is now lower on the day (DXY -0.2%).  It’s also possible that the sharp moves in markets have led to a positioning unwind across asset classes.  With CFTC data indicating the speculative market is heavily net long USD, position liquidation would be expected to lead to USD selling. 

Unsurprisingly, the safe-haven Japanese yen and Swiss franc sit atop the currency leader-board, with both currencies around 0.75% stronger.  The GBP is flat against the USD, underperforming all currencies in the G10 with the exception of the oil-sensitive Canadian dollar and Norwegian krona.  British prime minister Theresa May is expected to announce her resignation in the coming days, with the only debate it seems around whether the announcement comes on Friday, as the Times reported, or Monday, after the results of the European parliamentary election are known. 

The NZD and AUD have tracked movements in the broad dollar and have appreciated over the past 24 hours.  The NZD made a fresh year-to-date low of 0.6482 early in the London morning, but it has subsequently rebounded to 0.6520, up 0.4% on the day. 

NZ rates were made fresh record lows yesterday amidst the decline in rates offshore.  The 2 year swap was 2bps lower to 1.515% while the 10 year swap rate fell 4bps to 2.01%.  Given the chunky moves in the overnight trading session, the 10 year swap will break below 2% for the first time on record when trading opens this morning. 

In other NZ news, Fonterra yesterday announced a wide, but realistic, range on its opening 2019/20 milk price forecast of $6.25 to $7.25. The milk price mid-point of $6.75 is likely lower than many were expecting given that if current international pricing and currency levels persist for the season ahead they would equate to a milk price of at least the mid $7s. Implicitly, on our calculations, Fonterra’s forecast builds in some easing in international pricing ahead and/or a higher NZD. This seems sensible to us, given the uncertainties prevailing. For the 2018/19 season, the milk price forecast has been tightened to $6.30 to $6.40 from $6.30 to $6.60 previously. We previously forecast $6.50 but have adjusted down to $6.35 following today’s guidance.

Also, ahead of the Budget next week, Finance Minister Grant Robertson yesterday indicated that the government was looking into changing its fiscal debt target.  The current target is that net core Crown debt fall to 20% of GDP by 2021/21, but Robertson indicated that the government was considering adopting a 15% - 25% for subsequent years.  The shift to a range, on Treasury’s advice, is meant to ensure that the government can respond to different economic circumstances in the future (for instance, more government spending to support the economy in a recession, which will increase debt/GDP).  The move gives the government more wiggle room with regard to future spending, although Robertson said the Budget would still show the government on track to hit its current 20% target.  There was a mild underperformance by government bonds to the announcement, with long-term NZGB yields falling 2bps on the day, less than the 4bp decline in the 10 year swap. 

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