Equity and bond markets stabilised on Friday night; USD fell for a second session running with investors starting to contemplate Fed rate cuts this year; NZD has continued to recover from its year-to-date lows reached earlier in the week

Equity and bond markets stabilised on Friday night with Trump’s comment that Huawei could be included in a possible trade deal with China helping to calm nerves.  The USD fell for a second session running with investors starting to contemplate Fed rate cuts this year.  Against that backdrop, the NZD has continued to recover from its year-to-date lows reached earlier in the week.  NZ rates continued to slump on Friday, with new lows across the curve and OCR rate cut expectations building. 

After the sharp falls on Thursday night, global equities stabilised on Friday, supported by comments from Trump that Huawei could be “included” in a possible trade deal with China.  Huawei has become the recent focus of the trade dispute, with the US commerce department placing the company on its ‘entity list’ that bars US companies from supplying it with critical equipment for its products, unless a special licence is granted.  Trump described Huawei as “very dangerous” but his suggestion that the US could ease restrictions on the firm in the event of a trade deal seemed to support the view of some commentators that the president sees it leverage in the negotiations.  Trump added that there was a “good possibility” that US-China trade negotiations could get back on track, although no talks are currently scheduled. 

China continues to threaten retaliation, with Chinese ambassador to the US Cui Tiankai saying “we will do whatever’s necessary to protect the legitimate interests of our companies, of our people and of our country…if things are moving in the wrong direction, then you could see a response very soon.”  While China hasn’t specified what that response might be, commentators have speculated that it could include greater restrictions and red tape on US firms operating in China, possible consumer boycotts of US brands, such as Apple, export restrictions of rare earth materials used in high tech electronics and, of course, the potential for China to allow the CNY to depreciate. 

The S&P500 and NASDAQ were both up a modest 0.1% on Friday following gains of 0.5% to 1% among European indices.  That still left the S&P500 and NASDAQ 1.2% and 2.3% lower on the week respectively.  Commodity prices also partially recovered from the sharp falls the previous session, with WTI crude 1.2% higher and copper up 0.5%.  Trading activity was light ahead of the long weekends in the US (Memorial day) and the UK. 

US Treasury yields have edged higher, after reaching their lowest levels since late-2017 on Friday.  The 10 year Treasury yield was 3bps higher to 2.32%.  US durable goods orders were slightly weaker than expected in April, although prior months were revised down and capital goods orders disappointed expectations.  Like the Markit Manufacturing PMI survey the previous day, the report suggests that the US manufacturing sector has softened in response to the global slowdown and trade tensions with China. There wasn’t much change in Fed expectations, with the market still pricing a slightly better than even chance of a rate cut by the September meeting. 

The USD was weaker across-the-board for the second day running.  After making year-to-date highs on Thursday, the USD has since moved lower (with the much weaker than expected US PMI data the proximate cause).  The DXY was 0.4% lower on the week and BBDXY down 0.5%.  Growing expectations of Fed rate cuts, albeit without much change on Friday, look to have been the trigger for the turn-around in the USD. 

UK Prime Minister Theresa May announced her resignation on Friday, effective 7th June.  This was no surprise to anyone, including the market, and there was little reaction in the GBP (in fact, the GBP was 0.5% stronger on Friday).  The market’s attention now turns to the impending leadership contest, with the front-runners all Brexiteers, including current favourite Boris Johnson.  The risk of a no-deal Brexit and new elections has undoubtedly increased, which explains the GBP underperformance over the past week (it was the only currency to fall against the USD last week, albeit marginally).  The leadership contest is expected to take some weeks, with a new leader likely to be appointed before end of July, before the parliamentary summer recess. 

The NZD and AUD were both stronger on Friday night, with the latter recovering from an earlier dip in Asian trading after Westpac became the first bank to forecast three rate cuts this year by the RBA.   29 of 30 economists now expect an RBA rate cut in June and 24 of 28 expect a follow-up cut in August, but Westpac was the first to call for a third cut.  The AUD was up 0.4% on Friday to 0.6925, while the NZD increased 0.5% to close the week at 0.6550.  The weaker USD backdrop, and probably some position unwinding in the speculative community, contributed to the moves in the AUD and NZD. 

NZ rates made fresh lows on Friday, with the 10 year swap falling below 2% for the first time on record.  The 10 year swap fell as much as 5bps, to a low of 1.955%, as Australian rates fell in response to Westpac’s forecast change for the RBA.  Rates recovered slightly over the remainder of the session, with the 10 year swap eventually closing 3.5bps lower at 1.97%.  Shorter-dated swap rates continued to fall as well with OCR rate cut expectations steadily building – an August rate cut is now seen as a 75% chance and the market prices around 1½ cuts by early 2020. 

There is plenty to focus on domestically this week.  The Budget is on Thursday, and we will be watching for any tweaks towards more fiscal stimulus, especially around CAPEX plans.  The RBNZ releases its Financial Stability Report on Wednesday and there will likely be discussion around the Bank’s proposal to significantly increase bank capital requirements.  Also on Wednesday, the ANZ business survey is released, the first since the government’s decision not to go ahead with its proposed capital gains tax.  While there are still plenty of other issues that continue to weigh on business sentiment, the government’s decision may provide something of a boost to the survey’s activity indicators.  Offshore, the official Chinese PMIs are released on Friday as well as the US core PCE deflator, the Fed’s preferred inflation gauge. 

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