US Treasury yields have drifted lower, aided by a dovish speech by Fed Vice Chair Clarida; New Zealand government bond yields moved higher yesterday; the broader theme still remains one of USD strength

Global market moves overnight have been minimal, with the exception of a sharp fall in oil prices.  US Treasury yields have drifted lower, aided by a dovish speech by Fed Vice Chair Clarida.  In contrast, New Zealand government bond yields moved higher yesterday after the Budget revealed smaller surpluses than previously forecast and a corresponding increase to the bond programme. 

There hasn’t been much to move markets overnight, with little fresh news on the US-China trade front.  The S&P500 and NASDAQ are marginally lower (-0.1%) while the 10 year Treasury yield has slipped 3bps from its closing level the previous session, to 2.23%.  Most currencies movements have been restricted to less than 0.15% against the USD.  Oil prices fell sharply (Brent crude -4.5% to its lowest level since late March) after the weekly DOE report revealed a much smaller than expected drawdown in crude oil inventories. 

Influential Fed Vice Chair Clarida gave a speech a few hours ago, in which he strongly hinted at the scenarios that could trigger Fed rate cuts.   Clarida noted “if the incoming data were to show a persistent shortfall in inflation below our 2% objective or were it to indicate that global economic and financial developments present a material downside risk to our baseline outlook, then these are developments that the committee would take into account in assessing the appropriate stance for monetary policy”.  While the US economy was seen to be in a “very good place”, and hence the Fed has argued for a patient approach to policy, it is clearly cognisant of the downside risks to the outlook.  Clarida added that longer-term inflation expectations were “at the low end of a range that I consider consistent with our price stability mandate”.  On the yield curve, Clarida said the Fed pays attention to it, including the recent inversion of the 3m10y spread, and attributed the recent flattening to global developments, although he added that there has yet to be a sustained period of inversion. 

It’s perhaps a measure of how much the market is pricing by way of Federal Reserve rate cuts that there hasn’t been much reaction to the Clarida speech, despite its clear dovish overtones.  The market continues to price around an 80% chance of a September cut by the Fed, almost 40bps by the end of the year and slightly more than three cuts by the end of 2020.  The 2 year Treasury yield was 4bps lower, at 2.78%, with the yield curve steepening modestly. 

In terms of overnight economic data, the second estimate of US Q1 GDP was revised down a fraction, to an annualised rate of 3.1%, mainly due to revisions to capital expenditure.  The US core PCE deflator, the Fed’s preferred inflation measure, was revised down to a 1% annualised rate in Q1 which adds some downside risk to the consensus forecast for tonight’s April reading, which is currently at 1.6% year-on-year.  The US trade deficit was smaller than expected, while pending home sales were much weaker than expected, although the latter series is volatile month-to-month.  The Atlanta Fed GDPNow forecast for Q2 was unchanged at 1.3%, and there wasn’t anything to move the needle on market expectations of Fed policy. 

Currency movements have been negligible, although the broader theme still remains one of USD strength (the USD indices are hovering around their year-to-date highs).  The EUR tested its year-to-date lows in the New York morning, but it has since bounced back to be unchanged on the day.  There was little impact on the AUD from weaker than expected capital expenditure data, which our NAB colleagues viewed as increasing the downside risk to their 0.5% Q1 GDP forecast (the RBA’s forecast is 0.6%).  The NZD is also unchanged over the past 24 hours, and is sitting just above 0.65.  Initial support for the NZD comes in at the recent lows around 0.6480. 

Yesterday’s NZ Budget revealed smaller forecast operating surpluses for the next two years (0.4% for the year-ended June 2020 vs. 1.3% at December’s HYEFU) and a corresponding increase to the domestic bond programme.  Our economics team noted that they saw downside risks to Treasury’s growth forecasts and upside pressure on future expenditure compared to that forecast which present the very real possibility that the Government will soon return to deficits.  As things stand, the government still projects net core Crown debt to decline to 20% by June 2022, in line with its fiscal commitments.  In terms of the economic impact, the fiscal impulse, as measured by Treasury, is negligible but we will await the RBNZ’s interpretation with interest since it flagged government spending as a potential source of upside risk in its May MPS.

The bond programme was bumped up by $2b for the coming fiscal year (to $10b from $8b previously forecast) and by $5b in total over the coming five years.  New Zealand Debt Management (NZDM) also announced its intention to syndicate a new 2031 nominal bond before the end of the calendar year.  Finally, NZDM said it intended to reduce its issuance of inflation-indexed bonds to $500m from the current $1b annual pace of issuance. 

The increase in the bond programme was unexpected, although we saw the risks tilted in that direction, and long-end NZGB yields increased 7bps, outpacing the 4bp increase in the 10 year swap rate, as the market factored in the greater duration it will need to absorb over the coming year.  Net issuance of nominal NZGBs will be positive in 2019/20 for the first time in four years.  In contrast, inflation-indexed bonds performed well, with breakeven inflation on the 2030 to 2040 linkers rising by 5-6bps. 

The focus in the session ahead is the release of the official Chinese PMIs (both manufacturing and non-manufacturing) and the US core PCE deflator during US trading hours. 

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