Risk appetite improves on Omicron optimism and China policy easing. US equities, UST yields, oil prices all higher

Whippy market conditions continue, with a new week seeing a reversal of some of Friday’s price action, with US equities up about 1% and the US 10-year rate up 7bps. Oil prices are up over 3%, which has supported the AUD and CAD, but the NZD has been left behind in the commodity currency recovery, languishing around 0.6750.

Market sentiment has improved for a day at least, but with the VIX index still near 30% there is still a fairly cautious underbelly. The market might have taken some heart from US CDC head Fauci’s weekend comments that the early data on Omicron are “a bit encouraging regarding the severity” of the variant. An easing of policy by China has been an added bonus.

The early indications are that the new Omicron variant is likely to evade the protections of current vaccines to at least some extent, but it is unlikely to cause more severe illness than previous variants. This is because the T-cell response is still active against Omicron, even if the mutations on the spike protein reduce the chance of antibodies to bind. A South African immunologist noted that early computer analysis backed this theory, while lab results are still in process to confirm this suspicion.

On Chinese policy, the PBoC cut the reserve ratio requirement by 0.5%, a move widely expected after Premier Li indicated as much on Friday. The move coincides with maturing loans from the medium-term lending facility worth 950b yuan, while the RRR cut will free up 1.2T yuan of liquidity, effectively providing a modest net injection.

Likely more important for the market was a report from state news agency Xinhua that outlined economic priorities for 2022 after a meeting of the communist party central committee. It contained the statement that the government would “support the commercial housing market to better meet the reasonable housing needs of buyers, and promote the healthy development of the real estate industry”.  The statement avoided commentary used in previous releases that took a harsher stance towards the property market, which the market took as a signal that property curbs will be eased.

Meanwhile, more detail has been leaked on Evergrande’s imminent debt restructuring, which would be the largest on record, expected to include all public bonds (including offshore) and its private debt obligations.

The economic calendar has been light to start the week. German factory orders unexpectedly slumped by 6.9% m/m in October, driven by an almost 11% fall in investment goods from outside the euro area, while domestic orders rose 3.4%.

After Friday’s 0.8% fall, the S&P500 opened on a positive note and over the past few hours has hovered around the +1% mark. The Euro Stoxx 600 index closed up 1.3%, recovering much of the loss seen over the prior two sessions. US Treasury yields jumped higher on the Asian open and have pushed up further, with the 10-year rate tracking up around 1.42%, up 7bps for the day. The curve is slightly flatter, with the 2-year rate up only 4bps.

After last week’ s tumble (in fact six weekly consecutive falls), oil prices have opened the new week higher, currently up over 3%, with Brent crude near USD72. The combination of higher oil prices and China’s policy easing have supported the AUD, up 0.6% to 0.7050 since Friday’s close. The CAD has also been well supported, up 0.5%, while the NZD missed the memo, trading flat by hovering in a tight range around the 0.6750 mark, seeing a notable fall in NZD/AUD to 0.9580.

RBNZ Deputy Governor Bascand gave an interview to the FT where he said that if house prices cooled down faster than expected it could affect the RBNZ’s forecast for rapid interest rate rises next year. In last month’s MPS, the Bank projected 5.6% house price inflation next year but a number of anecdotes already suggest that the housing market has hit the wall, following the 180bps lift in key mortgage rates, the tighter macro prudential setting, tighter bank lending conditions and the government’s investor tax changes.

Reflecting the more positive risk sentiment backdrop, JPY and CHF have been the worst performing majors. USD/PY is up 0.6% to 113.50 while the EUR has also underperformed, down 0.3% to 1.1280.

The domestic rates market saw lower rates across much of the curve yesterday, reflecting a combination of Friday’s offshore moves and the modest reversal from the Asian open. The 10-year swap and NZGB rates both fell 4bps.

In the day ahead, outgoing RBNZ Deputy Governor Bascand gives an on-the-record speech on “Reflections of a Central Banker”. He is too-nice and diplomatic to get stuck in and argue how central banks have sown the seeds for the next financial crisis.  It is fitting then, that the RBA follows this afternoon, with a likely on-hold policy decision, which means it will keep buying $4b of government bonds per week until at least mid-February to keep interest rates suppressed, despite a rising inflationary backdrop.  Elsewhere, Chinese and US trade data, and German industrial production round out the calendar.