Equity markets ended the week higher, while bond yields fell; USD was weaker across the board, with commodity currencies the top performers; NZD more-than-fully reversed its earlier losses

By Nick Smyth

Markets finished last week in a positive mood, on growing expectations of a US-China trade deal.  Equity markets ended the week higher, while bond yields fell.  The USD was weaker across the board, with commodity currencies the top performers.  The NZD more-than-fully reversed its earlier losses after RBNZ Deputy Governor Bascand said that the central bank could cut if the OCR if the proposed increase to bank capital requirements tightened monetary conditions, although his statement was heavily caveated.  Over the weekend, Theresa May said she was postponing the meaningful vote on her Brexit deal – again – although parliament will still have a vote on extending the Article 50 deadline date this week. 

Market optimism around an extension to the trade war ceasefire, and a possible US-China trade deal, continues to grow.  Chinese Vice Premier Liu, who was in Washington for talks with US Trade Representative Lighthizer, extended his trip to over the weekend to continue the talks, a sign that the two sides were making headway.  Lighthizer said they had made progress on some of the thornier structural issues – such as intellectual property protection – although he added that there were still major hurdles that needed to be agreed, while Liu said he thought a deal was “very likely”.  On Friday, Treasury Secretary Mnuchin said the two sides had come to deal over the USD/CNY exchange rate.  Mnuchin didn’t elaborate, but media have reported that the US has requested that China keep its currency stable (i.e. it doesn’t seek to offset the impact of tariffs by depreciating the CNY).  Over the weekend, Trump labelled the talks “very productive”, setting the scene for an extension to the March 1st deadline for higher tariffs, and allowing time for a meeting with Chinese Premier Xi, to sign off a possible trade deal, at a later date. 

Markets had already been primed for an extension to the trade war ceasefire, but the signs of progress on some of the bigger issues boosted sentiment nonetheless.  The S&P500 was 0.6% higher, closing at its highest level since mid-November, while the NASDAQ was 0.9% higher.  The moves in US equity indices came despite a 27% fall in Kraft Heinz, which revealed a $15b writedown, reported poor earnings results, and said the SEC had opened an investigation into its procurement practices.  The issues at Kraft Heinz look idiosyncratic and don’t necessarily reflect the overall state of the US consumer.  Commodity markets also signalled more optimism on the growth outlook, with copper prices rising 1.5% to their highest levels since July. 

US and global rates were lower on Friday, despite the buoyant mood in equity markets.  The US 10 year Treasury yield fell 4bps to 2.65% while the 10 year German bund fell 3bps to 0.1%.  Interest rate volatility remains very subdued, with the 10 year Treasury yield stuck in a tight 2.60% - 2.80% range since early January and the MOVE index of volatility near record lows.  There was no US economic data on Friday. 

NY Fed President Williams and San Francisco Fed President Daly both alluded to the potential for the Fed to shift towards “average inflation targeting” at some point in the future, at a conference in New York.  The Fed is conducting a review of its inflation targeting framework this year, and some officials are concerned that inflation expectations could drift below their 2% target if inflation does not average 2% over the cycle.  US core inflation has been below 2% for almost all the time since the GFC, although it is currently close to target.  Under an average inflation targeting framework, the Fed would target a period of higher inflation to compensate for the earlier undershoot.  While no decisions have been made, the discussion around average inflation targeting suggests the hurdle for the Fed resuming rate hikes is high.  US 10 year breakeven inflation rose 1bp on the day to 1.92%, its highest level since early December. 

The USD was weaker across the board on Friday with commodity currencies outperforming.  The NZD closed the week at 0.6845, a rise of 0.7% on Friday, and the second-best performing of the G10 currencies, behind the Canadian dollar.  The NZD more-than-fully reversed its fall late Friday afternoon after Bloomberg headlines that the RBNZ could cut the OCR due to the proposed increase in capital requirements.  RBNZ Deputy Governor Geoff Bascand told reporters that the RBNZ’s proposal to increase capital requirements would likely result in a marginal tightening of monetary conditions, although he emphasized that the RBNZ’s decision on the OCR would be based on its outlook for inflation and employment (something the initial headlines did not convey).  The initial fall in the NZD from 0.6810 to 0.6758 looked like an over-reaction given the heavily caveats that Bascand applied, and the NZD spent the remainder of the session moving steadily higher, to close near the highs of the day.  The NZD/AUD closed the week above 0.96. 

The AUD was 0.5% higher on Friday, as RBA Governor Lowe reiterated the central bank’s neutral stance, disappointing those who were expecting a more dovish steer.  On reports of a Chinese ban on Australian coal imports, Trade Minister Simon Birmingham said over the weekend that delays were unprecedented and that there was no indication that Australia was being singled out.  On Friday, China’s foreign ministry denied there was a ban on Australian coal. 

Finally, UK Prime Minister Theresa May announced overnight that she was delaying the parliamentary vote on her Brexit deal, which was originally scheduled to take place this week.  The final vote will now happen before March 12th, ostensibly to allow more time for negotiations with the EU, although critics accuse her of “running down the clock” to put pressure on MPs to agree to the deal.  There will still be a vote this week on an amendment proposed by Labour MP Yvette Cooper to extend the Article 50 process if parliament doesn’t agree to a deal by mid-March.  In other Brexit news, Labour Shadow Chancellor McDonnell told the Evening Standard that Labour was “moving towards” a second referendum.  Another amendment has been tabled for Wednesday by Labour backbenchers that would put May’s deal to another public vote, although it’s uncertain whether this will have the numbers to pass in parliament.  

It’s a big week ahead for markets.  Besides the likely extension to the March 1st deadline date for higher tariffs on Chinese imports, US Q4 GDP is released on Thursday and the manufacturing ISM on Friday.  Consensus for US Q4 GDP is 2.4%, but the Atlanta Fed’s GDPNow is at only 1.4%.  The Chinese PMIs are released on Thursday, with the Caixin version on Friday.  In NZ, the ANZ Business Survey is on Thursday, and some Q4 GDP partials are also released this week, including Q4 retail spending this morning. 

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