NZD at day's low around 0.7230 USD after touching 0.7300 on an illiquid day; local rates biased upwards; USD up and UST higher across the curve on NY Fed's Dudley's speech, market remains sceptical that the Fed will raise rates this year

By Jason Wong

It’s all looking pretty good out there, with global equities showing solid gains, helped by a positive turnaround in the US tech sector and no releases of US data – which have shown an underwhelming run recently – to spoil the party.  Argentina plans to issue 100-year bonds, a country that has defaulted five times in the last century, at less than 8%.  It must be a bull market.

On Sunday, newly-elected French President Macron’s party won a decisive majority in Parliamentary elections, giving him plenty of scope to push through his agenda, which includes liberalising the labour market and pushing for closer European integration.  The result was well-anticipated and had little impact on the euro or French assets.

The only event of note was a talk given by the influential NY Fed President Dudley.  He was upbeat about the growth outlook, suggesting that although the current recovery was long, “we still have quite a long way to go”.  He was also optimistic that the tight labour market would lead to higher inflation and was keen to “very judiciously” withdraw monetary policy accommodation.

This drove a broadly based recovery in the USD, although the move has been fairly modest, with the USD majors index up 0.3%.  US Treasury yields are higher across the curve, with the 2-year rate up 4.5bps to 1.36% and the 10-year rate up 3.5bps to 2.185%.   The latter has now almost fully recovered the 10bps fall in yield after the soft CPI result last week, with the Fed’s unrevised firm policy outlook supporting the move.

The market is still sceptical that the Fed will hike rates again this year, with the probability of a rate hike before year-end currently sitting around 45%.  We think that the Fed will probably pause the hiking cycle in September and instead begin to reduce its balance sheet and leave the next rate hike until December.  Beyond this year, the market prices in only one hike during calendar 2018.

Apart from the stronger USD overnight, there is little else to report on currency markets, with little variation in cross currency moves.  The yen is the weakest of the majors, reflecting higher US rates.  USD/JPY is up 0.6% to 111.50 and NZD/JPY is up to a fresh 3-month high of 80.6, after earlier touching 81.  If we’re right in our view that US rates will track higher in the second half, then downward pressure in the yen should continue, given the BoJ’s yield curve control policy which ensures widening global-Japan bond yield spreads.

The NZD almost touched 0.73 in yesterday’s illiquid Monday Asian trading session for no good reason, although stronger PSI and consumer confidence data didn’t go unnoticed.  It has been a fairly steady fall since then and the NZD is currently near its low for the day around 0.7230.  At the local close yesterday, NZD crosses were all higher, but they have since moderated, and now look fairly flat for the day.  The AUD is around 0.76 and NZD/AUD is flat at 0.9520.

The local rates market saw a slight bias to higher rates, with 2-year and 10-year swap rates up about 1bp to 2.205% and 3.155% respectively.  From the end of last week, some paying interest emerged at the short end of the curve, with some fearing that the RBNZ on Thursday could surprise with a more hawkish tone, as did the Bank of England, US Fed and Bank of Canada last week.  We doubt any surprise will be forthcoming, with the RBNZ likely to repeat the key “neutral” policy message it has been delivering all year.

There’s a little bit more on the economic calendar over the next 24 hours, with key speeches by the Fed’s Fischer and the Bank of England’s Carney’s Mansion House speech.  Tonight’s GDT dairy auction is expected to be fairly flat, although the recent trend has been for positive surprises.


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