A day that looked quiet on paper has turned out to be newsworthy. In currency markets, European currencies have surged, led by EUR on hawkish comments by ECB President Draghi, while the NZD has underperformed. Bond yields are higher across the board, driven by Draghi’s comments and this has helped drag down equity markets.
After a number of low vol sessions, EUR is up a chunky 1.4% to 1.1340, its highest level since August last year, driving up other European currencies in the process like SEK, CHF and NOK. ECB President Draghi offered an upbeat assessment of the euro area economic recovery and signalled an eventual removal of policy accommodation. The key sentence in a speech delivered was “As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments – not in order to tighten the policy stance, but to keep it broadly unchanged.” The speech talked of “reflationary” forces in the economy and that factors weighing on the path of inflation at present are “mainly temporary factors that typically the central bank can look through”. The market took that as signalling a further step towards policy normalisation, allowing a discussion of the tapering of asset purchases over coming months.
Draghi’s more hawkish tone sent German bond yields higher, with the 10-year rate up 13bps to 0.37% and driving global bond rates higher, with UK rates up 8bps and the US 10-year rate up 6bps to 2.20%. The ECB’s highly accommodative policy stance has been instrumental in depressing European bond yields and the euro so the market is taking notice of Draghi’s signal that the end of that policy setting is nigh. The ECB will need to tread carefully from here in its communications to avoid a taper-tantrum scenario that the US saw back in 2013. Back then the US 10-year rate shot up by 140bps in a space of a few months after then-Fed Chair Bernanke first signalled a possible tapering of asset purchases.
Much stronger European currencies have spilled over into a stronger GBP, which is up 0.6% to breach the 1.28 mark. Following the release of its Financial Stability Review, the Bank of England raised banks’ counter-cyclical capital buffer initially to 0.5% by June 2018 and then again to 1% in November 2018 to mitigate against the risks posed by 10% annual gains in consumer credit and to prepare for the uncertain outcome of Brexit talks. This will require banks to raise over £11b in fresh capital. By tightening macro-prudential policy members who voted for a rate increase at the last MPC meeting might now pull back on that view, making an imminent tightening less likely. But the UK OIS curve didn’t show much change to near-term policy expectations after the announcement.
In US news, consumer confidence was stronger than expected, with an increasing number of respondents saying that “jobs are plentiful”. The IMF reduced its forecast for US growth by 0.2pp to 2.1% for 2017 and by 0.4pp to 2.5% for next year after removing the previously assumed fiscal stimulus. That remains well short of Trump’s optimistic budget proposal which assumes a 3% target. Fed’s Yellen’s speech in London didn’t offer much new. She noted that the gradual rate-hike pace is well anticipated in markets and that asset valuations are “somewhat rich by traditional metrics”. The S&P500 was already lower before her speech, driven by a weaker tech sector again, and the index made further losses during the speech to be currently down 0.5%.
For the day, only the NZD and yen are currently weaker against the USD. USD/JPY is up 0.2% to 112.10, no doubt driven by wider global rate-JGB spreads. The risk-off tone to markets has seen NZD down to 0.7280 after a short lived spike up to 0.7344 last night. After making a number of breaks above 0.73 over the last couple of weeks, the NZD has yet to close above that mark using New York closes. This suggests the 0.73 mark remains an important area of resistance.
We’ve already noted the rise in US 10-year rates. The curve steepened, with rates driven higher at the long end. The 2-year rate was up by a more modest 3bps to 1.365%. The overnight move suggests that ECB policy is as much an influence on US rates, or even more important, than Fed policy from here.
The NZ rates curved showed only small moves yesterday, but we’ll see a jump higher on the open today. In the calendar ahead, known Fed dove Kashkari speaks this morning during the NZ time zone and there’s not much else tonight either. I imagine that markets will be trying to find their feet and wondering how much higher to take bond yields in the immediate future. If we do see further upward pressure then the overdue equity market correction feared by many investors could be in the makings. This wouldn’t be NZD-supportive.
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