NZD battered as New Zealand enters sharp lockdown, RBNZ still to hike?

Tuesday saw another downbeat session for Asia Pacific markets; major equity bourses were down across the region, with China’s major index the Shanghai Comp losing 2.0%, the Hang Seng dropping 1.7%, the Nikkei 225 falling 0.4%, the ASX 200 down 0.9% and the NZX 50 down 0.7%. A few different negative fundamental catalysts are being cited by analysts as weighing on sentiment; 1) further regulatory crackdowns were announced by Chinese authorities last night, with new regulations aimed at the internet sector designed to ban “unfair competition” and restrict the use of user data, 2) Covid-19 concerns; Japan is set to extend its state of emergency in Tokyo and several other regions, new reported infections in Australia’s New South Wales state (which contain the country’s largest city Sydney) continue to rise and New Zealand was abruptly placed under the highest level of lockdown restriction after the first Covid-19 infection in six months was detected in Auckland, 3) news that China held sea and air military exercises near Taiwan.

Geopolitical strategists fear that one of the spills over effects from the rapid collapse of the Western backed Afghan government after the US military pull-out will be the emboldening the US’s major geopolitical adversaries. In other words, signs of American geopolitical weakness (which the failure in Afghanistan signals) may increase the risk of a Chinese invasion of Taiwan. Meanwhile, another point being raised by geopolitical strategists is the risk that, under Taliban control, Afghanistan is likely to become a haven once again for international terrorist groups, whose international terrorist attacks have in the past had serious market ramifications. Stocks in Europe and major US equity futures are down this morning (Stoxx 600 -0.1%, S&P 500 futures -0.5%), weighed by downbeat Asia market sentiment given the above concerns.

The global economic slowdown narrative has also received a boost this week; following a sharp downturn in the Chinese credit impulse a few months ago (a widely followed lead growth indicator) and months of deceleration in Chinese PMIs, Monday saw a sharp slowdown in the YoY growth rates of Chinese Retail Sales, Industrial Production and Fixed Asset Investment. Meanwhile, warnings signs that the pace of the US economic recovery has peaked are blinking after early August survey data (the University of Michigan Consumer Sentiment survey last Friday and the NY Fed Manufacturing Survey on Monday) showed signs of a deterioration in sentiment in both consumers and businesses this month, with sentiment in the former seemingly predominantly weighed by the recent rise in Covid-19 infection rates in the US. US Retail Sales for the month of July is expected to show a slowdown in consumer spending today, further strengthening this narrative. Some might find it surprising that all of the above negatives (concerns about the pandemic, geopolitics, the Chinese regulatory crackdown and global growth) is not weighing on US and European equities more; S&P 500 futures are just 0.5% below the record highs set during yesterday’s US session and are still up around 1.3% on the month, while the Stoxx 600 is just 0.7% below the record levels hit last Friday and is still up around 2.4% on the month.

That could be because; 1) the above noted market concerns have been weighing heavily on global bond yields; US 10-year yields are this morning heading back towards the 1.2% mark and are at their lowest in over a week while 10-year German yields briefly dipped below -0.5%, close to lows of the year set at the beginning of the month of -0.52% – remember that low bond yields increase the relative investment attractiveness of equities given their higher yields and greater scope for capital appreciation, 2) the above noted concerns (particularly about a slowdown in global growth) increase the probability that global central banks will maintain accommodative policy for longer (something equity markets love).

In that regard, the future policy path of the FOMC remains a key market theme; we had more hawkish rhetoric on Monday from Fed’s Rosengren, who judges that one more month of strong jobs growth would be sufficient to satisfy the bank’s requirement to begin tapering its bond buying programme. This was not a surprise to markets given Rosengren has typically been amongst the most hawkish Fed members. Much more importantly, Fed Chair Jerome Powell will be giving remarks later in the day. He has so far refused to give any specifics on what he deems might be an appropriate timeline for QE tapering. There is a chance his comments today could fail to add anything new, given he may want to wait for the Fed’s annual Jackson Hole event (26^th-28^th August), given that this has historically been used as a platform to guide market expectations regarding future FOMC policy. 

Taking a look at FX markets this morning; amid the market’s modestly risk off tone, safe-haven currencies including USD, CHF and JPY sit atop the G10 rankings this morning. The euro is also holding up quite well, after Eurozone Q2 Employment data was released this morning and showed a surprise increase in employment during the quarter of 1.8% versus forecasts for a 2.1% drop. GDP growth in the quarter was also confirmed at a robust pace of 2.0% QoQ. Underperformance is being seen in the more risk sensitive currencies, such as AUD, NZD, CAD and GBP and this has helped push the DXY 0.1% higher on the session to the 92.70s, though the aforementioned drop in US bond yields, which is being driven by a fall in US real yields (10-year TIPS are back to more than one-week lows around -1.15%), is capping further dollar gains for now.

The New Zealand dollar is by far this morning’s worst performer, with NZDUSD coming close to printing three-week lows just above 0.6900 this morning amid a near 1.5% drop in the pair on the session. The general risk off market tone is one factor, but the main thing weighing on the kiwi this morning is the news of New Zealand going back into a strict nationwide lockdown following the first reported case of Covid-19 in roughly six months in the city of Auckland. This complicates things for the RBNZ, who are set to announce a policy decision during Wednesday’s Asia Pacific session, where they had been expected to hike interest rates by 25bps. Westpac, who had been calling for a 25bps hike at this week’s meeting are now calling for the RBNZ to hold rates at 0.25%, saying the bank should wait for further clarity on the Covid-19 situation. Most other analysts/banks suspect that the bank will go ahead with the rate hike despite the lockdown, but its forward guidance is now expected to be more dovish by caveating that further rate increases will depend on the domestic Covid-19 situation. Elsewhere, we had the release of the minutes from the RBA’s last meeting, which at the time surprised markets when the bank stuck to its plan to start tapering bond buying despite lockdowns across the country. The minutes had a dovish tilt and indicated that the bank is prepared to take action should coronavirus lockdowns across the country threaten a deeper economic setback. AUDUSD is down about 0.7% this morning and has dropped back under 0.7300. 

Separately, pound sterling hit its lowest level in three weeks versus the US dollar this morning and cable has now slipped back under the 1.3800 level. A positive labour market reports this morning has mostly been overlooked; for reference, the unemployment rate unexpectedly fell to 4.7% in the three months to June, versus forecasts for it to hold at 4.8%, its lowest level since August 2020. Total employment, currently at 28.9M, is now just 201K below its pre-pandemic levels. Analysts at Credit Agricole said that “the data has offered the pound relatively little support… because the labour market conditions in the UK are expected to soon start deteriorating again after the expiry of the government’s furlough scheme next month”. Ahead, GBP traders will be on the lookout for July Consumer Price Inflation data on Wednesday, July Retail Sales data on Thursday and the release of the preliminary August Markit PMI surveys for the manufacturing and services sectors on Friday.

Finally, a quick check on commodity markets. The aforementioned Delta concerns continue to weigh on crude oil prices, with WTI down about 0.6% in the mid-$66.00s. That means WTI is down over 9.0% on the month and is down more than 13% from post-pandemic peaks set back in July of close to the $77.00 level. Crude got some modest support overnight after OPEC+ sources told Reuters that the cartel does not think oil markets need more crude than they currently plan to release in the coming months. This comes after White House urged the group to increase production last week given fears that rising crude oil prices threaten the global recovery. Another factor being touted by analysts as weighing crude oil market sentiment over the last few weeks is the fact that the peak fuel demand season (i.e. Summer) in the Northern Hemisphere is coming to an end.

Looking elsewhere in commodities, spot gold prices (XAUUSD) are being supported by the drop in real yields being observed in US and European bond markets. XAUUSD is back in the $1790s and looking to test the $1800 level again, having rebounded sharply in recent days from the post-July NFP “flash-crash” lows last Monday around the $1680 mark. That’s a more than 7.0% rally from lows in seven trading sessions – impressive stuff. In terms of why gold has been able to recover so well; the combination of 1) growing concerns about a slowing global economy as Chinese data continues to worsen and US data shows further signs of growth having peaked and 2) rising concerns that the spread of the Covid-19 delta variant may hurt global growth going forward, is creating a positive environment for gold, in part given that this combination has been pushing real yields lower (gold has a negative correlation to real yields). As long as the above-mentioned negatives don’t lead to too much strength in the safe-haven US dollar, which is not the case right now (largely thanks to low US real yields undermining the buck’s carry appeal), gold can continue to recover. However, if the Fed continues to press ahead with monetary policy tightening, as it seems likely that they will, this could create a positive environment for the US dollar. This could weigh on gold.

The Day Ahead

The July US Retail Sales report, out at 1330BST, is the first of two main events of the day; headline sales are expected to drop 0.3% MoM in July (a deceleration from June’s 0.6% growth rate), while the MoM rate of growth in core sales is expected to moderate to 0.1% from 1.3% in June. US Industrial Production numbers for the month of July are then out at 1415BST; production is expected to have risen 0.5% MoM, a slight acceleration from June’s growth rate of 0.4%. The final US data of note on the day is the NAHB Housing Market Index for August, expected to hold steady at 80. The second of today’s main events is a speech from Fed Chair Jerome Powell at 1830BST. Markets will closely scrutinise anything the Fed chairman might have to say on the bank’s QE tapering plans, as well anything regarding the potential timeline for eventual rate hikes.