The drift lower in the NZD has been against a backdrop of a broadly based, albeit modest, gain in the USD; GBP remains under pressure; UST 10-yr rate is down slightly to 2.93%

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By Jason Wong

In a quiet start to the week, the NZD has been tightly range-bound, with some drift towards the downside overnight, against a backdrop of a broadly-based nudge up in the USD.  GBP has been the weakest of the majors.  US 10-year rates are down slightly.

There has been no fresh news on the trade war front.  In yesterday’s note, we outlined Friday’s events and Trump’s weekend tweets.  Getting some airplay yesterday was an editorial published in the China Daily on Sunday night, the flagship state-run English newspaper.  The commentary was scathing towards the US and Trump, viz: “Considering the unreasonable US demands, a trade war is an act that aims to crush China’s economic sovereignty, trying to force China to be a US economic vassal just like Japan accepted the Plaza Accord…China has time to fight to the end. Time will prove that the US eventually makes a fool of itself.”

We have become increasingly nervous about the US-China trade war escalating to a new and more dangerous level and this presents significant downside risk to the NZD, even though the current spot rate has opened up a 5% discount to our short-term model estimate.  So while bad news is priced into the NZD and the number of short positions by speculators remains at a historical high, the NZD is likely to continue to struggle.  The NZD drifted down into the local close yesterday and slipped further overnight to 0.6725, taking it closer to the bottom of its tight 5-week trading range.  A technical break below support at 0.6690 remains a near-term threat.

The drift lower in the NZD has been against a backdrop of a broadly based, albeit modest, gain in the USD, so the NZD is flat on the crosses, apart from gaining 0.3% to 0.5200 on NZD/GBP.  GBP remains under pressure as Brexit risks overhang the currency, falling to an 11-month low of 1.2920. That milestone has been reached despite the positive turnaround in UK economic data over the past month and the BoE hike last week. The UK’s International Trade Secretary Fox said on Sunday that there is now a 60 percent likelihood of a no-deal Brexit outcome.  This was followed by a response by PM May’s spokesman that May still believes that a Brexit deal with the EU is likelier than not and that no deal is better than a bad Brexit deal.

In economic news, Germany factory orders slumped by 4% in June, much weaker than market expectations, with the Economic Ministry acknowledging that “uncertainty from trade policy played a role”.  The figures pre-date last month’s agreement by the US and EU to hold off from further tariffs as long as negotiations are ongoing.

In the bond market, in a quiet trading session the US 10-year Treasury rate is down slightly to 2.93%, pushing further away from the 3% handle seen last week.  One might argue that the move towards lower rates reflects the escalation of US-China trade wars, but the US equity market doesn’t reflect that risk.  The positive run in US equities continues, with the S&P500 currently up 0.4% and getting close to revisiting January’s high.

NZ rates were 3bps across much of the curve yesterday, responding to the post non-farm payrolls rally on Friday night.  The 2-year swap rate traded as low as 2.10%, the lowest rate since the OCR has been at 1.75%.  However, monetary policy expectations have been steady for the past month or so and the more than 20bps fall in the 2-year rate over recent months reflects the fall in the bills-OIS spread, which has largely been driven by global forces.

This afternoon sees the release of the RBA’s latest policy update, with the Bank’s clear on-hold position and messaging unlikely to change.  Tonight’s GDT dairy auction is expected to show relatively flat pricing.

 


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