The USD and US rates drift lower. US wants more trade talks with China. Fed sees ‘restrictive’ rates needed. Oil prices reach four year highs. Eyes on US CPI

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By Nick Smyth

Press reports that US Treasury Secretary Steve Mnuchin had invited China to attend trade talks have given a sharp lift to the NZD and AUD.  There wasn’t much reaction in either equity or bond markets to the trade news though.  US yields have drifted lower ahead of tonight’s US CPI release.

After reaching a low of 0.6503 in the London morning, the NZD has since moved almost 1% higher to 0.6560 after the WSJ reported on a possible resumption in US-China trade talks.  According to the reports, US Treasury Secretary Mnuchin – who is perceived to be one of the more moderate voices within the US administration – had invited Chinese officials to meet in the coming weeks to discuss trade.  President Trump may hold off on imposing tariffs on the $200b of Chinese imports before the conclusion of the talks. 

Market expectations of a breakthrough are probably reasonably low given the two sides have failed to reach agreement in previous rounds of talks (the US demands to date have been unacceptable to China), but the news came as a welcome boost to the CNH and, consequently, the NZD and AUD.  The CNH is around 0.7% stronger on the day, with the AUD – the market’s preferred China ‘proxy’ within G10 – up 0.8%.  Given the current negative sentiment towards China and the near-record short positioning in the NZD and AUD according to the CFTC, there is the potential for last night’s moves to extend further in the near-term. 

Outside of EMFX and commodities, which were both higher on the day, there wasn’t much positive spill-over from the trade news to broader risk markets.  The S&P500 is down around 0.1% on the day and the NASDAQ 0.5% lower.  US equities have been relatively unaffected by the ratcheting up in trade tensions over recent months, which suggests they probably won’t benefit to the same extent as Chinese equities, for instance, from more positive developments. 

US rates have drifted slightly lower over the past 24 hours, with the 10 year yield down 1bp to 2.96%, but still within reach of the psychologically important 3% level.  Lower than expected US PPI and a strong US 10 year bond auction both helped support bonds on the day, although there will be far more interest in the US CPI report released tonight. 

Fed Governor Brainard, seen as an influential member of the FOMC, spoke overnight and echoed comments from several other Fed officials recently that the cash rate may need to go into restrictive territory.  Brainard noted that “it appears reasonable to expect the shorter-run neutral rate to rise somewhat higher than the longer-run neutral rate.”  Brainard said she kept a close eye on the yield curve (the 2s10s curve is now just 21 bps), but cautioned that the decline in the term premium may distorting the level of longer-dated Treasury yields and, by extension, the information content that the curve provides; an inverted yield curve has been a historically reliable lead indicator of US recession since WWII.  Finally, Brainard noted rising risks in the corporate sector, and in particular leveraged lending, which could suggest some emerging signs of ‘overheating’ in the financial sector.  Brainard’s comments didn’t have much impact on market pricing, but we would interpret them as implying the Fed intends to tighten by more than the market currently prices. 

In FX, the USD is weaker across the board against G10 currencies, as well as most of the EMFX universe, amidst the more positive news on trade.  The DXY is 0.4% lower on the day and at a two-week low. 

Oil prices have moved higher again, with Brent crude oil reaching $80 per barrel for the first time since 2014.  Against a backdrop of reduced Iranian oil supply and the impending arrival of Hurricane Florence (which is expected to pressure US gasoline supplies), the weekly DOE report showed a larger than expected drawdown in crude inventories. 

The rise in oil prices and growing hopes of a NAFTA deal has boosted the Canadian dollar by over 1% from this time yesterday.  Shortly after we published our report yesterday, the CAD moved higher after President Trump said that talks were going well and Canada wanted a deal.  Those gains have extended overnight after Mexico’s economy minister Guajardo said he believed there was a “high chance” of a US-Canada trade deal.  USD/CAD has now moved below the 1.30 mark. 

NZ rates moved up 1-1.5bps yesterday following the previous sessions moves in US Treasury yields, with a steepening bias evident on the curve.  The long-end of the government bond curve was 2-2.5bps higher ahead of the NZDMO’s tender of $250m of 2029 maturity nominal bonds today.  NZ inflation-indexed bonds performed strongly for the second day running, with real yields falling around 2bps, although the implied 10y market ‘breakeven inflation rate’ is still languishing around 1.3%, well below the 2% mid-point of the RBNZ’s inflation target. 

There is a busy session ahead with the Australian labour market report released, the BoE and ECB meetings and US core CPI.  The Turkish central bank also meets, with the median expectation for a 325bp hike to 21%, although the range of estimates for the central bank’s move at this meeting is as wide as 725bps. 


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