Overnight, there was a series of central bank rate cuts that sent bond yields sharply lower and unsettled global markets.
The Reserve Bank of New Zealand (“RNBZ”) cut its policy rate by 50bps to 1.00%. The move was larger than expected as only a 25bp had been anticipated. One thing is for sure, the RBNZ is trying to get out ahead of this global growth slowdown. The aggressive policy rate move overnight seemed pre-emptive. You can watch the RBNZ press conference here in which Governor Adrian Orr discusses the “business du jour.” His words, not mine. The Reserve Bank of India (“RBI”) cut its policy rate more than expected by 0.35 percentage point to 5.40%. The Bank of Thailand (“BoT”) also cut its policy rate overnight to 1.50% from 1.75%. All three economies are impacted by trade conflicts and global growth slowdowns.
Notably, G10 central banks who have not “blinked” yet are the European Central Bank (“ECB”) – behind the curve once again – and the Bank of Canada. This suggests that when and if they do “blink” and cut their respective policy rates that their currencies are likely to be negatively impacted.
All eyes will be on the September 4th Bank of Canada policy rate decision, and even more-so, the September 12th ECB policy decision and the September 18th Federal Reserve policy decision. Speaking today, Chicago Fed President Charles Evans suggested there could be more Fed easing saying, “And you could take the view that the risks now have gone up, and as we think we’re going to get closer to the zero lower bound with higher probability, that would also call for more accommodation.”
Buy Bonds, Wear Diamonds
The surprise outsized RBNZ rate cut and a weak German industrial production read for June further fueled a bond rally. Bonds, of course, are also a safe-haven/flight to quality asset. Regarding US bond yields, at the time of writing, the US 30 year yield is nearing an all time low and the US 10 year yield has fallen to an intraday low of 1.5931. German 10 year and 30 year bond yields have hit new lows. The sharp moves in the bond market made equity markets nervous. Equity markets are questioning — “Is there something we aren’t seeing?”
The chart below shows the German 10 year yield less the US 10 year yield (orange line). Although the German 10 year yield has fallen notably over the past week, the US 10 year yield has fallen more. As a result the spread German 10 year less US 10 year yield has become less negative and this has given support to EURUSD.
Chart: Spread German 10 yr yield less US 10 yr yield vs EURUSD (source Bloomberg)
Battle of the Safe Haven Currencies
The chart below shows the USD Index (“DXY”), the US 10 year yield, and the VIX Index. It looks as if, according to the VIX Index (yellow line), the USD Index is about where it should be. The USD is a safe-haven currency and should be supported during times of high market volatility. What is weighing a bit on the USD currently is, as discussed above, some EURUSD strength, due to the drop in US yields relative to German yields, and the strength in the other safe-haven currencies CHF and JPY. See the second chart below, which shows the G10 FX moves against the USD since July 31st – the Fed rate announcement. The USD index is sitting just under key resistance 98.00 and another spike in volatility, the VIX Index, should cause it to break higher.
Chart: USD Index vs. VIX and US 10 yr yield (source: Bloomberg)
Chart: G10 FX moves vs. USDJPY and CHF lead the pack (source Bloomberg)
Little Bird Causes Trouble
The aggressive 50bp rate cut by RBNZ overnight, negatively impacted NZDUSD (“the Kiwi”), which fell from 0.6650 to 0.6446. AUDUSD suffered collateral damage as a result of RBNZ rate cut. AUDUSD took out the January flashcrash low of 0.6741, falling to 0.6677. Risk-off sentiment is bad for growth and equity sensitive commodity currencies, and both AUDUSD and NZDUSD will continue to feel negative effects of this market sentiment. AUDUSD is especially vulnerable to further weakening of China’s Yuan – 0.6500 is the next support. NZDUSD has little support as well – 0.6130 (low of Aug 2015).
Chart: Intra-day AUDUSD and NZDUSD at time of RBNZ rate cut (source:Bloomberg)