Extreme volatility across global markets after China escalated the trade war by hitting an extra 34% tariff on US goods. S&P closed 6% lower as growth assets slumped. Powell focused on inflation suggesting limited scope for a near-term policy pivot

There was extreme volatility across global financial markets into the end of last week. The S&P closed the session more than 6% lower and there were huge moves in currency markets. The US dollar strengthened against G10 currencies and left its largest footprint in the NZD and AUD, which dropped 3% and 4% respectively against the US dollar from the local close. US Treasuries extended the recent rally with 10-yields trading below 4.0%.

Risk sentiment was already fragile as the new US tariff regime continued to reverberate across markets. The initial catalyst for a renewed bout of weakness came after China escalated the trade war by announcing an extra 34% tariff on US goods and imposed export controls on rare earths. The 34% rate matches the level of the reciprocal tariffs. Equities didn’t take any comfort from Fed Chair Powell’s speech which didn’t reflect an increased sense of urgency around lowering rates.

Commodity prices fell sharply on concern about global growth and how tariffs might impact the demand outlook. Brent crude traded below US$65 for the first time since August 2021, with the OPEC+ decision earlier last week to increase supply, also weighing on prices. Base metals tumbled with US traded copper falling 9%. The selling even extended to gold, which illustrates the impact of elevated market volatility, and the requirement to trim positions by investors.

Powell said the tariff increases were larger than expected and would result in higher inflation and slower growth. He noted that tariffs could result in a more persistent rise in inflation and the Fed is obligated to keep inflation expectations anchored. Powell said the central bank was well-positioned to wait, and that it is very difficult to assess the economic impact, until there is greater clarity on the details.

Large market moves made the US labour report less of a focus than normal. US payrolls rose by 228k in February, above the 151k consensus estimate, though there were downward revisions of 48k to previous months. The unemployment rate increased to 4.2%, from 4.1% in February. Hourly earnings met consensus estimates, increasing 0.3% in the month which saw the annual rate dip to 3.8%.

There was an initial sharp move lower in US treasury yields following the news about China’s retaliation. This saw 2-year yields drop nearly 20bp, to a session low of 3.46%, before fully retracing the move after Powell’s comments didn’t imply a near term pivot to easier monetary policy. 10-year yields broke below 4.0% in Asia and traded as low as 3.86% but ended the session little changed at 4.01%.

The US dollar made strong gains against G10 currencies. The defensive properties of the yen and Swiss franc meant they declined the least. On the other end of the spectrum, the AUD, NZD and Scandies saw outsized falls given their typical sensitivity to global growth. The Australasian currencies were already weak in the local session on Friday. By the New York market close, AUD/USD had fallen 4.7% and NZD/USD 3.7% from 7am NZT.

Having traded above 0.5800 on Friday, NZD/USD traded to a session low down towards 0.5550 before recovering to 0.5600. To put the fall in context, it is the sixth largest daily fall in the past twenty-five years. NZD/AUD gained and traded above 0.9250, the highest level since September. Otherwise, the NZD was a lot weaker on the other major crosses. NZD/EUR fell towards 0.5100, a level only seen during the pandemic in the past 15 years. NZD/GBP and NZD/JPY reached multi-year lows.

Amid the volatility, the Chinese authorities have continued to support the yuan and have kept the fix broadly unchanged suggesting a desire to maintain currency stability. FX markets will be closely watching for any change in policy from the Peoples Bank of China, which could damage investor confidence and worsen trade negotiations, as well as weigh on other CNY sensitive currencies, particularly in the Asia Pacific.

There was a significant repricing across NZ fixed income in the local session on Friday reflecting global risk off sentiment. Swap rates moved sharply lower, and the curve steepened. 2-year swaps broke below the bottom of the range at 3.30% and extended lower, ultimately rallying 13bp on the day and closing at 3.19%, a new low for the cycle. The market is pricing the terminal OCR around 2.85%.

Government bonds outperformed swaps at the margin. Of note, the 10y/30y NZGB curve continued to steepen to fresh highs with the ultras lagging in the rally. Australian 10-year government bond futures are little changed since the local close on Friday having rebounded from the yield lows, suggesting limited directional bias, for NZ yields on the open.

It is a quiet economic calendar start to the week with no domestic and only second-tier international data. In any case, economic data will only provide the base case to overlay the impact of the trade war. The RBNZ Monetary Policy Review is the key NZ event in the week ahead. The Quarterly Survey of Business Opinion and the manufacturing PMI are also scheduled. The main release on the international calendar is US CPI data for March.

This note is from BNZ Research and re-posted with permission. The original is here.