Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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China's faltering economy sets the mood
John J. Hardy
Chief Macro Strategist
Summary: China reported a year-on-year drop in both Imports and especially exports for December, data that raises further concerns about the trajectory of the country's economy. Elsewhere, Brexit developments are set to accelerate this week after tomorrow’s meaningful vote on Theresa May’s ill-fated deal.
China reported a 7.6% drop in exports in December, a development that looks particularly negative given the widespread front-loading of demand from the US ahead of the feared tariff increases that were originally set to go into effect on January 1. In that light, data in the coming months will be closely watched. For now, the weak Chinese data has set the tone for the beginning of the week.
An FT opinion piece questions whether some sort of secret G20-like accord has been agreed in secret to engineer some relief for global markets, in which the Fed has shifted to a more dovish stance in exchange for China boosting its currency. The aim would be to ensure Chinese exchange rate stability and confidence in investing in a China clearly confronted with a severe policy challenge in managing its deleveraging process while preventing a strong US dollar from weakening global liquidity and the global growth outlook as too much debt in the world is denominated in US dollars.
Others argue that the stronger CNY is merely an effort by China to leverage its position in ongoing trade negotiations with the US as the highest level trade representative from China, Liu He, is set to visit Washington at the end of this month. Either way, the key question for currency traders from here is how much further the CNY rally will advance. Late Friday saw the first push back and two-way price action in a few weeks – so we have established a pivot point at minimum here.
Elsewhere, Brexit developments will pick up pace from here after tomorrow’s failure of the parliamentary meaningful vote on Theresa May’s Brexit deal. May is warning that the House of Commons could try to frustrate Brexit entirely and has also vowed not to pursue an extension of Article 50, though I have a hard time seeing how a delay is avoided. Opposition leader Jeremy Corbyn provides only incoherent counterpoint as he is caught between the rock of resounding remain sentiment among Labour MP’s and the hard place of widespread popular support for Brexit among Labour voters.
Chart: AUDUSD
AUDUSD is a reasonable proxy in FX crosses for whether the new CNY strength and Fed dovishness will continue to drive sentiment and flows in the near term. The AUDUSD has arguably reached its first important pivot point in the form of the 61.8% retracement of its last sell-off wave (if we use the lowest daily close as the key low rather than the JPY cross flash-crash inspired low) that comes in just below 0.7250.
An FT opinion piece questions whether some sort of secret G20-like accord has been agreed in secret to engineer some relief for global markets, in which the Fed has shifted to a more dovish stance in exchange for China boosting its currency. The aim would be to ensure Chinese exchange rate stability and confidence in investing in a China clearly confronted with a severe policy challenge in managing its deleveraging process while preventing a strong US dollar from weakening global liquidity and the global growth outlook as too much debt in the world is denominated in US dollars.
Others argue that the stronger CNY is merely an effort by China to leverage its position in ongoing trade negotiations with the US as the highest level trade representative from China, Liu He, is set to visit Washington at the end of this month. Either way, the key question for currency traders from here is how much further the CNY rally will advance. Late Friday saw the first push back and two-way price action in a few weeks – so we have established a pivot point at minimum here.
Elsewhere, Brexit developments will pick up pace from here after tomorrow’s failure of the parliamentary meaningful vote on Theresa May’s Brexit deal. May is warning that the House of Commons could try to frustrate Brexit entirely and has also vowed not to pursue an extension of Article 50, though I have a hard time seeing how a delay is avoided. Opposition leader Jeremy Corbyn provides only incoherent counterpoint as he is caught between the rock of resounding remain sentiment among Labour MP’s and the hard place of widespread popular support for Brexit among Labour voters.
Chart: AUDUSD
AUDUSD is a reasonable proxy in FX crosses for whether the new CNY strength and Fed dovishness will continue to drive sentiment and flows in the near term. The AUDUSD has arguably reached its first important pivot point in the form of the 61.8% retracement of its last sell-off wave (if we use the lowest daily close as the key low rather than the JPY cross flash-crash inspired low) that comes in just below 0.7250.
The G-10 rundown
USD – The government shutdown is now the longest ever and must be solved at least partially in coming days as major airports are beginning to shut down terminals and bills and wages are not being paid. The overarching question is the degree to which the USD is being managed lower and whether the confidence in global markets this has inspired can extend. USDCNY is the chief driver of USD direction at the moment, in my estimation.
EUR – the reversal of the 1.1500 break is an ugly development for bulls, and must be overcome quickly in the coming session or two or we risk getting bogged down in the lower range again.
JPY – yen strength returns on the weak risk sentiment at the beginning of the week. Highest beta for JPY pairs in the JPY/risk crosses and versus EM.
GBP – sterling bid at the margin on hopes that Brexit process is derailed and ends in no change to the status quo – but this can go anywhere and may just shift to a chaotic endgame that stretches over the horizon we risk a delay and the any or both of elections or a referendum.
CHF – the rally last week, likely correlated with the EURUSD move, was a red herring and has retreated on the setback to risk sentiment as the week gets underway. Likely to see continued correlation with EURUSD? To the downside, 1.1200 is pivotal.
AUD – as we have noted above, AUDUSD likely to maintain the highest correlation with the ongoing twin impacts of the dovish downshift from the Fed and CNY strengthening. Still, let’s not forget the concerns for the domestic credit crunch in Australia.
CAD – USDCAD finally bounced and for the moment looks passively correlated with oil markets and risk appetite.
NZD – AUDNZD support in the 1.0550 area hanging in there for now and New Zealand short rates have more aggressively slipped lower recently – and are now yielding 165 basis points, 10 bps below the Reserve Bank's official cash rate and 15 bps below Australia’s 2-year paper. Still long-term supporter of upside outlook there.
SEK – core CPI coming in a touch hotter than anticipated, but massive decreases in Swedish housing prices last week caught our attention and set up the idea that the Riksbank is only normalising because QE and NIRP don’t work, not because the desired inflation and growth normalisation outcomes have been achieved. The proposed new Löfven government coalition with passive support from the traditional centre-right opposition is not necessarily good news for Sweden as it is a spin on a German-style grand coalition that risks only emboldening the populists if the growth trajectory weakens from here.
NOK – oil prices correcting at a pivotal level have NOK on the defensive again as EURNOK couldn’t quite make the plunge through the 9.75-80 pivot zone.
Upcoming Economic Calendar Highlights (all times GMT)
1000 – Eurozone Nov. Industrial Production
1330 – Canada Dec. Home Price Index
USD – The government shutdown is now the longest ever and must be solved at least partially in coming days as major airports are beginning to shut down terminals and bills and wages are not being paid. The overarching question is the degree to which the USD is being managed lower and whether the confidence in global markets this has inspired can extend. USDCNY is the chief driver of USD direction at the moment, in my estimation.
EUR – the reversal of the 1.1500 break is an ugly development for bulls, and must be overcome quickly in the coming session or two or we risk getting bogged down in the lower range again.
JPY – yen strength returns on the weak risk sentiment at the beginning of the week. Highest beta for JPY pairs in the JPY/risk crosses and versus EM.
GBP – sterling bid at the margin on hopes that Brexit process is derailed and ends in no change to the status quo – but this can go anywhere and may just shift to a chaotic endgame that stretches over the horizon we risk a delay and the any or both of elections or a referendum.
CHF – the rally last week, likely correlated with the EURUSD move, was a red herring and has retreated on the setback to risk sentiment as the week gets underway. Likely to see continued correlation with EURUSD? To the downside, 1.1200 is pivotal.
AUD – as we have noted above, AUDUSD likely to maintain the highest correlation with the ongoing twin impacts of the dovish downshift from the Fed and CNY strengthening. Still, let’s not forget the concerns for the domestic credit crunch in Australia.
CAD – USDCAD finally bounced and for the moment looks passively correlated with oil markets and risk appetite.
NZD – AUDNZD support in the 1.0550 area hanging in there for now and New Zealand short rates have more aggressively slipped lower recently – and are now yielding 165 basis points, 10 bps below the Reserve Bank's official cash rate and 15 bps below Australia’s 2-year paper. Still long-term supporter of upside outlook there.
SEK – core CPI coming in a touch hotter than anticipated, but massive decreases in Swedish housing prices last week caught our attention and set up the idea that the Riksbank is only normalising because QE and NIRP don’t work, not because the desired inflation and growth normalisation outcomes have been achieved. The proposed new Löfven government coalition with passive support from the traditional centre-right opposition is not necessarily good news for Sweden as it is a spin on a German-style grand coalition that risks only emboldening the populists if the growth trajectory weakens from here.
NOK – oil prices correcting at a pivotal level have NOK on the defensive again as EURNOK couldn’t quite make the plunge through the 9.75-80 pivot zone.
Upcoming Economic Calendar Highlights (all times GMT)
1000 – Eurozone Nov. Industrial Production
1330 – Canada Dec. Home Price Index
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