Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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FX Update: Geopolitics and the usual suspects
John J. Hardy
Chief Macro Strategist
Summary: No surprise to see the formerly very weak yen coming out on top as the risk party has been interrupted by the sudden spectre of geopolitical conflict with unpredictable outcomes and aggravated headline risk. While the latest injection of volatility is a refreshing change of pace for currency traders, this kind of environment is fraught with danger.
Overnight, US President Trump approved a successful mission in Iraq to take out Iran’s top military leader, a move that is a drastic escalation of the situation after pro-Iran forces recently attacked a US base and after the US embassy was besieged in Baghdad. The US stock market futures were off over 1% from the highs as of this writing on the news and among currencies, the usual suspects, the JPY and CHF, are absorbing safe haven flows. The market positioning is particularly poor around this ugly introduction of geopolitical risk into the market as the recent focus has been on the celebration of generous liquidity provision from global central banks and a general “reach for yield”.
Unless the US-Iran situation de-escalates very quickly from here, unlikely in the nearest term, market participants may find it difficult to navigate this environment as geopolitical risk is the polar opposite of recent market drivers, unless we are to see especially negative macro data over the next cycle. In the bigger picture, the fault-lines across Iraq have never been resolved and the situation there could remain fraught for the foreseeable future, with any involvement from other major regional powers presenting a further risk of escalation.
In macro data yesterday, the final December EU Manufacturing PMI’s yesterday generally notched slightly higher, but we note the exception of the ongoing “sick man of Europe” Italy, where the number plumbed new depths for the cycle at 46.2. The US December ISM Manufacturing is out later today and is expected to bounce slightly, if still printing below 50. Meanwhile, yesterday’s latest US weekly jobless claims prints remains ever so slightly elevated from the previous range, but not sufficiently so to send a clear signal.
The FOMC minutes are up later today and we will focus on the discussion in the minutes on members’ attitude and guidance on the course of balance sheet expansion in 2020 and any concerns about market behavior driven by Fed actions in 2019.
Chart: AUDJPY
With the sudden injection of geopolitical risk as the New Year gets underway in earnest and ahead of a weekend, no less, we have a look at one of the traditional proxies for risk appetite within the G-10 – AUDJPY, which has reversed hard on the events overnight as traders seek safety in safe haven bonds and pull-back on “reach for yield” trades. The damage to the former rally is particularly heavy here, more so than in AUDUSD and the selling could deepen significantly if the market narrative shifts away from the recent celebration of generous G3 central bank liquidity provision. Another figure or so of downside needed to fully break the back of the rising channel.
The G-10 rundown
USD – the US dollar coming out on top as geopolitical risk disrupts the “easy Fed” narrative and goes against the recent intensification of USD selling. So far, however, the upside has been rather modest, so USD bulls have much to prove.
EUR – the Euro negatively impacted by the situation – perhaps especially via EURJPY flows and EURUSD must stabilise quickly here around 1.1150 or so to avoid the impression that we are reverting to range-bound purgatory once again.
JPY – no surprise to see the JPY suddenly performing its role as the main proxy for risk-on and risk-off here as both bonds rally, driving lower yields and stocks sell-off, reversing recent drivers for a weaker JPY.
GBP – sterling a bit weaker on the change of focus as safe haven seeking at odds with recent popular long sterling trades like GBPUSD and possibly GBPJPY. 1.3000 is an important technical and psychological level for cable.
CHF – the franc is absorbing safe haven flows and the SNB is likely leaning against the price action here now that EURCHF is pushing on the cycle lows this morning.
AUD – the Aussie suffering on some consolidation after the run-up into year-end and especially on the sudden narrative shift that tears the focus away from celebrating the US-China trade deal likely set to be signed later this month. The AUDUSD rally remains intact if the pair steers clear from closing below the 0.6925-00 area.
CAD – the loonie celebrating the big boost in oil prices – particularly as demand for Canadian crude could accelerate if the risk of supply shocks is concentrated in the Middle East. A big technical break here as 1.3000 has fallen in USDCAD as well – the first break of that level since 2018.
NZD – the kiwi not liking the sudden change of focus away from the US-China trade deal and hopes for a global rebound. The NZDUSD rally is so extended that it will take tremendous further downside (far below 0.6600 to start) to demoralize the bulls.
SEK – the krona not taking a liking to relatively weak EU PMI’s yesterday, but more so the sudden risk-off tone and concerns for global growth that come with geopolitical risk-driven higher oil prices. NOKSEK perhaps a bit of a theme on oil prices as well, but SEK bulls in business in EURSEK as long as we remain below 10.60-ish.
NOK – the NOK absorbing inflows as oil prices spike, though with risk appetite negatively impacted, the reaction is muted. Couldn’t be better timing for Norway as the country’s largest new oil field in a long time has come on line in recent months.
Upcoming Economic Calendar Highlights (all times GMT)
- 0930 – UK Dec. Construction PMI
- 0930 – UK Nov. Mortgage Approvals
- 1300 – Germany Dec. Flash CPI
- 1500 – US Dec. ISM Manufacturing Survey
- 1900 – US FOMC Minutes
- 0145 – China Dec. Caixin Services PMI
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