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: Limited but clear contagion into FX from corona virus
John J. Hardy
Chief Macro Strategist
Summary: We are seeing a fairly typical risk-off pattern across currencies on the worrying news of the corona virus outbreak in China and concerns that this could impact the economic outlook for Asia and beyond. The CNY is off sharply and the US dollar continues to maintain an even keel as watch whether this disease outbreak drives further contagion across asset classes.
The corona virus outbreak in China has taken on new urgency and a spike in attention from financial markets on the confirmation that human-to-human transmission is occurring and on worries of its spread across China, unfortunately ahead of the intensive traveling season during the Chinese New Year that sees hundreds of millions of trips to visit family. We have no way of assessing the potential for this story to drive a further mark down in risky assets from here, we can only highlight that the story can get far worse, both in terms of the human. It took a number of months for the SARS virus outbreak – a similar coronavirus – outbreak to die down back in late 2002 and well into 2003, as we discussed on this morning’s Market Call podcast. The CNY saw one of its largest one-day weakening moves on this story as yesterday’s low near 6.84 in USDCNY is nearly a full percent below the level this morning above 6.905.
Most of the market action yesterday, a US holiday, has aligned along the axis of risk appetite, with the US dollar showing that it doesn’t really mind which way the risk barometer needle swings, broadly speaking, but did show that USD/EM is quickly impacted by risk appetite swings, and even within the G10, the smaller currencies were all impacted negatively by the story - particularly NOK.
Today we watch the German ZEW to see if the December expectations spike continued into this month and suggests rising confidence in the outlook – with further input on the status of the EU economy with Friday’s flash PMI surveys for this month. Expectations are low around this Thursday’s ECB as we await the outcome of the ECB’s comprehensive policy review. Note that if Asian growth fears mount on the virus outbreak, the EU risks a powerful negative impact on its export-oriented economy. Note that the US and France have agreed to a stand-off on the digital tax issue until the end of this year – conveniently after the US election, just like the probably any other issue that might negatively affect Trump’s chances at re-election. (To boot, the White House has begun beating the drum for a zany payroll tax cut to juice sentiment and the economy in the months ahead.)
Chart: EURJPY
EURJPY reached pivotal levels again recently as the yen has underperformed recently on the global inflows into in carry trades and risky assets. The pair poked above the pivotal, major 38.2% Fibo level (of the entire sell-of sequence from the early 2018 highs) in recent days, but looks in danger of rejecting that test if the risk off move currently unfolding worsens, whether driven by the corona virus story or otherwise. A deeper cut lower – perhaps through 121.00 – needed to suggest a more profound technical reversal here and would expect the direction of safe haven bond yields to act as a coincident indicator (lower yields spelling stronger JPY).
The G-10 rundown
USD – the US dollar firmer against the entire EM complex this morning as the CNY has steeply retraced a chunk of its recent gains and on general risk off. Volatility still muted, and the modest dollar rally has yet to show any real momentum.
EUR – the euro a bit heavy as we discuss above in EURJPY, and EURUSD is also having a look at the lows for the year, though the market is giving up on the prospects for any EURUSD volatility after record lows were posted in the implied volatility for all major EURUSD options tenors recently. Given that 1-year options are trading 5.3% and that easily encapsulates the US election – longer term USD bears have opportunity to establish a position for record low options premium (and with far less premium due to carry and basis considerations than a year ago!).
JPY – the Bank of Japan a non-factor overnight as the focus on the corona virus has taken the JPY a bi higher here – nothing profound yet, but the currency may have the potential to come alive rather suddenly if risk off accelerates – particularly given the recorded quiet in JPY volatility.
GBP – speculative positioning in the US currency futures shows speculative sterling longs continuing to build aggressively, but the price action going nowhere amid the risk that the trade deal uncertainty continues to drag on after the UK is sending the signal it wants leeway in establishing its own regulatory framework rather than being forced to copy EU rules.
CHF – the CHF disproving for the moment that it will trade in negative correlation with risk appetite (due to SNB holdings of a large equity portfolio) as EURCHF trades heavily on the lows of the cycle on this modest bout of global risk off.
AUD – downside potential on risk-off and the negative focus on Asia from the virus outbreak as we watch AUDUSD poking at the lows of the year this morning.
CAD – USDCAD refusing to move here, but may get the signal from a cautious Bank of Canada tomorrow, which may finally take the pair more firmly back into the range as we await a vaulting of the 1.3100-50 area to confirm upside potential into 1.3500 again.
NZD – the kiwi potentially impacted by the Asia-focus of the corona virus concerns and any additional risk off on that issue – watching NZDUSD technically as it pokes at the sub-0.6600 pivot levels and then watching the Q4 CPI release this week together with follow-on commentary from the RBNZ.
SEK – would expect pressure on SEK on the corona virus worries – but SEK may be catching a bit of a bid this morning via NOKSEK correcting – see NOK below.
NOK – the populist Progress Party has abandoned the government over an “ISIS bride” and her children being repatriated back into the country – this and weaker oil prices pressuring the currency.
Today’s Economic Calendar Highlights
- 0930 – UK Dec. Jobless Claims Change
- 0930 – UK Nov. Earnings and Unemployment Rate
- 1000 – Germany Jan. ZEW Survey
- 1330 – Canada Nov. Manufacturing Sales
- 1500 – UK BoE’s Carney to Speak
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