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: Spotlight on JPY crosses and EURNOK
John J. Hardy
Chief Macro Strategist
Summary: While markets await the Fed Chair Powell speech today it is worth having a look around the edges of the G10 for other themes outside the inevitable USD focus in coming hours and days. On that note, we consider interesting developments in JPY crosses that will lie ahead as the safe haven bond market volatility has come alive in fits and starts over the last two weeks and have a look at EURNOK, which traded down near key support this morning.
Trading focus:
USD reaction over and on the other side of Fed Chair Powell speech: already covered this week, particularly in yesterday’s FX Update. We’ll update our impressions of the action on the other side of the speech in tomorrow’s update.
JPY crosses – an interesting development of note in recent sessions has been the Japanese yen’s sympathetic gyrations with the increased volatility in safe-haven bond markets, which will inevitably take their signal from Fed Chair Powell’s speech today as well. (The JPY often moves in positive correlation with bond prices, negative correlation with yields) Since the trough of the market crisis back in March, the lower safe haven yields, strong rebound in risk appetite and the commodity price rebound have driven a reflationary narrative that have generally sunk the JPY. The Powell speech event risk could have profound consequences for the market’s confidence in its underlying narrative for the better or the worse, and the implications for the JPY could easily be as affected as for the US dollar. If the Powell speech proves a “sell the narrative” moment and yields back down and risk appetite goes negative, we would likely see a JPY lurch to the upside – with EURJPY the JPY cross closest to approaching interesting downside pivot levels as we look at below. If the market is impressed with Powell’s Average Inflation Targeting (AIT) argument and yields rip higher as bonds sell off (under the assumption that any eventual yield cap policy only comes much farther down the road), the JPY could fall sharply again. Stay tuned, the JPY volatility could match or exceed that for the US dollar today and tomorrow.
Chart: EURJPY
EURJPY has come under some pressure in fits and starts over the last two weeks of trading and we eye the 124.00-50 area in the wake of today’s Powell speech, with further downside potential quite large if the market at least temporarily waxes cautious again on the outlook and bids back up safe haven bonds in the wake of the speech after a recent sell-off that had generally taken the JPY to new lows basket-wise versus the other G-10 currencies. Either way, the speech is a test of the narrative since the market trough and commodity recovery that took place in late March into early April and drove the JPY weaker over that time frame (such that AUDJPY just scraped a new cycle high ahead of Powell’s speech today).
EURNOK – as we await the impact of the Fed Chair Powell speech later today, we also keep an eye on EURNOK, which has once again been pressing down on an interesting chart area below 10.50 this morning, having since backed up slightly. Factors supporting the NOK include a country that has suffered less of a growth hit to its GDP at -5.1% QoQ, relative to any other European economy in the same quarter. As well, this crisis won’t touch Norway’s sovereign balance sheet, as all of the significant deficit spending the government is doing to stimulate will be funded by unloading assets from the country’s pension fund, so unlike the central bank QE required by other countries for governments to fund themselves. NOK is still cheap in long term valuation terms and could be set for an additional rally if sentiment in Europe continues to improve as we note below.
Chart: EURNOK
From here, EURNOK prospects are focused to the downside (stronger NOK), provided oil finally breaks higher more durably than it has been able to recently, and provided we sidestep the double-dip fears in Europe and elsewhere from the COVID-19 outbreak, which may require a steady drumbeat of positive outcomes from the various vaccine candidates undergoing trials at present. If the outlook darkens, NOK could remain rangebound here and EURNOK could explore higher resistance levels after a series of lower highs that looks NOK-positive, provided we soon break below this line of consolidation and the 10.50 area more forcefully. That could set up a run toward the next important area into 10.30-25. Specific to today’s key Fed chair Powell event risk and beyond the medium term fundamental situation, If Powell’s speech triggers a “sell the fact” consolidation in the narrative supporting risky assets and even oil prices in recent weeks, NOK could be in for some rough sailing here, but the structural picture looks better for NOK at these valuations than for the euro, so any setback and squeeze higher would likely prove temporary unless we are headed for a profound and sustained new trough in oil prices and market sentiment. We’ll update the outlook either way on EURNOK in the days ahead, but the situation will likely need to break one way or the other in the near term after a persistent shrinking of trading ranges over the last several weeks.
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