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Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
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Head of Fixed Income Strategy
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Macron caves to yellow vests, shifts EU narrative
John J. Hardy
Chief Macro Strategist
Summary: PM May's ill-received vote shift pushed GBP lower but has not lent markets much more visibility while in France, Macron's policy shifts raise the question of deficits.
While UK Prime Minister May’s cancellation of the Brexit deal vote in Parliament has grabbed the headlines and punched sterling for steep losses, this by no means provides further visibility on sterling. Elsewhere, the game changer yesterday was French president Macron caving to the protesters and changing policy that will sharply expand the French deficit and thus dramatically shift the EU narrative.
Sterling was dragged sharply lower after UK Prime Minister May cancelled the vote yesterday and announce that she would meet with counterparts around the EU to appeal for measures that could change a future vote. On the EU side, there is a refusal to change the deal, though promises were made to offer “assurances” that seek to skirt the worst fears surrounding the “Irish backstop” issue that has been a lightning rod of criticism. More below on the GBPUSD chart.
Macron spoke late yesterday and offered a partial mea culpa and a number of policy changes, including tax cuts and a raise of the minimum wage. Most importantly, the measures will increase France budget deficit to well beyond 3.0% next year – possibly as high as 3.5-3.6% depending on the pace of French growth yesterday. This is a game changer for the EU narrative as we now have an essentially core country abandoning fiscal discipline and leaving zero credibility in negotiations with Italy in the populist governments’ plans there to widen deficits.
Were it not for the latest Brexit developments dragging sterling through the dirt, the euro might have rallied more sharply yesterday. Solidarity on the need to abandon austerity would shift the goalposts and could drastically improve the outlook for the euro eventually. Hurdles remain – especially if the EU makes a catastrophic miscalculation on Brexit as we discuss in the chart caption below – as well as whether the new German leadership can sign on to a more expansive fiscal stance – and importantly, one that is pan-European and not aimed at a narrow domestic agenda.
Chart: GBPUSD
Cable the big move yesterday on the news that May would cancel the parliamentary vote on the Brexit deal. She is unlikely to get the EU to salvage the extant deal sufficiently. If the EU gambit is to play chicken on Brexit in the hopes that they can wring a vote from the British public in some future referendum between a stark “WTO no-deal” terms and “pre-Brexit vote status quo” I think they have another thing coming. If this is the gambit, then it would still likely require an extension of the Article 50 deadline to allow some combination of new elections and the definition of second referendum language. Regardless, GBPUSD likely to provide far more beta to the direction in sterling than EURGBP, where a darkening scenario for sterling would feed collateral damage into the euro.
The G-10 rundown
USD – the US dollar generally firm even as equities avoided a fresh meltdown late yesterday. GBPUSD likely a significant driver as it hit fresh lows. The USD may trade in choppy fashion until we get a look at the FOMC statement next week and Powell’s press conference – a dovish hike is the consensus scenario. USD bears will hope for an extremely dovish hike or no hike at all and a melt-up in risk assets.
EUR – Macron’s move to expand the budget is a game-changer for Europe – on the one hand, it eases the focus on Italy, but on the other raises the stakes for EU solidarity coming into 2019. Euro might have taken the news of fiscal stimulus more positively were it not for the aggravation of Brexit fears weighing so heavily on sterling and indirectly on the euro yesterday.
JPY – the yen having a difficult time of late firing consistently as a safe haven, and perhaps Japan’s latest growth data is behind some of the market’s reluctance to take a shine to the currency – nominal GDP in Q3 was down -0.7% on the previous quarter.
GBP – not sure I understand why the market saw the parliamentary vote cancellation as such a shock. It looked headed for an inevitable defeat anyway and there is no clarity on where the situation heads next, but GBPUSD likely to show far more beta to developments than EURGBP, where the euro has to take some collateral damage if sterling continues to weaken on fears of a no deal.
CHF – yesterday’s rally in the franc likely linked to the sterling weakness on latest Brexit developments, but if the fiscal stimulus bug spreads across the EU, the euro eventually finds support – that may have to await longer term developments once and if short-term Brexit hurdles are cleared.
AUD – AUD traders struggling for traction, but we have strong concerns on Aussie as the housing bubble unwinds on the risk that the RBA and the government have to respond along the lines of the US in 2008-09 if credit seizes up. CNY relative stability the only thing anchoring AUD here short term?
CAD – an easier path to downside on the weak housing theme as oil prices drop and there is more to unwind in policy expectation terms from the Bank of Canada.
NZD – the RBNZ’s Orr out speaking late today and have to wonder if he is beginning to get a bit uncomfortable with the kiwi’s relative strength. Given weak risk appetite backdrop, the strong kiwi of late sticks out like a sore thumb.
SEK – short Swedish rates holding up well, given the recent pressure on the currency as the market hanging in there in favouring a view to a Riksbank hike next Thursday. The inability to form a government after the election all the way back in September may be finally weighing at the margin as well.
NOK – a fresh downdraft in oil does NOK no favours. EURNOK rally puts the top of the range toward 9.75 back in focus. Norges Bank on Thurdsay will be happy to sit on its hands.
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