Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Euro focus more on ECB than Italy
John J. Hardy
Chief Macro Strategist
Italy’s new Prime Minister Giuseppi Conte won a Senate confidence vote after outlining an aggressive populist platform for Italy that is fully in line with the campaign promises of the two populist parties comprising the government. Conte will also face a vote in the lower house today, but the populists have a stronger majority there.
Italy currently runs a primary budget surplus of around 2% but a net deficit of around -2.3% in 2017 due to interest expenses.
Estimates suggest that a full implementation of the populist programme of flat taxes, a universal basic income, and other measures could cost some 4-5% of GDP and therefore put Italy in massive violation of the EU’s budget deficit rules. The country's sovereign debt yields rose sharply on these developments, with the two-year back to 1.00%, up 25 basis points from the previous day’s close and in contrast with the -0.35% that Italy could fund itself at for two-year debt before the election.
The euro was relatively firm despite the developments in Italy, as we discuss below in the G10 rundown.
Australia reported a stronger than expected rate of Q1 growth and this gave the Aussie a fresh boost as AUDUSD interacts with all manner of pivotal resistance – see our chart below.
Outside of USDJPY, the greenback is back on the defensive coming into this morning as risk appetite has perked up, if in a haphazard fashion as the major equity markets are in a complacent/positive mood even as EMs are showing ugly signs of strain here and there. The Brazilian real is in a negative spiral at the moment and MXN was blasted for sharp losses to new local lows after the Mexican government announced tariffs on US pork, steel, and whiskey.
The US is not making nice with China at the moment. It’s bad enough that the latest round of trade talks have ended with no progress and Secretary of Defense Mattis has raised objections to China’s activities in the South China Sea. But then overnight, the Trump administration encouraged airlines to defy China’s call to not list Taiwan as a country, a move guaranteed to raise Beijing’s ire.
Chart: AUDUSD
The USD is weaker again versus the smaller G10 currencies this morning, led by the AUDUSD charge back higher, as that pair is testing a key zone with local Fibonacci swing level, flatline resistance, and major old trendline implications. The bears need an immediate end of the squeeze here as another firm leg higher and close above 0.7700-50 would fully neutralise the bearish case for now.
The G-10 rundown
USD – the US dollar is on the defensive against the G10 smalls at the moment, but US yields are pushing higher again. If yields can rise gently without upsetting the risk appetite apple cart, the USD may continue to soften, but that may prove a tough combination to sustain. AUDUSD is the bellwether.
EUR - The ECB’s Praet is out this morning with comments taken as hawkish, as he suggests that “signals on convergence of inflation have improved”. A Bloomberg story cites ECB officials claiming that next week’s June 14 ECB meeting could produce an announced end date for QE purchases. Praet also said this morning that the ECB will have to assess whether to unwind the QE programme at the ECB meeting next week. EURUSD first resistance zone 1.1750-1.1825 and then 1.1910 and then 1.2000.
JPY – the yen proving the weakest link as risk appetite has rebounded and yields have risen, both JPY-negative. We are near the critical inflection point again in USDJPY in the 110.00-25 area, just as the US 10-year benchmark is back near the bottom of the 2.95%-3.0% inflection zone.
GBP – sterling getting a boost from a solid services PMI for May and the weaker US dollar. 1.3500 is the next psychological level and the 1.3500-1.3600 zone is the major chart resistance after the massive run lower. Until proven otherwise, we look for opportunities to fade the rally.
CHF – EURCHF managing to avoid a sell-off after the latest widening of Italian sovereign spreads, but seems to run into resistance just above 1.1550 with consistency.
AUD – as noted above, AUDUSD running into critical levels here – all while Australia short rates are modestly higher locally, but still in the middle of the two-month range.
CAD – USDCAD rejecting another attempt at the 1.3000 level yesterday as oil prices rebounded from fresh local lows. The USD outlook the pivotal factor here for whether the pair can punch through higher.
NZD – AUDNZD has put on a show of finding support, and NZDUSD found resistance right near the 38.2% Fibo of the sell-off from the April highs, a possible starting point for fresh bearish involvement.
SEK – the EURSEK chart looks heavy and a break below the 10.20 level could set a test to the big 10.00 level in motion.
NOK – a whole lot of nothing going on, but we’re very close to the big range supports below 9.50 in EURNOK.
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