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: FX is sitting out the equity fun. Sterling to price BoE cuts?
John J. Hardy
Chief Macro Strategist
Summary: The US dollar has refused to turn lower despite the generous liquidity provision from the Powell Fed and the US-China trade deal and equity market melt-up have failed to inspire the normally risk appetite-sensitive Aussie and Kiwi, a curious disconnect. Boris Johnson reminds us that we still face a tough post-Brexit uncertainty slog from here.
The equity market melt-up continues apace and we even discuss in this morning’s Market Call podcast whether the action is turning outright parabolic, which has been associated in the past with a rapid destabilization. We saw a similar, far more protracted episode of parabolic upside action in early 2018 that preceded the big volatility event that wiped out short volatility funds. In any case, currencies are largely sidelined and showing very little beta to the equity market’s celebration of central bank liquidity provisioning. One of the bigger disconnects is that inability of the Aussie and Kiwi to rally despite the strong-as-it-gets backdrop of risk appetite and the conclusion of the phase one US-China trade deal.
Part of the weakness in AUD is from the RBA overnight, in which the minutes from the recent meeting point to a policy review at the February meeting and the discussion of having further room to cut rates took short Australian rates sharply lower. The action in AUDUSD looks downright bearish, and will look even more so on a run below 0.6825-00.
Elsewhere, UK Prime Minister Boris Johnson reminds us that Brexit isn’t over just because it happens, because one of the biggest questions of all after the de facto Brexit now certain to take place on January 31 next year is the end of the transition period at the end of 2020 and whether the UK and EU have managed to put together a free trade agreement. Johnson declared yesterday it is his intention to get the deal nailed down by then and wants to keep a No Deal position on the table as leverage in ongoing negotiations with the EU side. Sterling caution gathered pace yesterday and 1.3200 in GBPUSD has fallen this morning, suggesting the risk of a deeper setback for sterling here. Today’s UK data may remind us how weak the UK economy remains and lead to BoE rate cuts in 2020.
Chart: GBPUSD
The market seems to be rediscovering that Brexit uncertainty is still a clear and present danger for sterling, as Boris Johnson taking a tough stance on the post-Brexit transition period (end of 2020) trade deal and insistence on keeping a No Deal option on the table could make for a drawn out game of chicken that we know too well from the past three and a half years. Sterling took a dive yesterday and the price action deepened this morning, taking GBPUSD below 1.3200 and thus nullifying the entire rally post-election. The risk now is a full retreat back to 1.3000 or even lower if price action is not corralled near this 1.3200 area gap-closure.
The G-10 rundown
USD – impressive that the US dollar maintains a bid despite the massive provision of Fed liquidity, and we’re very interesting to see how the US dollar behaves over the transition to the New Year on all of the focus of liquidity issues into year end. For now, the comeback is sufficiently strong to keep the bears at bay.
EUR – the very weak sterling offering a bit of contagion for the euro as well, and disappointing for EUR bulls that EURUSD is shying away from the pivotal 1.1200 level again. Also disappointing is that a boost in sentiment on the Chinese outlook in the wake of the US-China trade deal hasn’t done more to support the single currency.
JPY – the yen is the one currency showing some consistent beta to the melt-up in risk appetite into year-end here, and will likely prove high beta exposure to any shift in the mood - especially if US data proves weaker from here and changes the narrative.
GBP – post-Brexit transition period could stretch out over the horizon and lead to BoE cuts next year, a risk the market is not sufficiently pricing. Interesting to see which candidate emerges in the days/weeks to take the BoE governorship.
CHF – quite inert to all of the hubbub affecting sterling and the JPY – really not sure what to do with the franc except ignore it until it shows signs of life.
AUD – the Aussie really dragging here and can only imagine where it would be if the backdrop was more pessimistic. The market pricing 60% odds of a February cut after the RBA minutes overnight..
CAD – the firmer USD finally felt in USDCAD as well after the recent run lower and it looks like the run below 1.3150 was too much for now. The CAD sensitive to oil prices and the US economy outlook as USDCAD trades dead in the middle of the last several months’ range and implied volatilities recently hit record lows.
NZD – the kiwi continuing to absorb some weakness from the weak AUD and AUDNZD is working through the last bits of its range back to 2016 if it drops below 1.0400.
SEK – a modest consolidation in EURSEK this morning after its run lower, but the next pivotal test for SEK is the Thursday Riksbank and how the bank spins guidance on a rate hike back to zero interest.
NOK – EURNOK steering away from the downside break NOK bulls are gunning for as we are seeing some consolidation after the strong move down from 10.20 to just ahead of 10.00. The beginning of 2020 and end of NOK’s seasonality changes may prove more pivotal than this Thursday’s Norges Bank meeting.
Today’s Economic Calendar Highlights (all times GMT)
- 0930 – UK Nov. Jobless Claims Change
- 0930 – UK Oct. Employment Change
- 0930 – UK Oct. Unemployment Rate
- 1330 – Canada Oct. Manufacturing Sales
- 1330 – US Nov. Housing Starts/Building Permits
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