Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Risk sentiment strong despite trade war, rising yields
John J. Hardy
Chief Macro Strategist
Summary: Markets have just seen Washington and then Beijing deploy the largest round of tariffs yet in their ongoing trade scuffle, but risk sentiment remains resilient. One possible factor there could be Beijing's disavowal of using CNY devaluation as a policy plank.
Two key developments driving market action at the moment for the major currencies:
Rising bond yields: rising sovereign bond yields around the world are driving a weaker USD and a weaker JPY due to the ability of risk sentiment to rally at the same time. Yes, in many cases the US rate rises are a bit sharper than elsewhere, but the sense of some convergence nonetheless (core EU yields have risen nearly as fast as US yields) is helping other currencies to keep pace with the greenback and even rally sharply. In Japan’s case, the more or less fixed yields out to 10 years mean that the currency absorbs the impact of rate rises elsewhere since JGB’s theoretically can’t. An until the Bank of Japan sends the signal that it will turn yields loose to move of their own accord, and/or until the US Tweeter-in-Chief turns his attention to BoJ policy and JPY weakness as essentially a pillar of Japanese economic policy, the JPY will likely weaken in tact with the rise in yields. Overnight, the Bank of Japan failed to show signs of shifting on policy once again.
Risk-on despite trade war headlines: the ability of markets to put on a risk-on show just as the US and China have announced their most aggressive trade tariff announcements looks like a classic “sell the fact” moment, as risk has rallied across the board despite this latest very aggressive exchange between the US. Everyone is searching for answers on how this can be, and not sure I have much to add to the noise other than agreeing that China’s electing to go with a 5-10% level on its latest round of tariffs rather than 10% across the board suggests a measure of friendliness in its stance. As well, fresh promises not to use CNY devaluation as a policy provided a fillip (which makes sense as China’s external balances show imports rising far more rapidly than exports in recent years and especially the energy import bill would rise perilously if China chose the devaluation route).
Today, look out for the UK CPI up this morning and then how the Brazilian real and other EM currencies react to today’s rate announcement from Brazil’s central bank. Brazil’s currency has been under tremendous pressure, but the central bank has failed to signal any intent to hike rates. The first round of the country's chaotic presidential election is up on October 7.
Chart: AUDUSD
The Aussie is working higher on the ebullience in Asian markets despite the latest exchange of tariff threats from the US. China’s avowal to avoid CNY devaluation and a chunky rally in the major Australian mining stocks are a boost for the Aussie, and heavy short speculative positioning could drive a further squeeze higher. Note that we are rapidly running out of room in the descending channel, a break of which could open up for 0.7500 or higher, even if we remain in a secular bear market.
Rising bond yields: rising sovereign bond yields around the world are driving a weaker USD and a weaker JPY due to the ability of risk sentiment to rally at the same time. Yes, in many cases the US rate rises are a bit sharper than elsewhere, but the sense of some convergence nonetheless (core EU yields have risen nearly as fast as US yields) is helping other currencies to keep pace with the greenback and even rally sharply. In Japan’s case, the more or less fixed yields out to 10 years mean that the currency absorbs the impact of rate rises elsewhere since JGB’s theoretically can’t. An until the Bank of Japan sends the signal that it will turn yields loose to move of their own accord, and/or until the US Tweeter-in-Chief turns his attention to BoJ policy and JPY weakness as essentially a pillar of Japanese economic policy, the JPY will likely weaken in tact with the rise in yields. Overnight, the Bank of Japan failed to show signs of shifting on policy once again.
Risk-on despite trade war headlines: the ability of markets to put on a risk-on show just as the US and China have announced their most aggressive trade tariff announcements looks like a classic “sell the fact” moment, as risk has rallied across the board despite this latest very aggressive exchange between the US. Everyone is searching for answers on how this can be, and not sure I have much to add to the noise other than agreeing that China’s electing to go with a 5-10% level on its latest round of tariffs rather than 10% across the board suggests a measure of friendliness in its stance. As well, fresh promises not to use CNY devaluation as a policy provided a fillip (which makes sense as China’s external balances show imports rising far more rapidly than exports in recent years and especially the energy import bill would rise perilously if China chose the devaluation route).
Today, look out for the UK CPI up this morning and then how the Brazilian real and other EM currencies react to today’s rate announcement from Brazil’s central bank. Brazil’s currency has been under tremendous pressure, but the central bank has failed to signal any intent to hike rates. The first round of the country's chaotic presidential election is up on October 7.
Chart: AUDUSD
The Aussie is working higher on the ebullience in Asian markets despite the latest exchange of tariff threats from the US. China’s avowal to avoid CNY devaluation and a chunky rally in the major Australian mining stocks are a boost for the Aussie, and heavy short speculative positioning could drive a further squeeze higher. Note that we are rapidly running out of room in the descending channel, a break of which could open up for 0.7500 or higher, even if we remain in a secular bear market.
The G-10 rundown
USD – in cycles past we would have looked for a breakout in US long yields to serve as a positive USD catalyst, but as long as yields elsewhere are managing to track the US and risk appetite avoids destabilisation, the USD could instead underperform for now.
EUR – the euro a bit of a laggard here as the focus is more on currencies that tend to be more high beta to risk appetite, but still constructive on upside potential as long as EU yields are participating in the global sell-off in bonds.
JPY – as described above, as long as the BoJ keeps its fixed rate – “YCC” regime, the yen will absorb global yield rises. Still, the market could get testy if the BoJ shows the least crack in its resolve as 10-year JGB yields approach the 15 bps level.
GBP – sterling pulling away from fresh highs this morning ahead of the CPI data. At these levels, more notable moves more likely to be driven by Brexit developments, whether positive or negative.
CHF – makes sense to finally see CHF weakening as risk sentiment improves even amid rising yields– a decent rally here in EURCHF and there may be more to come – the next focus is the upside pivot just ahead of 1.1350.
AUD – an Aussie short squeeze has been set in motion – how far will it shoot higher is the next question. There isn’t much more room within the descending channel in AUDUSD before the upside bound is impacted – see above, while the reversal in AUDJPY is already rather profound.
CAD – the loonie working into the last layers of support, with the close this week looking pivot for whether a more profound sell-off into 1.2500 can unfold from here. Canadian CPI print on Friday a key even risk for whether Canadian short rates can tighten relative to their US counterparts.
NZD – NZDUSD in danger of a squeeze if the action remains above 0.6600 on the other side of this evening’s NZ GDP report and the USD is on its back foot. Given the recover in the Aussie, would have expected AUD outperformance – but let’s have a look at the NZ data tonight.
SEK – Fibo retracement levels for EURSEK incoming below 10.35, but not seeing much to corral this move until the 10.20-25 area comes into view. The 200-day moving average is now above 10.20 and was last crossed above last October.
NOK – Key test for NOK over the Norges Bank tomorrow and the bank’s guidance. We’re constructive on NOK given the backdrop and if the Norges Bank guidance supports the recent move in Norway’s 2-year rates to the highest since late 2014.
Upcoming Economic Calendar Highlights (all times GMT)
• 0830 – UK Aug. CPI
• 1230 – US Q2 Current Account Balance
• 1230 – US Aug. Housing Starts / Building Permits
• 1300 – ECB’s Draghi to Speak
• 1430 – US Weekly Crude Oil/Product Inventories
• 2100 – Brazil Selic Rate
• 2245 – New Zealand Q2 GDP
USD – in cycles past we would have looked for a breakout in US long yields to serve as a positive USD catalyst, but as long as yields elsewhere are managing to track the US and risk appetite avoids destabilisation, the USD could instead underperform for now.
EUR – the euro a bit of a laggard here as the focus is more on currencies that tend to be more high beta to risk appetite, but still constructive on upside potential as long as EU yields are participating in the global sell-off in bonds.
JPY – as described above, as long as the BoJ keeps its fixed rate – “YCC” regime, the yen will absorb global yield rises. Still, the market could get testy if the BoJ shows the least crack in its resolve as 10-year JGB yields approach the 15 bps level.
GBP – sterling pulling away from fresh highs this morning ahead of the CPI data. At these levels, more notable moves more likely to be driven by Brexit developments, whether positive or negative.
CHF – makes sense to finally see CHF weakening as risk sentiment improves even amid rising yields– a decent rally here in EURCHF and there may be more to come – the next focus is the upside pivot just ahead of 1.1350.
AUD – an Aussie short squeeze has been set in motion – how far will it shoot higher is the next question. There isn’t much more room within the descending channel in AUDUSD before the upside bound is impacted – see above, while the reversal in AUDJPY is already rather profound.
CAD – the loonie working into the last layers of support, with the close this week looking pivot for whether a more profound sell-off into 1.2500 can unfold from here. Canadian CPI print on Friday a key even risk for whether Canadian short rates can tighten relative to their US counterparts.
NZD – NZDUSD in danger of a squeeze if the action remains above 0.6600 on the other side of this evening’s NZ GDP report and the USD is on its back foot. Given the recover in the Aussie, would have expected AUD outperformance – but let’s have a look at the NZ data tonight.
SEK – Fibo retracement levels for EURSEK incoming below 10.35, but not seeing much to corral this move until the 10.20-25 area comes into view. The 200-day moving average is now above 10.20 and was last crossed above last October.
NOK – Key test for NOK over the Norges Bank tomorrow and the bank’s guidance. We’re constructive on NOK given the backdrop and if the Norges Bank guidance supports the recent move in Norway’s 2-year rates to the highest since late 2014.
Upcoming Economic Calendar Highlights (all times GMT)
• 0830 – UK Aug. CPI
• 1230 – US Q2 Current Account Balance
• 1230 – US Aug. Housing Starts / Building Permits
• 1300 – ECB’s Draghi to Speak
• 1430 – US Weekly Crude Oil/Product Inventories
• 2100 – Brazil Selic Rate
• 2245 – New Zealand Q2 GDP
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