Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Trade war whiplash ahead of the FOMC
John J. Hardy
Chief Macro Strategist
The market has been buffeted by trade war headlines in the space of well under 24 hours, first with an article yesterday suggesting that the US and China could be headed back to the negotiating table followed by news that Trump administration advisers overnight are arguing for an increase in tariffs on $200 billion of Chinese goods.
The market is suffering from a rather bad case of headline fatigue on all things Trump policy-related, however, as the reaction has been rather muted – AUDUSD, for example, doing a round trip from 0.7405 to 0.7440 and back to the 0.7405 area this morning.
The follow-up reaction in the Japanese bond market and the yen to the Bank of Japan’s policy tweaks deserves considerable attention here, as JGB yields first plunged from the former yield ceiling around 10-12 basis points for the 10-year JGB back to about five bps yesterday on the disappointment that the BoJ wouldn’t abandon the ceiling. Now they have spiked all the way back to new highs overnight just above the old ceiling at a new 2-year high of 12.5 bps.
This sets up a very interesting situation for the BoJ and the JPY if global yields pull higher again – note the US 10-year poised near 3.00% again and potentially threatening higher.
If yields do continue higher in the US and elsewhere, the 10-year JGB yield would likely quickly pull to the new 20 basis point ceiling indicated by BoJ Governor Kuroda at yesterday’s press conference and, if the BoJ makes good on its YCC policy, the JGB “market” won’t be allowed to price yields higher from 0 to 10 years, meaning the yen will have to take the adjustment. A constant stream of unlimited JGB purchases and a sharply weaker JPY could sap confidence in BoJ policy and the nation’s currency in the worst instance.
Of course, the entire scenario depends on US yields pulling notably higher, something they have failed to do in any sustained way since approaching the 3.00% level (for the 10-year benchmark) for the first time for this cycle all the way back in February. Still, stay tuned.
Today’s FOMC meeting has all of the makings of a non-event, but we’ll join everyone else in pouring over the statement for any tweaks that suggest a change of stance – unlikely in our view. Yesterday’s slightly weaker than expected PCE inflation data point was shrugged off, suggesting that the bar is a bit higher for pulling down Fed rate hike expectations.
Chart: EURUSD
Time for some resolution in the EURUSD chart as the pair has been triangulating for weeks – some have noted assumptions that August is a low volatility month because it is a summer month are misplaced – the key local levels look like 1.1500 and 1.1800, with the tighter formation breaks more like 1.1600 and 1.1750.
The G-10 rundown
USD – the US dollar is looking firm within an absurdly choppy and constricted range; the tone in USDJPY has changed dramatically, however, and more USD strength could be on top if the US yield curve can lift all along the curve – something that has simply failed to happen for months, so it’s a big “if”.
EUR – the euro somewhat firm in the crosses as inflation beat expectations and has now risen to over 2.0% for the headline number for the first time since 2012 and printed +1.1% at the core. This keeps the ECB on track for eventual policy unwind.
JPY – the JPY very weak and could possible remain so if yields continue to push higher globally here – watching whether the 10-year JGB hits up into the supposed 20+ basis point new yield “ceiling”.
GBP – sterling biding its time for Brexit news as any BoE guidance has to be extremely cautious due to the endless Brexit unknowns.
CHF – the local downside break in USDCHF was a red herring and has been scooped up. EURCHF needs to recover to 1.1700+ for renewed upside interest.
AUD – AUDUSD similar to EURUSD as we suffer a drawn out range trade – waiting for a decisive move above perhaps 0.7500 or below 0.7310
CAD – the drama around the pivotal 1.3000 level continues – bulls need a strong pull back above 1.3100, while a weaker USD scenario could see a test toward the 200-day moving average at 1.2820.
NZD – the employment and earnings data overnight haven’t moved the needle, even with a very disappointing plunge in the average hourly earnings increase of +0.2% QoQ vs. +1.0% expected.
SEK – disappointment once again as EURSEK can’t develop downside momentum…stuck in limbo without fresh catalysts for SEK for some time and technically, nothing going on unless we challenge toward 10.20.
NOK – no interest here and wondering where the next catalyst will come from to drive the EURNOK action either above 9.60 or below 9.40
Upcoming Economic Calendar Highlights (all times GMT)
• 0830 – UK Jul. Manufacturing PMI
• 1215 – US Jul. ADP Employment Change
• 1400 – US Jul. ISM Manufacturing
• 1430 – US Weekly DOE Energy Inventories
• 1800 – US FOMC Meeting
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