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: The end of sterling outperformance. Euro next?
John J. Hardy
Chief Macro Strategist
Summary: The June UK CPI report this morning came in softer than expected and saw the market marking the UK yields sharply lower, likely spelling the end of the remarkable outperformance year-to-date. Elsewhere, the weak CNH continues to weigh on AUD and NZD, while the euro may be next in line to see its broad strength ease as the ECB seems to be climbing down from its hawkish stance and European yields are falling.
FX Trading focus:
- Sterling’s outperformance since the beginning of this year is likely over after this morning’s June CPI data point
- The euro could be the next major currency to feel the heat as the ECB climbs down from hawkish stance, EU yields drop.
- Weak CNH weighing on AUD and NZD
Sterling has come in for a drubbing today after the June UK CPI numbers came in softer than expected. The focus is on the core CPI, which dropped to 6.9% versus 7.1% expected and the 7.1% in May. The headline CPI also dropped more than expected to 7.9% versus 8.1% expected and 8.7% in May, with the M/M figure of a mere 0.1% (0.4% expected) That May core CPI figure was the second of two consecutive new multi-decade highs in core UK inflation that spooked the market and had rate expectations for the BoE arching well north of 6.00% by the end of this year. After today’s inflation print, the 2-year Gilt has fallen over 20 basis points and trades south of 4.9% after the high of 5.56% just under two weeks ago, with only about 90 basis points of further tightening now priced from the BoE (down from over 150 bps). It’s an enormous pivot, enhanced by the BoE’s obvious hope/expectation that CPI is set to fall sharply in the second half of the year. The August meeting is now a 50/50 probability for 25 or 50 basis points after having been pinned at 50 basis points in recent weeks. The BoE will deliver as little as it can get away with from here if the data continues to head in the right direction.
This June UK CPI number likely spells the end of the sterling outperformance that characterized the first half of this year. The EURGBP rally discussed below is the most important pair to watch for the broader sterling status.
Chart: EURGBP
EURGBP rocketed higher in the wake of the UK CPI release this morning, thoroughly confirming the recent rejection of the new cycle lows below 0.8520. In the big picture, this chart often shows long periods of range-trading behaviour, but this strong rally, should it hold up here into today’s close, could point toward a reasonable short-term trend to the range highs into 0.8900+ in the weeks ahead, though going may be slower beyond here if we are seeing a more concerted effort by the ECB to slow rate hike expectations (more below).
Is the strong EUR/weak CNH & JPY prompting ECB dovish shift?
The center of gravity for currencies in Asia is the Chinese renminbi, which generally failed to make much hay out of the recent USD weakening, as it has now bounced from the lows on Friday of 7.12 to 7.22 into today’s European session. On that note, it is worth pointing out that EURCNH has gone almost vertical this year, trading above 8.10 after starting the year nearer 7.25 on concerns that China is not committing to sufficient stimulus to grow its economy as it does not want to add to already leveraged sectors of the economy.
The pronounced CNH weakness, together with the wild rise in EURJPY this year, is worth considering as a driver of the ECB’s turn to less hawkishness, with one of the most traditionally hawkish members Klaas Knot weighing in yesterday against the idea of two more hikes from here. The powerful Euro erodes the competitiveness of European exports on the world market. Can we expect the breadth in euro strength to ebb from here? German 2-year yields pushed all the way down below 3.00% at one point today, but so far EURJPY and EURUSD are not really playing ball as the air leaks out of ECB expectations – this is a space to watch, as Europe can ill afford weak growth and a strong currency. Next Thursday’s ECB is likely shaping up as a chance to deliver a message on the currency and links to ECB policy, together with no commitment to further tightening beyond a presumed 25 basis point hike (and if EURJPY and EURCNH making new highs into next Thursday, could the ECB even shock with pause?)
Elsewhere, the CNH weakness is holding back AUD and NZD in the crosses, with NZDUSD on the verge of a full bearish reversal if it moves much lower, and AUDUSD likewise. Further USD strength in these pairs would add to the cracks in the weak USD picture.
Table: FX Board of G10 and CNH trend evolution and strength.
USD weakness is leaking out of the picture quickly here, but the greenback has not yet strengthened enough to threaten a reversal, particularly not within the G3. Note that CNH weakness is now eclipsing USD weakness. The sterling jolt lower has not neutralized its former broad up-trend. If euro outperformance is set to ease as we discuss above, the Scandie snap-back rally may not have much follow through potential.
Table: FX Board Trend Scoreboard for individual pairs.
AUDNZD trending status remains in flux – and watching AUDUSD And NZDUSD closely for status confirmation in the coming days as USDCNH is trying to flip back to the positive side. USDCHF looks overdone but has shown no signs of bouncing.
Upcoming Economic Calendar Highlights (all times GMT)
- 1230 – US Jun. Housing Starts and Building Permits
- 1430 – US Weekly DoE Crude Oil and Product Inventories
- 1700 – US Treasury to auction 20-year Bonds
- 2350 – Japan Jun. Trade Balance
- 0115 – China Rate Announcement
- 0130 – Australia Q2 NAB Business Confidence
- 0130 – Australia Jun. Employment Data
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