Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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AUD jumps on RBA, USD still firm
John J. Hardy
Chief Macro Strategist
Summary: The Aussie jumped higher overnight as the RBA waxed far less dovish than the market was anticipating, although the Royal Commission outcome may be a more important driver of AUD strength. Elsewhere, USDJPY mulls 110.00 break ahead of important US Treasury auctions.
A veritable torrent of developments overnight for AUD traders, first as the January AiG performance of services index dropped all the way to 44.3 versus 52.1 in Dec, and then on very weak Dec. and Q4 Retail Sales report. AUD dipped on these before the Reserve Bank of Australia reassured AUD longs with a less dovish tilt than expected.
The RBA did raise the concern level and lowered the inflation level slightly, but the insistence on putting a positive spin on things and only lowering the growth outlook to 3.0% for the year when housing is collapsing is still quite a hawkish feat. AUD snapped higher on the RBA statement release, but on the sidelines another development may have provided more relief for the Aussie: the release of the Royal Commission report and its recommendations on what to do after its long investigation of Australian banks’ lending practices.
The headlines are that the report is far less harsh in its recommendations than feared and Australian bank stocks have ripped higher overnight to the tune of 5% in reaction. This article provides a good rundown. Our take is that the momentum for a credit crunch has already been set in motion, as housing price declines and the inevitable increase in non-performing loans provides its own self-reinforcing.
The rise in risk appetite continues to dominate, with local highs in many equity markets, new levels of tightness in the high yield credit spreads, and a new local low in the VIX since early October, when the whole equity market rout was set in motion. How much more can this market wring out of the dovish shift from the Fed since the December? That may be answered this week if US treasury auctions today through Thursday come in sufficiently weak to see a significant further boost in US yields. At some point, higher US yields would temper enthusiasm for risk assets. Outside of risk appetite, we focus in particular on USDJPY as it toys with 110.00 resistance, with higher US yields supportive of a test of higher resistance.
Chart: AUDUSD
AUDUSD in a pivotal area here after the RBA and Royal Commission report – a strong close toward the top of the range keeps the bears at bay and suggests risk of a further squeeze, but if today’s price action can’t hold and we close back south of 0.7200, bears may pounce for a push at the bottom of the range and then some.
The RBA did raise the concern level and lowered the inflation level slightly, but the insistence on putting a positive spin on things and only lowering the growth outlook to 3.0% for the year when housing is collapsing is still quite a hawkish feat. AUD snapped higher on the RBA statement release, but on the sidelines another development may have provided more relief for the Aussie: the release of the Royal Commission report and its recommendations on what to do after its long investigation of Australian banks’ lending practices.
The headlines are that the report is far less harsh in its recommendations than feared and Australian bank stocks have ripped higher overnight to the tune of 5% in reaction. This article provides a good rundown. Our take is that the momentum for a credit crunch has already been set in motion, as housing price declines and the inevitable increase in non-performing loans provides its own self-reinforcing.
The rise in risk appetite continues to dominate, with local highs in many equity markets, new levels of tightness in the high yield credit spreads, and a new local low in the VIX since early October, when the whole equity market rout was set in motion. How much more can this market wring out of the dovish shift from the Fed since the December? That may be answered this week if US treasury auctions today through Thursday come in sufficiently weak to see a significant further boost in US yields. At some point, higher US yields would temper enthusiasm for risk assets. Outside of risk appetite, we focus in particular on USDJPY as it toys with 110.00 resistance, with higher US yields supportive of a test of higher resistance.
Chart: AUDUSD
AUDUSD in a pivotal area here after the RBA and Royal Commission report – a strong close toward the top of the range keeps the bears at bay and suggests risk of a further squeeze, but if today’s price action can’t hold and we close back south of 0.7200, bears may pounce for a push at the bottom of the range and then some.
The G-10 rundown
USD – the US dollar is still firm against the lowest yielding currencies and to a degree versus the euro, but not cutting much of a profile elsewhere, as strong risk appetite supports interest in risky EM trades. At this point, as we discuss above, we are unwilling to call a top, but the risk/reward is certainly not what it used to be.
EUR – the air is slowly leaking out of EURUSD, with potential for a stress-test of the 1.1300 range low if US data refuses to cooperate with the increasingly bearish economic outlook and US yields rise further this week.
JPY – Mostly focused on US yields as a coincident indicator for more upside potential in USDJPY beyond 110.00. Note this post from Wolf Street describing the BoJ’s odd tapering policy, in which they increase their balance sheet for two months running before actually shrinking it for the following month. Whatever it is doing – it’s not working. Try again.
GBP – GBPUSD resting right on its 200-day moving average and it would prove a psychological blow if the pair can’t maintain above 1.3000.
CHF – CHF likely a fellow traveller with the JPY here – as we watch for upside potential in EURCHF and USDCHF mulls the psychologically important parity level (range high above 1.0100 more important and would fit well with the 1.1300 in EURUSD.
AUD – we discuss AUD above and important to underline that the market’s assessment of RBA trajectory hasn’t shifted one bit, so happy to pounce on the negative side if this rally fades now, otherwise may have to sit on our hands for a negative outlook on the currency.
CAD – AUDCAD, a focus pair, likely to follow AUDUSD directionally on whether RBA not clearing dovish bar and royal commission report has a sustained impact. USDCAD for its part remains heavy with crude oil prices still near local highs.
NZD – NZD finding resilience on the strong risk appetite - theoretically further upside potential if rose-tinted glasses stay on for risk takers, but New Zealand yields going nowhere and we would prefer to fade NZDUSD upside until that changes – though no real technical hook for a downside hook just yet.
SEK – EURSEK dribbling up above 10.40 looking locally strong but still in the shadow of the big 10.72 top and reversal. Would rather sell than buy EURSEK in the big picture, but would like to see at least a modest technical hook first.
NOK – EURNOK comes back lower after yesterday’s spike – a mirror image of yesterday’s oil market moves. GDP report up on Friday.
Upcoming Economic Calendar Highlights (all times GMT)
1500 – US Jan. ISM Non-manufacturing
1800 – US 3-year Treasury Auction
USD – the US dollar is still firm against the lowest yielding currencies and to a degree versus the euro, but not cutting much of a profile elsewhere, as strong risk appetite supports interest in risky EM trades. At this point, as we discuss above, we are unwilling to call a top, but the risk/reward is certainly not what it used to be.
EUR – the air is slowly leaking out of EURUSD, with potential for a stress-test of the 1.1300 range low if US data refuses to cooperate with the increasingly bearish economic outlook and US yields rise further this week.
JPY – Mostly focused on US yields as a coincident indicator for more upside potential in USDJPY beyond 110.00. Note this post from Wolf Street describing the BoJ’s odd tapering policy, in which they increase their balance sheet for two months running before actually shrinking it for the following month. Whatever it is doing – it’s not working. Try again.
GBP – GBPUSD resting right on its 200-day moving average and it would prove a psychological blow if the pair can’t maintain above 1.3000.
CHF – CHF likely a fellow traveller with the JPY here – as we watch for upside potential in EURCHF and USDCHF mulls the psychologically important parity level (range high above 1.0100 more important and would fit well with the 1.1300 in EURUSD.
AUD – we discuss AUD above and important to underline that the market’s assessment of RBA trajectory hasn’t shifted one bit, so happy to pounce on the negative side if this rally fades now, otherwise may have to sit on our hands for a negative outlook on the currency.
CAD – AUDCAD, a focus pair, likely to follow AUDUSD directionally on whether RBA not clearing dovish bar and royal commission report has a sustained impact. USDCAD for its part remains heavy with crude oil prices still near local highs.
NZD – NZD finding resilience on the strong risk appetite - theoretically further upside potential if rose-tinted glasses stay on for risk takers, but New Zealand yields going nowhere and we would prefer to fade NZDUSD upside until that changes – though no real technical hook for a downside hook just yet.
SEK – EURSEK dribbling up above 10.40 looking locally strong but still in the shadow of the big 10.72 top and reversal. Would rather sell than buy EURSEK in the big picture, but would like to see at least a modest technical hook first.
NOK – EURNOK comes back lower after yesterday’s spike – a mirror image of yesterday’s oil market moves. GDP report up on Friday.
Upcoming Economic Calendar Highlights (all times GMT)
1500 – US Jan. ISM Non-manufacturing
1800 – US 3-year Treasury Auction
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