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: Contrarian EURUSD thoughts for the longer term
John J. Hardy
Chief Macro Strategist
Summary: EM currencies were in for a long overdue adjustment lower as coronavirus fears have been reignited since yesterday and safe haven seeking is in evidence nearly everywhere, save for the Japanese yen after the recent blowout sell-off. Zooming out for the longer term, we consider ways to trade EURUSD for a longer term rally.
Trading interest
- Taking profit on USDJPY
- Buying long term (Nov 6 – days after election) EURUSD calls
Yesterday our bandwidth was entirely occupied by the recent JPY sell-off move that was historic in “sudden volatility” terms as we watch whether the USDJPY rally can proceed now that we have both of the traditional cylinders of yen support firing: risk off in equities and safe haven bond strength. Arguably, a third cylinder is EM carry trades, which are under more considerable pressure since yesterday than they have been in some time – USDMXN finally catching up with some of its peers in rather violent fashion, in particular. This is important to watch on the risk that USDJPY is underdoing some sort of regime shift, perhaps a flight of capital or other.
Today we zoom out and have a look at EURUSD, which we see as very undervalued for the longer term. As the US yield curve flattens toward inversion as US 30-year yields poke at historic lows today (and the curve is already inverted for the 3-month-10-year portion of the curve), it is clear that the Fed is behind the curve and will eventually have to chop rates further and ratchet QE higher, its declared intention to eventually taper the “Not QE” notwithstanding. Looking at EURUSD upside potential through options and with expiries on the other side of the US election in November is one to begin establishing a position, as we discuss below.
The US Philly Fed was absurdly strong yesterday – not sure whether to take anything away from that number – and given its history of extreme spikes, we need another strong reading to begin arguing that US manufacturing is picking up. Also of concern in the US is a data point like the US Cass Freight Index (a measure of freight shipment by road, rail, air and barge), which, as the wolfstreet.com website points out was down some 9.4% year-on-year in January, it’s worst level since 2009.
Chart: EURUSD, implied volatility and risk reversals
(Source: Bloomberg) This is a chart I sent out with today’s Market Call podcast (discussion specifically on EURUSD starts around 14:30 – supporting on the first slide of today’s Market Call slide deck), talking about the still very low implied volatilities for EURUSD. From these levels in spot combined with the low implied volatility, we see compelling risk/reward in being long EURUSD upside via options for the other side of the US election, with a further position to be added in the event a technical reversal materializes in the weeks ahead.
The G-10 rundown
USD – interesting to note the USD easing lower versus the EUR and JPY this morning as risk off washes over markets – the greenback may be vulnerable against everything save for EM in the event of a meltdown in US megacap stocks.
EUR – the selling looking a bit overdone and consolidation risk high, though questionable whether any consolidation can engineer a technical reversal. Rather supportive flash Feb. PMI’s out of Europe this morning.
JPY – the yen sell-off cut hard and deep and is particularly interesting now that we have transitioned suddenly to a market backdrop since yesterday that is normally as supportive as possible of the yen – a great test of whether we are witnessing a regime shift unfolding here.
GBP – sterling pulled back from the brink versus the USD after punching to a new multi-month low, but too early to call this a recovery.
CHF – the franc impressing in ignoring the JPY move entirely – could risk finding a stronger bid still if the current risk off deepens. Note that USDCHF is turning lower after a look close to the 200-day moving average.
AUD – the weak job data this week knocked the Aussie to new lows versus the USD – chief risk to AUD bears is one of positioning here, but taking the break lower at face value unless reversed with a move back above 0.6700.
CAD – unrealistically resilient given the backdrop and now oil turning lower again – watching top of range in USDCAD at 1.3300+ as possible catalyst for more gains. Canadian Retail Sales figures out later today
NZD – kiwi and the Aussie following one another in lock step – rate spread offers a bit of support, but price action is inert.
SEK – EURSEK valiantly avoiding the upside swing zone of 10.60-65 and getting a modicum of support from bump in EU PMI’s this morning.
NOK – downside focus for EURNOK is 10.00 and would need the market to shift back into a more positive stance on the outlook for global growth, i.e., fading coronavirus fears and firmer oil prices.
Upcoming Economic Calendar Highlights (all times GMT)
- 1330 – Canada Dec. Retail Sales
- 1445 – US Flash Feb. Markit PMI
- 1500 – US Jan. Existing Home Sales
- 1515 – US Fed’s Brainard (Voter) to Speak
- 1700 – ECB’s Lane to Speak
- 1830 – US Fed’s Mester and Clarida (Both voters) Speaking
- Saturday: US Nevada Democratic Primary
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