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: JPY firms again as US yields inversion continues
John J. Hardy
Chief Macro Strategist
Summary: Markets are concerned that the US and China may not be in dialog, despite Trump’s claim to the contrary, as China moves the CNY fix more aggressively lower than at any point in the last few weeks. The JPY remains the primary shock absorber as headline risks abound.
Trading interest
- Maintaining EURJPY shorts with stops lowered to 118.50. Targeting 112.00
- Maintaining AUDNZD longs with stops below 1.0520
The lack of corroboration from the Chinese side that the US and China are in ongoing dialog on trade has the market concerned again overnight. Indeed, confidence seems to be quickly slipping out of market sentiment, which had tried to stage a rebound to start the week after Chinese trade negotiator Liu Hu called for calm and Trump claimed that high level talks are ongoing. Almost as if to add an exclamation point, China moved the USDCNY fix the most it has in weeks, setting it 34 basis points higher at 7.08. The USDCNY rate is theoretically allowed to trade 2% on either side of the fix, explaining how the spot rate this morning is some 7.16. Before the devaluation move, the USDCNY was trading around 6.88, taking the total move to beyond 4% so far. The CNY move may be the chief driver of a weak EM complex.
Given the above, general sentiment or “animal spirits” are the only game in town at the moment, and if confidence slips beyond a certain point, we are likely to see a further aggravation of the strong correlations across markets we witnessed at the end of last week (and then reversing to start the week): JPY and CHF strength, and EM and G10 small weakness.
We highlighted the heavy US treasury auction schedule this week. Yesterday’s large 3-month and 6-month bill auctions (combined $87 billion) went off without a notable hitch. Today sees a large 2-year treasury auction, followed by a 5-year auction tomorrow and 7-year auction Thursday. We’re looking for increasing signs that the market and dealers are having a hard time absorbing issuance.
Chart: AUDNZD
AUDNZD trading up against local resistance, having rebounded smartly from the threat to Australia’s economy from the latest aggravation of US-China trade tensions, where the market reflexively sells AUD first. But the pair is largely tracking AUD vs. NZ yield spreads of late, which could stretch further in the Aussie’s favour on further signs of NZ data slippage. New Zealand’s largest milk producer Fonterra is in a debt crisis, not helpful for the kiwi at the margin, as milk products are some 25% of NZ exports.
The G-10 rundown
USD – the USD trades as a safe haven against EM and the riskier corners of the FX world when risk off is afoot, but underperforms CHF and JPY.
EUR – the euro dribbling back lower versus the greenback and needs to put in a rally here to avoid a test into 1.1000 in EURUSD. USD liquidity issues could pressure USD higher here as well until the Fed gets the plot and brings massive easing. EURUSD is the key for whether the USD moves to new highs on a broad basis and ushers in an eventual response from the Fed and more importantly – the Trump administration.
JPY – USDJPY is wilting back lower, a move that may be set to continue if the market confidence slips. Beyond 105.00 to the downside and we are back to a full-fledged sell-off that negates the impression after yesterday’s close that the pair was trying to stage a bullish reversal.
GBP – sterling remains steady here as the UK side has now said that it will not pay the £39 billion divorce settlement in the event of a no deal Brexit.
AUD – the AUDUSD unbearably rangebound for crowded bearish positioning over the last three (!) weeks – and serves as a general barometer in FX on the temperature of US-China relations.
CAD – the loonie is likely over-performing here if risk sentiments slips again, and have a hard time seeing Canada’s yields continuing to outperform US yields, but certainly the latest sell-off underlines that the 1.3300+ resistance area has held for now.
NZD – the kiwi still a weak performer, only set to rebound on a dramatic change in the global sentiment.
SEK and NOK – plenty of disappointment here as the revival of risk sentiment to start the week provided no real boost here – the pivot levels are 10.00 in EURNOK and 10.80 in EURSEK. (Sweden Household lending data today interesting, by the way, as a pointer on recession risk rising there.)
Upcoming Economic Calendar Highlights (all times GMT)
- 0730 – Sweden Jul. Household Lending
- 1200 – Hungary Central Bank Rate Decision
- 1300 – US Jun. S&P/CoreLogic House Price Index
- 1400 – US Aug. Consumer Confidence
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