Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
EM risks rising as we can’t find a pulse for the USD
John J. Hardy
Chief Macro Strategist
Summary: The euro is stuck in neutral on political paralysis, trade fears and as Italian yields rise on Interior Minister Matteo Salvini’s latest rhetoric. EURJPY is looking at cycle lows as core EU yields scrape bottom while EM risks are picking up.
Please tune in later for my latest FX Update webinar (sign up here), in which I will provide an interactive look at the current themes moving (and not moving) currencies. I will cover the latest news on China and the CNY, the EU election results and much more.
The initial relief that populists parties failed to make as much headway in the EU parliamentary elections as mainstream parties feared has yielded to a general worry that the lack of a clear majority at the centre could risk leading to political paralysis – always an EU vulnerability. The euro is perhaps offered at the margin on the uncertainty as to what degree the EU can appoint the leadership necessary for the EU to get ahead of its existential challenges in the coming cycle.
France’s Macron is gunning for a pro-Europe visionary for European Commission President (to replace Juncker) who can build a majority across the party lines and is clearly against German “Spitzenkandidat” Manfred Weber, who remains strongly backed by Germany and is the leader of the EU Parliament’s largest party, the centre-right EPP.
In Italy, Salvini is talking tax cuts and railing against EU budget rules, which has seen Italian BTP yields spike back higher after an initially supportive reaction to the election result early yesterday. EURJPY looks the preferable way to trade a weakening euro, as long as global bond yields remain weak (yesterday saw German 10-year bunds close at their lowest for the cycle at -14 basis points, only a few bps above the record low from 2016).
Finally, another angle of risk for the EU is the risk of a trade policy row over autos with the US, with risks escalating now that the EU has drawn a red line on refusing to allow any quota system. A sharp response/tweet from the US side could further escalate the situation.
EM risks picking up again
We are seeing a more notable pickup in EM spreads though they remain modest compared to the episode in Q4, a development that is in tune with the general weakness across EM equity markets and concerns for global growth. The weakest link is Turkey, where the government is in a last-ditch effort to shore up its currency defenses and point to the risk of eventual capital controls. Turkey is now requiring banks to up foreign FX reserves and mandating that pension funds place 10% of funds in the Turkish equity market and 25% in Turkish government bonds. Turkish CDS prices (insurance on Turkish sovereign debt) has risen back above 515 in recent days, only some 60 points below the worst levels during the lira crisis late last summer.
Chart: EURJPY
EURJPY is looking heavy again and could plumb new depths if risk sentiment remains in the dumps and European yields head lower still, with German bunds poised near the all-time lows. The downside looks rather open here with few downside anchors besides the former major cycle low at 110.
The initial relief that populists parties failed to make as much headway in the EU parliamentary elections as mainstream parties feared has yielded to a general worry that the lack of a clear majority at the centre could risk leading to political paralysis – always an EU vulnerability. The euro is perhaps offered at the margin on the uncertainty as to what degree the EU can appoint the leadership necessary for the EU to get ahead of its existential challenges in the coming cycle.
France’s Macron is gunning for a pro-Europe visionary for European Commission President (to replace Juncker) who can build a majority across the party lines and is clearly against German “Spitzenkandidat” Manfred Weber, who remains strongly backed by Germany and is the leader of the EU Parliament’s largest party, the centre-right EPP.
In Italy, Salvini is talking tax cuts and railing against EU budget rules, which has seen Italian BTP yields spike back higher after an initially supportive reaction to the election result early yesterday. EURJPY looks the preferable way to trade a weakening euro, as long as global bond yields remain weak (yesterday saw German 10-year bunds close at their lowest for the cycle at -14 basis points, only a few bps above the record low from 2016).
Finally, another angle of risk for the EU is the risk of a trade policy row over autos with the US, with risks escalating now that the EU has drawn a red line on refusing to allow any quota system. A sharp response/tweet from the US side could further escalate the situation.
EM risks picking up again
We are seeing a more notable pickup in EM spreads though they remain modest compared to the episode in Q4, a development that is in tune with the general weakness across EM equity markets and concerns for global growth. The weakest link is Turkey, where the government is in a last-ditch effort to shore up its currency defenses and point to the risk of eventual capital controls. Turkey is now requiring banks to up foreign FX reserves and mandating that pension funds place 10% of funds in the Turkish equity market and 25% in Turkish government bonds. Turkish CDS prices (insurance on Turkish sovereign debt) has risen back above 515 in recent days, only some 60 points below the worst levels during the lira crisis late last summer.
Chart: EURJPY
EURJPY is looking heavy again and could plumb new depths if risk sentiment remains in the dumps and European yields head lower still, with German bunds poised near the all-time lows. The downside looks rather open here with few downside anchors besides the former major cycle low at 110.
The G10 rundown
USD – tough to draw a bead on drivers for the US dollar here, as we will discuss in today’s FX Update webinar.
EUR – the existential side of the equation is heating up again on the fear that the fragmentation will result in dysfunctional paralysis for the EU that will make decision-making difficult. EURJPY may outperform EURUSD if the euro stumbles here.
JPY – trading back toward recent lows as Europe sets new record core yields for the cycle and the long bond in the US does the same. If we see more general risk-off added to the mix, the JPY could strengthen more aggressively here, though it requires constant fuel from these sources to drive a move.
GBP – sterling caught between fears of a Corbyn victory if elections are eventually called and a hard-Brexit Tory leader emerging in the wake of May’s exit. Sterling is back looking at the cycle lows versus the euro above 0.8825 and could be set to weaken further.
CHF – EURCHF under some pressure again from the euro-negative factors we discuss above (and Switzerland manages a solid GDP print for Q1) and particularly any further aggravation of Italian yield spreads to the core risks a confrontation with the 1.1200 area support.
AUD – waiting for Chinese iron ore prices to show signs that they have topped out after the latest speculative frenzy for improving confidence in shorting AUD. The Australian two-year yield has pushed to 1.12%, a full 103 bps below that of the US.
CAD – CAD doesn’t deserve much notice until we break through 1.3300 or 1.3500 in USDCAD – the Bank of Canada meeting tomorrow may do the trick. We don't expect much drama there, perhaps a slight dovish risk given the grinding lower in growth rates since mid-2017.
NZD – The RBNZ Financial Stability report up tonight could be a catalyst for NZD in the crosses. Governor Orr will also discuss the report before a parliamentary committee.
SEK – the krona getting a boost this morning from the April household lending survey steadying at 5.0% year-on-year growth after its steady, grinding deceleration since early 2018. EURSEK trying lower – but still, the confidence surveys today were universally weak and the next test for SEK is the Q1 GDP print tomorrow – expected at a weak sub-2.0% level.
NOK – EURNOK is stuck in limbo here – needs a move through 9.70-9.68 to flash downside potential. Norway credit growth for April up tomorrow.
Upcoming Economic Calendar Highlights (all times GMT)
09:00 – Euro Zone May Confidence Surveys
13:00 – US Mar. House Price Index
14:00 – US May Consumer Confidence
21:00 – New Zealand RBNZ Financial Stability Report
01:00 – New Zealand ANZ Business Confidence
01:10 – New Zealand RBNZ’s Orr to Speak on FSR
USD – tough to draw a bead on drivers for the US dollar here, as we will discuss in today’s FX Update webinar.
EUR – the existential side of the equation is heating up again on the fear that the fragmentation will result in dysfunctional paralysis for the EU that will make decision-making difficult. EURJPY may outperform EURUSD if the euro stumbles here.
JPY – trading back toward recent lows as Europe sets new record core yields for the cycle and the long bond in the US does the same. If we see more general risk-off added to the mix, the JPY could strengthen more aggressively here, though it requires constant fuel from these sources to drive a move.
GBP – sterling caught between fears of a Corbyn victory if elections are eventually called and a hard-Brexit Tory leader emerging in the wake of May’s exit. Sterling is back looking at the cycle lows versus the euro above 0.8825 and could be set to weaken further.
CHF – EURCHF under some pressure again from the euro-negative factors we discuss above (and Switzerland manages a solid GDP print for Q1) and particularly any further aggravation of Italian yield spreads to the core risks a confrontation with the 1.1200 area support.
AUD – waiting for Chinese iron ore prices to show signs that they have topped out after the latest speculative frenzy for improving confidence in shorting AUD. The Australian two-year yield has pushed to 1.12%, a full 103 bps below that of the US.
CAD – CAD doesn’t deserve much notice until we break through 1.3300 or 1.3500 in USDCAD – the Bank of Canada meeting tomorrow may do the trick. We don't expect much drama there, perhaps a slight dovish risk given the grinding lower in growth rates since mid-2017.
NZD – The RBNZ Financial Stability report up tonight could be a catalyst for NZD in the crosses. Governor Orr will also discuss the report before a parliamentary committee.
SEK – the krona getting a boost this morning from the April household lending survey steadying at 5.0% year-on-year growth after its steady, grinding deceleration since early 2018. EURSEK trying lower – but still, the confidence surveys today were universally weak and the next test for SEK is the Q1 GDP print tomorrow – expected at a weak sub-2.0% level.
NOK – EURNOK is stuck in limbo here – needs a move through 9.70-9.68 to flash downside potential. Norway credit growth for April up tomorrow.
Upcoming Economic Calendar Highlights (all times GMT)
09:00 – Euro Zone May Confidence Surveys
13:00 – US Mar. House Price Index
14:00 – US May Consumer Confidence
21:00 – New Zealand RBNZ Financial Stability Report
01:00 – New Zealand ANZ Business Confidence
01:10 – New Zealand RBNZ’s Orr to Speak on FSR
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