Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
FX Update: Risk correlated currencies bounce on US fiscal hopes
John J. Hardy
Chief Macro Strategist
Summary: Risk sentiment improved sharply yesterday as the market looks forward to the US moving forward with a $2 trillion rescue package as soon as late today, adding to boost provided by the massive Fed liquidity provision boost at the start of the week. Proxies in FX bear watching as coincident indicators for sentiment, as does the reaction to the next fiscal moves from the EU.
As usual, please consult today’s Quick Take for a great news roundup and setting of today’s market and trading agenda and then today’s Saxo Market Call podcast in which we discussed the market’s big positive risk sentiment shift and the potential for a nervous stability to shape up here.
After a mixed reaction to the Fed’s enormous move at the start of the week to backstop the markets, we saw far more constructive response to policymakers’ attempts to get ahead of the crisis as the Democrats in Congress and the Trump administration have apparently reached a deal that will be signed as early as late today and mean on the order of $2 trillion in fiscal stimulus.
The EU is the next focus as we await the scale of debt mutualization of “coronabonds” a revolutionary move as these would be funded by the European Stability Mechanism (ESM) and represent real mutual EU debt for the first time. The initial scale looks modest at 2% of member countries’ respective GDP, but it is still a momentous development. Japan also out looking at cash drops for every citizen similar to the scale of the package in the US.
The Covid19 outbreak is seeing shutdowns spreading around the world, with India announcing a three-week lockdown after the UK did so yesterday. The scale of the US outbreak will be critical for seeing whether the rest of the country ends up in total lockdown – certainly the “15 days” that the Trump administration has discussed for a lockdown period looks unrealistically short. I have personally been locked down for two weeks already in Denmark and they have extended the measures here until after Easter, which is over two weeks away.
Looking ahead, there is a lot of chatter about quarter-end rebalancing, especially of bond-equity portfolio allocations completely out of whack and favoring the latter if portfolio holders are to maintain their allocation models after the epic slide from mid-February to the lows this week. If this is true, it would theoretically support the higher risk currencies versus the G3, though my trading stance is one of fading enthusiasm tactically in FX into quarter end now that we have bounced so much already in the likes of AUDUSD and especially AUDJPY even if we are convinced that the authorities will continue to flood the system with stimulus and support until they finally get ahead of the curve over the medium term.
Chart: AUDJPY vs. US 10-year yield
We flashed this chart on the today’s Market Call podcast, and interesting to note that the long US treasury yield (the white line in the chart below) has been leading the price developments for AUDJPY, a classic proxy for risk appetite in G10 FX. The enthusiasm for equities yesterday didn’t see the bid for treasuries fading much – that could in part be due to certainty that the Fed will continue to keep interest rates low with its unlimited QE, but it is a divergence nonetheless. A key resistance level coming up for AUDJPY around 0.7000 as we watch how far this bounce in sentiment can extend.
The G-10 rundown
USD – the US dollar getting pushed back lower against risky currencies in line with the sentiment bounce – most charts have been so extended that this move could extend for a while without reversing fully the strong USD narrative.
EUR – a focus on EU bonds and the degree to which the euro can continue to get traction, though EURUSD is likely a low beta currency relative to other USD pairs if we look at how high the euro extended recently in many crosses.
JPY – the enormous Japanese GPIF pension fund upping its foreign bond allocation is “intervention by indirect means” from where we sit – estimates top $150 billion with US and EU markets the deepest for where the flows head.
GBP – sterling righting itself and showing its correlation with animal spirits – already staring down the important 1.2000 level in GBPUSD soon if this extends, though really there is plenty more space for a bounce to extend above that figure without reversing the recent epic slide.
CHF – the deluge of liquidity and bounce in risk sentiment finally turning EURCHF a bit more forcefully – but a lot of wood to chop to call any sort of trend reversal.
AUD – the Aussie bounce looks a bit sedate locally relative to the enthusiasm elsewhere – but has taken AUDUSD above the tactical bull/bear line. Next area there possibly 0.6250 – but not expecting to see the big move down reversed all in one go.
CAD – USDCAD downside can extend considerably if oil and risk sentiment stay buoyant, but still looking for reversal patterns to support fresh longs for a test of cycle highs eventually.
NZD – the kiwi underperforming AUD as we would have expected in a risk-on environment – the AUDNZD rally would need to extend well above 1.0300 to begin to point to a reversal.
SEK – SEK showing that it has become cheap as the price action in EURSEK is all the way back below the October highs – suggesting some diminishing returns in punishing EURSEK during bouts of risk off. One huge caveat on playing the SEK value story, however, the country is running a unique experiment with its more lax Covid19 quarantine policy relative to other EU counterparts – if the outbreak worsens there, it could require a massive “overcorrection” that hits Sweden’s activity level even harder.
NOK – the price action offering further evidence of stability – but that oil price needs a major recovery to get NOK out of the woods and have a hard time seeing significant move below 11.50 without forward crude oil prices picking up sharply – like 30% or more.
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