Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
FX Update: Trump’s backtracking boosts sentiment
John J. Hardy
Chief Macro Strategist
Summary: Trump’s backtracking on his anti-China trade stance and German hints that fiscal expansion will arrive with any recession threat are boosting sentiment as the week gets under way. A big week ahead for Italy and the Fed, with Powell set to speak on Friday.
Trading interest
- Maintaining long AUDNZD with stops below 1.0470 now for 1.0625 and eventually 1.0700
- Staying short EURJPY for 112.00 as long as remains below 119.50
Trump continues to sprint backwards on his latest tariff and sanction threats against China as his administration announced ahead of the weekend that Huawei will be extended a 90-day window to purchase US goods. A vague tweet about China (“We are doing very well with China, and talking!”) perhaps adding to the hopes on the margin that Trump’s bluster will quickly fold with every percentage point drop in the S&P 500.
We’ve seen a couple of recent stories with credible, but unknown sources citing Germany’s intent to expand its fiscal policy in the event of a recession, but now it’s getting a bit more official as German finance minister Scholz specifically indicated the potential to expand spending €50 billion, or about 1.5% of GDP - fairly modest stuff, but a signal nonetheless. Still, German 10-year bunds are yielding below -65 basis points this morning.
The week ahead full of potential event risks, with political developments in Italy and a speech from Fed chair Powell at Jackson Hole on Friday the two most prominent items on the agenda, although a breakthrough in the Brexit stand-off is a possibility as well (see comments . As well, we get a peek at Europe’s flash PMI’s for August on Thursday, as well as the minutes from the most recent ECB meeting that day.
Powell’s speech this Friday is far and away the most important event risk for markets this week. Powell has been beset with criticism from all sides – with particularly withering commentary from President Trump. The title of the speech is a rather vague “Challenges for Monetary Policy”. Will Powell take the opportunity to be a bit more honest about what is driving the Fed to ease – other central banks’ relative policy and especially Trump’s fiscal excesses? A real turn lower in the USD likely requires the Fed to cut more sooner and restart massive QE. Is Powell ready to go there and re-enact Bernanke’s famous 2010 Jackson Hole performance (which pre-announced QE2) or will he remain behind the easing curve?
FX implied volatility has jumped sharply in recent weeks, but trading ranges seem to collapse quickly and the realized volatility on a three-month time frame is still very modest by historic standards – particularly given the parabolic moves in global bond markets. The sympathetic move in the JPY and CHF, as well as GBP volatility on the rise in hard Brexit risks have been the chief drivers of volatility.
Chart: USDJPY
The USDJPY move lower having a hard time finding additional fuel as the recent slide in global bond yields – usually the main motor of yen strength, seems to have lost its ability to drive further JPY strength at the moment, perhaps as the recent revival of risk appetite has confused the picture. The more recent shorts could begin to drive short covering if USDJPY heads above 107.00 here.
The G-10 rundown
USD – FOMC minutes on Wednesday, but all eyes on Powell’s speech on Friday to see whether he can sufficiently impress to keep a lid on the broader USD here.
EUR – watching EU sovereign yields for the degree of consolidation we see in the wake of German fiscal stimulus promises in the event of recession. Italy’s political process heats up this week – but Italian yield spreads have calmed again. ECB minutes may hint at their approach to further easing in September – the future of intervention in the EU, in our view, is mostly political/fiscal, so not expecting large impact.
JPY – yen bulls stuck in limbo here as momentum has seeped out of the recent rally. The latest positioning report from the US CFTC shows the longest speculative yen position (vs. USD) since late 2016 at about +25k contracts (record long back in April of 2016 above 71k contracts for perspective.)
GBP – Boris Johnson on the road this week to Berlin and Paris ahead of the weekend G7 meeting in Biarritz – the market will be looking closely for any softening of the stance from either side.
CHF – Swiss franc trading maintaining altitude versus the euro – a bit surprising given the news flow and the solid rally in sterling.
AUD – downside momentum has dried up, but a bit disappointing for any AUD hopefuls that the positive mood of the last couple of sessions hasn’t provided a larger boost and heavy iron ore prices again overnight sounding a sour note for Australia. RBA minutes up tonight.
CAD – USDCAD caught in no-man’s land – with 1.3300-25 as the pivot point – Canada CPI reported this Wednesday.
NZD – AUDNZD has made its move higher, now it must sustain for a run at 1.0700.
SEK – Swedish housing prices under pressure despite negative rates and SEK at risk on further negative news on the EU economy this week. Still, SEK very cheap in the wider perspective and SEK strength will likely prove a durable theme if we see a transition to fiscal policy in Sweden.
NOK – the softened stance on further rate hikes from Norges Bank last week, together with weak oil prices keeping NOK on the weak side – with the 10.00 area in EURNOK clearly pivotal.
Upcoming Economic Calendar Highlights (all times GMT)
- 0800 – Switzerland Weekly Sight Deposits
- 0130 – Australia RBA Minutes
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