Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
FX Update: Ugly flash EU PMI’s pressure EUR
John J. Hardy
Chief Macro Strategist
Summary: Signs are popping up that hopes for a US-China trade deal are overdone, nonetheless, the market remains in maximum complacency after a somewhat shaky Asian session. More liquidity operations from the Fed this week and a heavy treasury auction calendar are among the highlights for a heavy USD focus this week, while the euro is under pressure on the flash September PMI surveys.
Friday saw a rather negative session after China announced a cancellation of a planned trade delegation trip to Montana and Nebraska, sparking concerns that the US-China trade negotiations are on the wrong track. Rumours have swirled that China is looking for a partial deal and a punt on the more contentious issues, while the US side is only interested in a comprehensive agreement. China’s announcement came about an hour after Trump said on Friday that he isn’t interested in a “partial deal”.
Asian markets stumbled out of the gate to start the week and South Korea reported a drop in exports in September of a stunning -21.8%, led by a drop in semiconductor shipments. The mood darkened again in early European trading hours as the French and especially Germany flash September PMI surveys from Markit rolled in, with Germany’s Manufacturing PMI survey coming in at a staggering, worst for the cycle 41.4.
Wolf Richter over at wolfstreet.com wrote an excellent post describing what is going on at the Fed with its repo operations, which actually hearken back to its approach to managing liquidity issues prior to 2008 – however, the size now is far greater than anything back then save for a single spike after the September 11, 2001 terror attacks. The USD outlook and how the market adjusts to these new liquidity operations looks pivotal this week after the FOMC meeting failed to produce immediate takeaways. The Fed is set to do 2-week repos starting with one tomorrow and we also have a heavy calendar for Treasury issuance this week.
Liquidity needs will only rise from here with the rise in US budget deficits and will spike further in a recession scenario or in the event of general market disruptions. Will the Fed be happy to continue to expand these operations ad infinitum? Eventually this ends up as QE, but in the meantime, I’m not at all sure that the market’s complacency on this issue is justified, nor do I get the sense that the Fed has shown itself to be on the ball and set to get ahead of the curve on bringing further policy easing or overwhelming liquidity provision.
Chart: EURUSD
EURUSD traders of both stripes have suffered during the recent, churning price action around the 1.1000 level as neither the sense that this is the last blast of easing from the Draghi ECB, nor the fairly hawkish FOMC meeting have been able to drive a notable directional move. The USD looks firm to start the week and a very ugly Germany Manufacturing PMI reading for September sets a negative tone for the euro this morning. A solid hold below 1.1000 could set up a run to at least 1.0800 for the pair.
The G-10 rundown
USD – USD pressuring to the upside here, and we use the cycle lows in AUDUSD and the 1.1000 area in EURUSD as proxies for the general USD outlook.
EUR – very ugly PMI data out of Germany this morning (managing a new low for the cycle at 41.4 for the flash Sep. manufacturing PMI) this morning putting new pressure on the euro, and recent Germany comments on lack of interest in fiscal not helping at the margin.
JPY – the yen staying anonymous in the background lately, but could be set to firm against high yielders if market complacency on USD liquidity issues proves ill founded.
GBP – Thomas Cook collapse not a nice headline for the UK, but sterling near the highs against the euro here, even if 1.2500 was too high for GBPUSD as we await the Supreme Court decision on Boris Johnson’s proroguing of Parliament.
CHF – the weak flash PMI’s out of Europe this morning taking EURCHF sharply lower and recent German signals on lack of interest in fiscal stimulus also applying pressure – a test of the lows and below 1.0800 a risk here for EURCHF as SNB intervention is no doubt set to rise.
AUD – looking for how AUDUSD behaves in a test of the lows scenario, with added vulnerability for the Aussie on any further signs that US-China trade negotiation hopes are foundering.
CAD – upside danger in USDCAD on a close well above 1.3300 as the market’s confidence that the Fed is addressing the USD liquidity issue sufficiently may be poorly placed.
NZD – an important week for the little kiwi as the RBNZ is set to announce rates on Wednesday and we may need a dovish surprise to drive further relative NZD weakness as rate spreads versus Australia have stalled around 0 basis points at the short end of the curve.
SEK – weak EU PMI’s are bad news for SEK and EURSEK looks set to test the highs for the cycle if the market continues to sour on the outlook for Europe.
NOK – EURNOK ripping higher into 10.00 on the weak EU news, which tends to multiply through the Scandies. It’s impressive to see the price action despite last week’s hike, admittedly a dovish hike.
Upcoming Economic Calendar Highlights (all times GMT)
- 1230 – US Aug. Chicago Fed Activity Index
- 1300 – ECB’s Draghi to Testify
- 1345 – US Flash Sep. Markit PMI
- 1350 – US Fed’s Williams (Voter) to Speak
- 1700 – US Fed’s Bullard (Voter) to Speak
- 1700 – ECB’s Chief Economist Lane to Speak
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