Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
USD teeters, not yet toppled
John J. Hardy
Chief Macro Strategist
Summary: The US dollar is teetering on the brink, but has not yet been sent packing after the recent dovish shift from Powell. The market may be pressing its case on the latter as hard as it can for now. Elsewhere, the CAD rally looks remarkably aggressive ahead of tomorrow’s Bank of Canada meeting.
The risk rebound continued yesterday, though the extension higher was rather muted compared to Friday’s rally, and we wonder if the move has already largely played out as we have risen as much as 10% from the lows in the case of the S&P 500 index. Again, we point to the difficulty in sustaining a rally in sentiment merely on the Fed backing down, as renewed strong risk appetite and solid or better US data can only mean that the Fed will revert to its former hike path. And if the economy and financial conditions worsen, further shifts in the Fed’s stance are only in recognition of the bad news. I suspect this dynamic will drive the risk of a very choppy, back and forth market next quarter or more.
The rally in CAD has outpaced that of every other currency since yesterday after a stronger than expected Ivey PMI. The late CAD strength is in sympathy with the relief rally in risk appetite and oil prices. This looks more than anything like a short squeeze ahead of tomorrow’s Bank of Canada meeting. Have traders forgotten the jarring dovish shift in the BoC’s policy guidance at the December 5 meeting?
My suspicion is that we are seeing a CAD short squeeze that may reverse quickly in the coming days. Further muddying the outlook for the Canadian economy, on top of energy market and housing bubble unwind risks, the Justin Trudeau’s government has just introduced a novel new carbon tax that may weigh on growth. Trudeau is likely in the final months of his time as Canada’s prime minister, as he looks vulnerable to the country's version of national populism at the election later this year.
Chart: USDCAD
USDCAD potentially pivotal over the next couple of days after a brutal correction to the churning rally higher. The price action has taken us all the way back near the level of the last Bank of Canada meeting on December 5, in which it effectively abandoned its forward guidance anticipating further rate hikes. This latest bounce in risk sentiment and oil prices look far from sufficient to drive any shift back to a more hopeful outlook from Poloz and company tomorrow. Short dated USDCAD call options one way to trade a CAD retrenchment. Any remaining bulls here will want support to come in quickly after we have traded below the old 1.3385 highs.
The G-10 rundown
USD – some broad US dollar measures have broken down through pivotal levels, though not the USD index, and a look at EURUSD reminds us that that this key pair has not torn free of the range- would like to see it clear of 1.1500 and rising to suggest a USD bear market is firing on all cylinders, to mix a metaphor.
EUR – the euro is sharply weaker in the G10 small crosses though this looks like a mirror image of equity market developments – not sure there is any other angle driving that development. Not enthused about the euro as a top performer in any scenario for now and for a turn back lower in risk appetite again, interested in whether EURJPY pivot around 125.00-50 holds. Just out before posting: German Industrial production dropped 1.9% month on month in November, taking the year-on-year figure to -4.7%, the worst since 2009. This is terrible news.
JPY – JPY crosses gyrating in sympathy with risk appetite for now after last week’s flash crash. Would expect the G10 small JPY crosses, especially AUDJPY, to trade with the most beta to risk appetite as they have for the last couple of weeks. See this op-ed piece from William Pesek on the BoJ’s ugly dilemma for more.
GBP – Therese May is supposedly looking at options for curtailing the risks of a no deal after a vote on her likely ill-fated deal next Tuesday, perhaps providing sterling support at the margin. Even with a rejection of May’s deal, surely the EU and UK will hammer out some sort of deadline extension with status quo conditions. Sterling traders’ safest option is to sit on their hands.
CHF – EURCHF is on a slow jagged path lower as the big 1.1200 level approaches – wouldn’t a sustainable move below that level require fresh hot existential risks or ugly turns in Brexit?
AUD – expecting the Aussie to trade with high beta to risk appetite. The November building approvals data tonight likely to show another steep decline and remind us that Australia’s housing bubble unwind has the added risk of having created too much new construction as at one point, more cranes were said to be active in Australia than in all of the US.
CAD - looks like CAD bears getting caught offside ahead of the Bank of Canada tomorrow, which will deliver no rate hike and likely remains very cautious on the outlook.
NZD – the kiwi is neutral here –likely to trade weaker than AUD if risk appetite extends aggressively higher and/or on positive China or US/China trade developments, but stronger than AUD if the latter weakens on the opposite set of developments.
SEK – EURSEK wants to look lower, but really the SEK performance has disappointed, given the scale of the rebound in risk appetite – may be due to the distraction of a hard charging NOK and NOKSEK flows.
NOK – EURNOK interacting with the pivotal 9.75-80 area – needs to fully take this out to suggest a full reversal of the upside risk.
Upcoming Economic Calendar Highlights (all times GMT)
1000 – Eurozone Dec. Confidence Surveys
1330 – Canada Nov. International Merchandise Trade
2130 – Australia Dec. AiG Performance of Services Index
0030 – Australia Nov. Building Approvals
USD – some broad US dollar measures have broken down through pivotal levels, though not the USD index, and a look at EURUSD reminds us that that this key pair has not torn free of the range- would like to see it clear of 1.1500 and rising to suggest a USD bear market is firing on all cylinders, to mix a metaphor.
EUR – the euro is sharply weaker in the G10 small crosses though this looks like a mirror image of equity market developments – not sure there is any other angle driving that development. Not enthused about the euro as a top performer in any scenario for now and for a turn back lower in risk appetite again, interested in whether EURJPY pivot around 125.00-50 holds. Just out before posting: German Industrial production dropped 1.9% month on month in November, taking the year-on-year figure to -4.7%, the worst since 2009. This is terrible news.
JPY – JPY crosses gyrating in sympathy with risk appetite for now after last week’s flash crash. Would expect the G10 small JPY crosses, especially AUDJPY, to trade with the most beta to risk appetite as they have for the last couple of weeks. See this op-ed piece from William Pesek on the BoJ’s ugly dilemma for more.
GBP – Therese May is supposedly looking at options for curtailing the risks of a no deal after a vote on her likely ill-fated deal next Tuesday, perhaps providing sterling support at the margin. Even with a rejection of May’s deal, surely the EU and UK will hammer out some sort of deadline extension with status quo conditions. Sterling traders’ safest option is to sit on their hands.
CHF – EURCHF is on a slow jagged path lower as the big 1.1200 level approaches – wouldn’t a sustainable move below that level require fresh hot existential risks or ugly turns in Brexit?
AUD – expecting the Aussie to trade with high beta to risk appetite. The November building approvals data tonight likely to show another steep decline and remind us that Australia’s housing bubble unwind has the added risk of having created too much new construction as at one point, more cranes were said to be active in Australia than in all of the US.
CAD - looks like CAD bears getting caught offside ahead of the Bank of Canada tomorrow, which will deliver no rate hike and likely remains very cautious on the outlook.
NZD – the kiwi is neutral here –likely to trade weaker than AUD if risk appetite extends aggressively higher and/or on positive China or US/China trade developments, but stronger than AUD if the latter weakens on the opposite set of developments.
SEK – EURSEK wants to look lower, but really the SEK performance has disappointed, given the scale of the rebound in risk appetite – may be due to the distraction of a hard charging NOK and NOKSEK flows.
NOK – EURNOK interacting with the pivotal 9.75-80 area – needs to fully take this out to suggest a full reversal of the upside risk.
Upcoming Economic Calendar Highlights (all times GMT)
1000 – Eurozone Dec. Confidence Surveys
1330 – Canada Nov. International Merchandise Trade
2130 – Australia Dec. AiG Performance of Services Index
0030 – Australia Nov. Building Approvals
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