FX Update: Yield curve inversion worries? Steepening may not help.

Trading interest

• Maintaining long AUDNZD with stops below 1.0450 now for 1.0625 and eventually 1.0700
• Abandoning short AUDUSD half position after interest in selling above 0.6800.
• Shorting EURJPY for 112.00 as long as remains below 119.50

The sharp rally in risk assets inspired by Trump’s tariff schedule delay on Tuesday faded quickly and then some yesterday as the Chinese response was hardly promising and further Trump tweets take the risky approach of linking trade deal progress with Hong Kong – likely a no-go area for China. Major equity indices suffered large losses in the violent momentum shift from the prior day’s squeeze.  A bit spooky, to say the least, that the mood can shift so viciously.

The rally in long duration continued yesterday, and the long-term obsession with the flattening US yield curve may begin to ease now that we have “achieved” an official inversion for the 2-10 portion of the US yield curve. The long 30-year US T-bond yesterday posted a new record low just below 2.00%. The narrative in the headlines suggests the yield curve inversion was the chief driver of the carnage in equity markets yesterday. But let’s remember that in the past, most market pain usually comes later, when policymakers are scrambling to ease quickly enough to provide stimulus and actually steepen the yield curve. Cue the latest chatter that the Fed will now be forced to cut rates before the regularly scheduled September 18 FOMC meeting to get ahead of galloping concerns. This is indeed a strong possibility and the Fed will have to move by fifty basis points, whether between meetings or in September, to even have a chance to slow the yield curve inversion. (50 basis point chop priced at nearly 40% probability for the Sep. FOMC meeting currently).

German data yesterday confirmed the weakness in the German economy as the headline Q2 GDP number came in at the expected -0.1% QoQ, although other versions of the number, like the “work-day adjusted” tally was actually a fairly strong beat at +0.4% vs. +0.1%. But no matter, German yields plunged lower still and the 30-year German sovereign stands at a stunning -21 basis points this morning. EURUSD retreated farther below 1.1200 as well to as low as 1.1135.

The CNY fix came in a hair weaker again today, providing little new energy in an otherwise nervous market.

Chart: USDCAD
The Canadian dollar has held relatively firmly until the last couple of weeks as weak oil prices have begun to apply downside pressure on top of wobbly risk appetite. Still, the 2-year US-Canada rate has moved into negative territory as the Fed is now seen as cutting more aggressively than the Bank of Canada over the next year. The market pricing just under 50 basis points of rate cuts through next June from the Bank of Canada, an outlook that will be tough to square with a weakening global growth environment. USDCAD zipped back toward the 1.3300+ resistance, the pivotal area that is the last pivot zone ahead of the 1.3500+ prior highs. Any further plunge in risk appetite and  oil prices here likely to put pressure on the market’s views of Bank of Canada’s likely policy path and on the currency itself.