Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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FX Update: Market sells the fact on RBNZ hike. New USD surge.
John J. Hardy
Chief Macro Strategist
Summary: The Reserve Bank of New Zealand hiked rates 25 basis point as expected to initiate a new hiking cycle, indicating more hikes to come. But the market had fully priced both the hike and the guidance and NZD dropped in the wake of the decision. Elsewhere, the US dollar is resurgent as the tick-tock of risk-on, risk off we have seen over the last few days continues, with cratering sentiment overnight and into early European hours today.
FX Trading focus: Market shrugs off RBNZ hike and guidance for more. USD resurgent.
The RBNZ meeting delivered pretty much everything expected, and not a bit more as the Governor Orr and company went ahead with the expected 0.25% hike to take the policy rate to 0.50% and forecast more rate hikes to come, saying that the medium term outlook would not be held back by the covid virus in their estimation. The rates markets in NZ tried to gin up a reaction, but that failed and NZ short rates are hovering around the average of the last couple of weeks as the meeting was deemed fully in line with expectations. The fact that NZD is off so hard in the wake of the meeting versus the USD (more on that below) and even the AUD has likely far more to do with still heavy positioning after the strong NZD was one of the best trends in recent months, and as a fresh bout of weak sentiment is seeing a general position squaring and safe haven seeking.
With the daily shift in risk sentiment – today back to the downside – the US dollar is rising fast and taking the JPY with it this morning after the JPY was actually weaker overnight. Late yesterday, US yields powered higher on a stellar Sep. ISM Services survey and even broke to new local highs overnight in the case of the US 10-year treasury benchmark before yields eased sharply back lower in the European session today. JPY crosses look heavy nearly everywhere suddenly after USDJPY was bid overnight – note EURJPY in particularly pushing back toward that critical 128.00 zone today.
The US ADP payrolls change number today and US Jobs and earnings report on Friday are the next best chance for US yields to continue to set the agenda. How would particularly strong numbers be greeted? With a flattening yield curve as short yields rise while longer yields stay rangebound and with risk off or would the reaction be more positive? Strong data will likely boost the USD dollar and shorter US yields, but longer yields and risk sentiment may prove more fickle.
Chart: NZDUSD
The NZDUSD pair looking heavy in the wake of the RBNZ decision overnight as discussed above. Since the beginning of the year, the 2-year rate spread between New Zealand and the US widened from about 10 basis points to as high as about 116 basis points at the most extreme in mid-September. The NZDUSD has not correlated tightly with that development, as surging US long yields were the focus in Q1 and generally supported the US dollar. The August RBNZ, however, did trigger an avalanche of interest in buying up the kiwi on the RBNZ’s huge hawkish shift, but that has now mostly unwound even as the RBNZ hiking cycle has now begun. I suspect the NZD is only ready to rally durably if the Chinese and global longer term growth outlook improve again – whatever the RBNZ is doing will prove irrelevant if the backdrop doesn’t look more supportive. For NZDUSD, watching the 0.68900 area as a possible trigger for a probe toward 0.6500 if risk sentiment in asset markets continues to deteriorate, while the next step for AUDNZD is the 1.0600 area – a major prior pivot low and the current approximate location of the 200-day moving average.
Economic damage will be significant from energy crunch – the commentary is not particularly robust out there on the implications of the ongoing energy crunch – particularly for China and Europe, but will mean a significant brake on the recovery at best and something on the scale of the 1970’s energy crises if a significant portion of the rise in gas and power prices already in the bag are sustained over the next few months. Already, energy intensive industries are shutting down production, while consumers and businesses have yet to alter behavior as electricity and gas prices, in most cases, don’t rise until periodic resets, and some energy bills are only assessed quarterly (at least they are here in Denmark). The price reset in Italy, for example, started on Friday in Italy and was set almost 30 percent higher for electricity, with gas prices only set to rise less than 15% even as the most closely watched gas price is up several multiples of its normal range in Europe.
And Europe has yet to really turn on the heat this fall, much less receive utility bills that reflect these prices. In short, the issue will hit Europe and elsewhere with a bang in coming months and could actually provide the spark for Europe to go big on the infrastructure investments and vision needed to reduce its vulnerability on this issue. Stay tuned. In China, by the way, ports are quietly accepting shipments of Australian thermal coal after authorities discouraged imports on Australia’s questioning of the Covid virus origins, as the country seeks to boost low thermal coal stockpiles for the winter. This is an AUD positive and comes after Australia posted a record trade surplus in August of some AUD 15.1 billion. And even if many consumers are set to be shielded from rising prices, this only subtracts from potential investments in solving the problem or improving productivity.
UK Prime Minister sends a loud populist signal on wages and is supporting higher wages for the lowest earners and, for example, for industry to improve its supply chains through rising productivity, wages and skills rather than via “low age, low growth, low skills and low productivity, all of it enabled and assisted by uncontrolled immigration. This “leveling up” approach could help drive a wage-price spiral in the UK and sterling is in a relatively positive mood in the crosses as UK short rates are up sharply recently and since yesterday, with 2-year UK swaps trading 78 basis points as Johnson speaks today.
Table: FX Board of G10 and CNH trend evolution and strength
We’ve had a big further spike higher and then retrenchment intraday in some energy prices – interesting to note the NOK and CAD stumbling a bit intraday today – the market may have been overdoing it there in recent days. Elsewhere, interested to see the status of the JPY relative to the US dollar on the other side of the rest of the US data this week through the Friday US jobs report.
Table: FX Board Trend Scoreboard for individual pairs
Note the JPY is trying to claim a couple of victims as NZDJPY and SEKJPY are in danger of rolling over to a negative trend and EURJPY has been negative for several days now.
Upcoming Economic Calendar Highlights (all times GMT)
- Poland Central Bank Rate Announcement
- 1200 – Hungary Central Bank meeting minutes
- 1215 – US Sep. ADP Employment Change
- 2300 – South Korea Sep. CPI
- 0100 – New Zealand RBNZ Official Cash Rate
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