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: US-China trade deal on the rocks. US yields signaling risk off?
John J. Hardy
Chief Macro Strategist
Summary: The currency market remains in a relatively low-energy mode despite rising risks of US-China trade tensions, and we see signs of safe haven-seeking as the rally in US treasuries picks up pace. CAD was taken down several notches after US crude oil supply figures triggered the biggest slide in oil prices in weeks and after dovish Bank of Canada rhetoric.
The US Senate yesterday passed a bill aimed at revisiting the Hong Kong trade status on an annual basis to determine whether Hong Kong is “sufficiently autonomous” and sanction individuals responsible for human rights abuses in the territory. The House passed a similar bill recently, and because the agreement in Congress is unanimous, a Trump veto would be immaterial as a supermajority in Congress would override a veto. I am unsure of the timeline here for this bill, and both houses of Congress must pass the same version of the bill for it to become law, but this efforts behind the bill have been very quick by US legislative standards and the time frame is likely quite compressed. China issued a sharp response, claiming it will retaliate.
I do not see how a US-China trade deal of any sort can be accomplished if this bill becomes law. That general sense seems to be settling over markets since late yesterday as risk sentiment has deteriorated sharply from yesterday’s highs. And given the levels of complacency we have thoroughly discussed in recent podcasts – especially this morning’s – volatility has plenty of room to expand here.
When markets lurch into risk off mode as they risk doing here, we might expect currencies to align themselves along the axis of risk as correlations go to one. This could mean especially vulnerable EM currencies, weak G10 smalls and perhaps weak GBP, the euro somewhat in between (but specifically vulnerable on weak Chinese demand fears for its exports) and a stronger USD and maybe even stronger JPY.
Chart: USDCAD
Whiplash for CAD traders yesterday as the loonie suffered a double whammy of a significant slide in oil prices and especially dovish talk from the BoC’s Wilkins. The news has taken the USDCAD pair to its highest level in several weeks. Still, to get significantly beyond the 1.3380 area in USDCAD (multi-month high), we’ll likely need a broadly stronger US dollar and a deterioration in risk sentiment.
The G-10 rundown
USD – the dollar bounce not a surprise given the source of the market’s unease this morning (US-China trade deal concerns) and we assume a deepening concern on this front together with risk off would be USD-supportive.
EUR – China related concerns are a net euro negative and we are all waiting for the next signals from EU policymakers – a EURJPY downdraft one way to trade further risk off on US-China concerns while avoiding the USD.
JPY – the powerful bid in treasuries finally making more of a mark on the JPY, where the general addition of risk off could see the yen rising to the top as EM sinks to the bottom (implications for carry trades, etc.).
GBP – sterling suffered a setback on Corbyn’s strong debate performance yesterday, but as well, I suspect any general downdraft in risk appetite could sideline sterling rally attempts for now.
CHF – the franc less reactive than the JPY to intermarket developments as we continue to find it difficult to pay attention here.
AUD – surprised to see AUDUSD still near 0.6800 after the overnight news flow – significant risks for the AUD will mount if risk off based on US-China trade tensions continues here. The 0.6770 area in AUDUSD a notable technical level/pivot.
CAD – the latest BoC rhetoric seeing a chunkier rally now at the short end of the Canadian yield curve – and there could be more pressure to come if today’s CPI misses to the downside, but especially on tomorrow’s “fireside chat” from BoC Governor Poloz tomorrow.
NZD – NZDUSD looks overambitious at these levels given the backdrop and a close back below 0.6400 would underline that point here.
SEK – our recent comment that SEK strength had been disappointing recently given the backdrop underlined now as SEK getting hammered today on still fairtly moderate risk off – though the Riksbank out with its financial stability review this morning frets rising financial stability risks (This morning, it emerged that the US is investigating Sweden’s Swedbank for money laundering with Russia).
NOK – everything going wrong for NOK as global growth and oil demand concerns will mount on a US-China trade negotiation failure. The oil sell-off and recent rejection of the attempt lower aggravating the NOK sell-off here – new EURNOK highs possible if we see an equity market correction here and lower oil prices.
Today’s Economic Calendar Highlights (all times GMT)
- 1000 – Sweden Riksbank Financial Stability Review press conference
- 1330 – Canada Oct. CPI
- 1530 – US DoE Weekly Crude Oil Inventories
- 1700 – ECB’s Lane to Speak
- 1900 – US FOMC Meeting Minutes
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