Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Bracing for new tariff impact
John J. Hardy
Chief Macro Strategist
The comment period for President Trump’s plan to introduce 25% tariffs on $200 billion in Chinese imports expired yesterday, and now we await the details of the implementation plan should Trump proceed, as well as China updating its intentions in a likely symmetric response.
Risk appetite is not taking the situation well, as key Asian indices like the Hang Seng have touched new lows for the cycle over the last couple of sessions and some European indices have done likewise. Our global risk indicator continues to show strain (see below), and as we discussed on the Morning Call, in FX we are noting a strong rise in the premium for JPY puts, with AUDJPY one-year 10-delta puts trading at a 7% premium in implied vol to calls, and USDJPY one-year 10-delta puts at around a 3.7% premium to calls.
The latter is near the levels last seen during the massive risk meltdown in early February of this year and JPY upside is the classic response to global risk aversion, as Japanese savings sloshing around the world try to return to their home base.
Given the backdrop, ad hoc developments from the Trump administration on trade are likely to drive market action more than incoming data like today’s US earnings and payrolls data, as US data has largely been shrugged off this week – including the stellar ISM Manufacturing and ISM non-manufacturing readings.
Our risk indicator remains mired in the red as emerging market spreads and corporate credit spreads have moved in the wrong direction again, even if there are no signs of broad panic. Market volatility indicators are also driving the negative tendency, though the volatility in G10 FX has been rather muted, especially relative to the woes in EM.
In EM, Brazil was shaken by a gruesome stabbing of a leading right-wing populist candidate Bolsonaro, who apparently barely survived the attack. In Russia, a speech from Prime Minister Medvedev gutted the ruble, as he called for a move “from neutral to stimulating oversight of the credit sphere to create conditions for more confident economic growth”. He also said that new US sanctions on Russian banks would be an act of economic war.
The political interference signal has the optics of similar moves by Turkish president Erdogan and is a remarkable turn of events, as markets have been pricing in higher short-term rates due to the pressure on the currency. Russia is far less fragile than Turkey, but market’s will be very sensitive to signals that the Russian central bank’s policy mandate is being hamstrung by the government.
Chart: USDJPY
USDJPY is pressing on the 100-day moving average again (highlighted in red), an indicator that has been a bit more interesting at key pivot points in recent months than the traditionally important 200-day moving average. Upside will require risk-positive headlines on trade and perhaps rising US yields all along the curve as well, while downside risk rises on any further weakening in global risk appetite, especially if it is of a sufficient degree to have the market smelling a turnaround in the Powell Fed’s policy intentions.
In EM, Brazil was shaken by a gruesome stabbing of a leading right-wing populist candidate Bolsonaro, who apparently barely survived the attack. In Russia, a speech from Prime Minister Medvedev gutted the ruble, as he called for a move “from neutral to stimulating oversight of the credit sphere to create conditions for more confident economic growth”. He also said that new US sanctions on Russian banks would be an act of economic war.
The political interference signal has the optics of similar moves by Turkish president Erdogan and is a remarkable turn of events, as markets have been pricing in higher short-term rates due to the pressure on the currency. Russia is far less fragile than Turkey, but market’s will be very sensitive to signals that the Russian central bank’s policy mandate is being hamstrung by the government.
Chart: USDJPY
USDJPY is pressing on the 100-day moving average again (highlighted in red), an indicator that has been a bit more interesting at key pivot points in recent months than the traditionally important 200-day moving average. Upside will require risk-positive headlines on trade and perhaps rising US yields all along the curve as well, while downside risk rises on any further weakening in global risk appetite, especially if it is of a sufficient degree to have the market smelling a turnaround in the Powell Fed’s policy intentions.
The G10 rundown
USD – right or wrong, US tariffs not seen as a major risk for the US dollar, though the market feels uneasy on what to do with the greenback in this environment – sell on risk that Fed turns cautious due to trade wars or buy due to the risk of a global squeeze on offshore USD from the tight Fed and Trump tax reforms?
EUR – EURUSD stuck in neutral here – need some reason to believe that the European outlook is turning more positive to get liftoff above 1.1750-1.1800. The recent bullish reversal back above 1.1500, meanwhile, begins to get stale if we don’t see that follow up move higher soon and especially if we plunge back below 1.1500.
JPY – JPY upside showing up again on risk aversion, though the market looks a bit fickle and nervous and trade war headlines can drive the action either way, with strong risk of developments over the weekend from Trump tweets and China’s response.
GBP – sterling traders' nerves are getting frazzled by the back-and-forth headlines – not sure we can add anything productive for the tactical outlook as the next headline will drive the action, though there is still a strong binary risk in either direction depending on Brexit developments.
CHF – While support for the Italian government appears very high, the Italian yield spreads have eased back sharply lower, providing little further pressure on the EU existential front, leaving us scratching our heads a bit at the new lows in EURCHF.
AUD – The Aussie can’t catch a break and poked to new lows for the cycle in today’s trade. Housing market concerns are rising on the latest reports that Australian banks are tightening lending standards. If the US-China trade spat deepens, it only adds to the risk.
CAD – USDCAD eased back lower after its late rally ahead of today’s US and Canadian jobs data for August. Yield spreads are mid-range, so it will take data surprises and/or drama in energy markets to shift the story out of recent ranges, though the recent rally appears so far to be a rather firm rejection of downside risk.
NZD – outperforming the struggling Aussie and gets more focus if the 1.0800-50 area can’t hold, though we struggle to find reasons for sustained upside, given King Dove Adrian Orr is in charge at the RBNZ.
NOK – the krone remarkably weak as thinly traded currencies are out of favour and there is no real resistance ahead of the massive 10.00 level.
SEK – EURSEK bouncing back despite the relatively hawkish Riksbank statement, which has Swedish 2-year rates neat the high for the cycle as the bank indicates it will hike in December or February and that it is reasonable to hike by 25 basis points rather than in smaller increments. Rather than the Riksbank, it is the election this weekend and the risk of a strong showing from the Sweden Democrats has the market on edge. Click here for Saxo Bank Chief Investment Officer's Steen Jakobsen’s thoughts on the election.
USD – right or wrong, US tariffs not seen as a major risk for the US dollar, though the market feels uneasy on what to do with the greenback in this environment – sell on risk that Fed turns cautious due to trade wars or buy due to the risk of a global squeeze on offshore USD from the tight Fed and Trump tax reforms?
EUR – EURUSD stuck in neutral here – need some reason to believe that the European outlook is turning more positive to get liftoff above 1.1750-1.1800. The recent bullish reversal back above 1.1500, meanwhile, begins to get stale if we don’t see that follow up move higher soon and especially if we plunge back below 1.1500.
JPY – JPY upside showing up again on risk aversion, though the market looks a bit fickle and nervous and trade war headlines can drive the action either way, with strong risk of developments over the weekend from Trump tweets and China’s response.
GBP – sterling traders' nerves are getting frazzled by the back-and-forth headlines – not sure we can add anything productive for the tactical outlook as the next headline will drive the action, though there is still a strong binary risk in either direction depending on Brexit developments.
CHF – While support for the Italian government appears very high, the Italian yield spreads have eased back sharply lower, providing little further pressure on the EU existential front, leaving us scratching our heads a bit at the new lows in EURCHF.
AUD – The Aussie can’t catch a break and poked to new lows for the cycle in today’s trade. Housing market concerns are rising on the latest reports that Australian banks are tightening lending standards. If the US-China trade spat deepens, it only adds to the risk.
CAD – USDCAD eased back lower after its late rally ahead of today’s US and Canadian jobs data for August. Yield spreads are mid-range, so it will take data surprises and/or drama in energy markets to shift the story out of recent ranges, though the recent rally appears so far to be a rather firm rejection of downside risk.
NZD – outperforming the struggling Aussie and gets more focus if the 1.0800-50 area can’t hold, though we struggle to find reasons for sustained upside, given King Dove Adrian Orr is in charge at the RBNZ.
NOK – the krone remarkably weak as thinly traded currencies are out of favour and there is no real resistance ahead of the massive 10.00 level.
SEK – EURSEK bouncing back despite the relatively hawkish Riksbank statement, which has Swedish 2-year rates neat the high for the cycle as the bank indicates it will hike in December or February and that it is reasonable to hike by 25 basis points rather than in smaller increments. Rather than the Riksbank, it is the election this weekend and the risk of a strong showing from the Sweden Democrats has the market on edge. Click here for Saxo Bank Chief Investment Officer's Steen Jakobsen’s thoughts on the election.
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