Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Complacency halts USD, JPY rise
John J. Hardy
Chief Macro Strategist
Summary: The recent strength seen in the dollar and the yen has been reined in as risk appetite surges.
Late last week, the spectacular comeback in asset markets from their late-December lows finally appeared to be rolling over – conveniently so, as the major US indices were testing their 200-day moving averages. But Friday’s session was a harsh rejection of that notion as the US equity market came roaring back.
US-China trade talks don’t appear perched on the verge of a breakthrough (and any likely deal seems mostly priced in) and there were no sufficiently impactful data points to drive the comeback. The one clear positive fillip for equities was the European Central Bank's Coeure on Friday airing the idea that there is scope for the ECB to do another TLTRO operation, but the price action seemed to suggest a squeeze on short positions as the major US indices pulled to new highs since early December.
We struggle to understand how the current market ramp, which almost impossibly coincides with a persistent bid in safe-haven assets like core EU bonds and US Treasuries, can extend much longer. Sure, one last flurry of strength on a positive trade deal headline might offer an additional modest, one-off boost. Eventually, however, with global liquidity tightening on the US Treasury’s issuance blitz and the Fed’s QT, it is simply not possible to maintain a simultaneous bid in risky assets and US Treasuries – either bonds falter and eventually provide their own headwinds for risk appetite or risk appetite rolls over again.
This week, we focus on the Federal Open Market Committee and ECB minutes up Wednesday and Thursday in particular and on the Eurozone flash February PMIs on Thursday. Meanwhile, equity market technical and animal spirits remain firmly in focus all week, particularly our notion that either Treasuries or equities must soon fall steeply. Note that US markets are closed today for a holiday.
Trading interest
Short EURUSD: still prefer the downside in EURUSD, perhaps given the tactically frustrating price action, with exposure via put options – 1.10 for four months takes us to the other side of EU parliamentary elections.
Short AUDUSD: given the lack of momentum, either patience is required for a fresh sell-off wave to arrive or the expression of a view in two-month or longer put options.
Short EURJPY: trade here via options (put spreads for one month or longer in case price action lower is halting) as the local price action has proven impossibly choppy and rangebound and the timing of a return of weak risk appetite difficult to discern.
Chart: EURUSD
The latest downside break attempt through 1.1300 was corralled on Friday , but the downside remains the focus, given the weak Eurozone outlook as we await a close below the range low of 1.1216 for signs of mounting downside momentum. Downside exposure via options still attractive as implied volatilities are quite low relative to historic averages – currently just above 6.5% for three-month options.
US-China trade talks don’t appear perched on the verge of a breakthrough (and any likely deal seems mostly priced in) and there were no sufficiently impactful data points to drive the comeback. The one clear positive fillip for equities was the European Central Bank's Coeure on Friday airing the idea that there is scope for the ECB to do another TLTRO operation, but the price action seemed to suggest a squeeze on short positions as the major US indices pulled to new highs since early December.
We struggle to understand how the current market ramp, which almost impossibly coincides with a persistent bid in safe-haven assets like core EU bonds and US Treasuries, can extend much longer. Sure, one last flurry of strength on a positive trade deal headline might offer an additional modest, one-off boost. Eventually, however, with global liquidity tightening on the US Treasury’s issuance blitz and the Fed’s QT, it is simply not possible to maintain a simultaneous bid in risky assets and US Treasuries – either bonds falter and eventually provide their own headwinds for risk appetite or risk appetite rolls over again.
This week, we focus on the Federal Open Market Committee and ECB minutes up Wednesday and Thursday in particular and on the Eurozone flash February PMIs on Thursday. Meanwhile, equity market technical and animal spirits remain firmly in focus all week, particularly our notion that either Treasuries or equities must soon fall steeply. Note that US markets are closed today for a holiday.
Trading interest
Short EURUSD: still prefer the downside in EURUSD, perhaps given the tactically frustrating price action, with exposure via put options – 1.10 for four months takes us to the other side of EU parliamentary elections.
Short AUDUSD: given the lack of momentum, either patience is required for a fresh sell-off wave to arrive or the expression of a view in two-month or longer put options.
Short EURJPY: trade here via options (put spreads for one month or longer in case price action lower is halting) as the local price action has proven impossibly choppy and rangebound and the timing of a return of weak risk appetite difficult to discern.
Chart: EURUSD
The latest downside break attempt through 1.1300 was corralled on Friday , but the downside remains the focus, given the weak Eurozone outlook as we await a close below the range low of 1.1216 for signs of mounting downside momentum. Downside exposure via options still attractive as implied volatilities are quite low relative to historic averages – currently just above 6.5% for three-month options.
The G-10 rundown
USD – further risk-on without a notable rise in US yields is the goldilocks scenario for USD bears, but we have a hard time believing that current conditions can persist for long.
EUR – seems the euro is set to perform poorly indifferently under almost any scenario as the prospects for the ECB easing are returning. ECB minutes may reveal more on that front, and the market will closely watch the Thursday flash Euro Zone PMIs for February. As if that wasn’t enough, tariffs on European cars for the US market are a risk.
JPY – what does a yen trader do with safe haven bond bid and super-strength risk appetite? Given our expectation that current market conditions can’t persist for long, we like exposure to JPY upside via options.
GBP – sterling easing back higher as the market edges the odds higher that the worst outcome for sterling will be a delay of Brexit if Parliament moves next week to take more control of the Brexit process in a an amendment vote to avoid a no-deal.
CHF – the idea of fresh ECB easing keeps EURCHF from moving higher on the back of stronger risk appetite, and USDCHF dips away from the range highs.
AUD – the risk-on vibe, led by a a parabolic ramping in Chinese mainland equities, is keeping the AUD certainly firmer than it would be otherwise. The AUDUSD focus is lower, though bears will find it uncomfortable if the price action backs up above 0.7200. RBA minutes up late tonight and jobs data up Thursday.
CAD – oil and risk appetite supportive of CAD, but the recent bullish reversal in USDCAD keeps technical focus higher for now – price action below 1.3150 there would begin to stress that view.
NZD – the kiwi priced for perfection – not sure where the catalyst is to spoil the picture as we watch whether AUDNZD can explore the last shreds of the longer-term range toward parity.
SEK – the market second guessed the Riksbank’s attempt to keep a (relatively) hawkish stance on its guidance last week, but strong risk appetite and an easy ECB keeping new highs in EURSEK at bay for now.
NOK – fresh strong highs in crude oil keeping a bid under NOK and EURNOK looks lower as long as the throwback rally to 9.84 is intact.
Upcoming Economic Calendar Highlights (all times GMT)
00:30 – Australia RBA Minutes
USD – further risk-on without a notable rise in US yields is the goldilocks scenario for USD bears, but we have a hard time believing that current conditions can persist for long.
EUR – seems the euro is set to perform poorly indifferently under almost any scenario as the prospects for the ECB easing are returning. ECB minutes may reveal more on that front, and the market will closely watch the Thursday flash Euro Zone PMIs for February. As if that wasn’t enough, tariffs on European cars for the US market are a risk.
JPY – what does a yen trader do with safe haven bond bid and super-strength risk appetite? Given our expectation that current market conditions can’t persist for long, we like exposure to JPY upside via options.
GBP – sterling easing back higher as the market edges the odds higher that the worst outcome for sterling will be a delay of Brexit if Parliament moves next week to take more control of the Brexit process in a an amendment vote to avoid a no-deal.
CHF – the idea of fresh ECB easing keeps EURCHF from moving higher on the back of stronger risk appetite, and USDCHF dips away from the range highs.
AUD – the risk-on vibe, led by a a parabolic ramping in Chinese mainland equities, is keeping the AUD certainly firmer than it would be otherwise. The AUDUSD focus is lower, though bears will find it uncomfortable if the price action backs up above 0.7200. RBA minutes up late tonight and jobs data up Thursday.
CAD – oil and risk appetite supportive of CAD, but the recent bullish reversal in USDCAD keeps technical focus higher for now – price action below 1.3150 there would begin to stress that view.
NZD – the kiwi priced for perfection – not sure where the catalyst is to spoil the picture as we watch whether AUDNZD can explore the last shreds of the longer-term range toward parity.
SEK – the market second guessed the Riksbank’s attempt to keep a (relatively) hawkish stance on its guidance last week, but strong risk appetite and an easy ECB keeping new highs in EURSEK at bay for now.
NOK – fresh strong highs in crude oil keeping a bid under NOK and EURNOK looks lower as long as the throwback rally to 9.84 is intact.
Upcoming Economic Calendar Highlights (all times GMT)
00:30 – Australia RBA Minutes
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