Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Investors scramble to position for a trade war
John J. Hardy
Chief Macro Strategist
The sudden escalation of trade tensions on Friday has raised the temperature for global markets as investors rush to position for the potential implications. In FX, the biggest movers have been Asian emerging market currencies leveraged to Chinese demand.
President Trump’s new tariffs on Chinese products announced Friday saw an immediate response from Beijing, which threatened a menu of US products in equal measure. The US announcement also touted a further set of measures should China choose to respond in kind, though we don’t know the shape of this follow-on threat. We’ll likely know very quickly this week.
In an eventual trade war, both countries have much to lose and China has more leverage than is immediately apparent from the tallies of total US exports into China versus Chinese exports to the US (China exports more than three times to the US versus what it imports).
In response to Trump’s move and China’s response, commodities markets were shaken, risk appetite softened into the weekly close, and FX traders scrambled to consider the implications after having already being buffeted by the Federal Open Market Committee and European Central Bank meetings last week. As we point out below in today’s chart focus, the Asian EMs have moved the most.
The euro was administered a double whammy late last week. First, after the market positioned for a slightly hawkish meeting, the euro suffered an ugly downdraft as Draghi delivered maximum dovishness (talking taper but also pushing current rate guidance deep into 2019 with conditionality). But a significant driver of euro weakness has also been down to the unanticipated German political developments over the last week. Chancellor Angela Merkel faces a mutiny from her CSU coalition partner, whose leader, Horst Seehofer, has given her two weeks to come up with a deal with other EU countries on dealing with asylum seekers at Germany’s southern border. This is coming to a head even amidst an already intense focus on next week’s EU Council summit.
Can the EU shape its future with dysfunction on the German domestic political front?
It’s a busy week for ad hoc developments on the trade war and EU political fronts. On the economic calendar, we have a Norges Bank meeting and Swiss National Bank meeting on Thursday, and the major central bank heads are in Sintra, Portugal for a conference mid-week. At the end of the week, an Opec meeting on Friday is guaranteed to be contentious given Saudi and Iranian sending opposing signals on production increases. Saturday sees a follow-on “Nopec” meeting with other major oil exporters, chiefly Russia.
Chart: USDTHB
The Thai baht saw a huge acceleration to the downside on Friday, as the market considers the implications for Asian EM economies that are leveraged to demand from China, while the previous focus was perhaps on China’s strong yuan policy. There may be an element of speculation as well in these currencies that China could abandon its strong FX policy if trade tensions worsen materially.
The G-10 rundown
USD – the USD is doing well (as per default) as the widespread uncertainty rewards the most liquid currency. Note that USDCNY has jumped to a new multi-month high to open trading this week, a move that could further rock the EM boat if China is seen as loosening its commitment to a strong CNY (doubtful at this phase, as this is the “nuclear option” in our view).
EUR – the euro doubly under threat from the ECB’s thoroughly dovish performance last week and now the sudden uncertainty over the stability of Germany’s coalition. A test through 1.1500 in EURUSD looks in the cards, though we see increasing value in EUR below that level for the longer-term perspective.
JPY- the yen is a confusing one at the moment as normally supportive developments like lower bond yields and weak risk appetite are offset partially by concerns that an eventual trade war threatens Japan’s current account surplus and export-focused economy. Yen strength in crosses preferred if risk appetite worsens from here.
GBP – a Bank of England meeting later this week with no expectations for a rate move, which has also faded recently for the August meeting (priced at 50/50). Technically, EURGBP looks interesting locally for EUR bears, but the larger range has held since September of last year.
CHF – EURCHF burdened by the sudden injection of EU existential risks from the situation in Germany. Interesting to see whether the SNB signals anything at its quarterly meeting this Thursday, though we’re not holding our breath.
AUD – the combination of weak recent data out of China and trade war risks is very AUD-negative. If industrial metals prices push lower, this could pile on the pressure. AUDUSD is looking at the cycle low since early 2017 this week below 0.7425.
CAD – Canada under siege from the trade tensions with the US and is also a victim of the US shale oil phenomenon, which heavily discounts North American grades relative to global benchmarks.
NZD – managing a leg up versus the AUD, though this is perhaps more due to the knee-jerk tendency to focus more on AUD whenever China developments are in the mix – the next test for NZD over the Thursday Q1 GDP release.
SEK – euro uncertainty and threats to global trade are no friend of SEK, and this EURSEK reversal may be rejecting the potential for a test of the 10.00 level that seemed in the cards before Friday’s session.
NOK – an important week ahead for NOK, given the Opec/Nopec meetings Friday and Saturday and the Norges Bank meeting on Thursday. EURNOK could reverse back into the former range above 9.50 if oil prices stay lower and risk appetite worsens over the prospects for a deepening trade war.
Upcoming Economic Calendar Highlights (all times GMT)
• 1400 – US Jun. NAHB Housing Market Index
• 1700 – US Fed’s Bostic (FOMC Voter) to Speak
• 1730 – ECB’s Draghi to Speak at Sintra conference
• 2000 – US Fed’s Williams (FOMC Voter) to Speak
• 0130 – Australia RBA Minutes
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