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: Blue Wave Lite crushes USD, but watching US yields
John J. Hardy
Chief Macro Strategist
Summary: The two Senate run-off races in Georgia are set to go to the Democrats, giving the incoming Biden administration control of the US Congress by the slimmest of margins. This has strongly rejuvenated the reflationary trade, driven by a weaker US dollar. Most importantly, US long yields have broken resistance, which eventually could become a hurdle for USD bears.
FX Trading focus:
Blue Wave Lite: clear sailing for USD bears now, but watching US yields
Although we may have to suffer through a recount episode due to the slim margins of victory, it appears certain that both of the two Senate seats up for grabs in the Georgia run-off elections are set to fall for the Democrats. This will give the incoming Biden administration marginal control of the Senate with a 50-50 tie, and VP Harris can cast the tie-breaking vote.
The market interpretation of the outcome is largely as expected – reflationary and USD bearish. The idea is that a slim Democratic majority is enough to allow the stimulus gravy train to roll and in bigger size than would have been the case in a divided Congress. We will likely see the larger stimulus checks very soon after Biden’s inauguration as a first step, for example. The path to more generous infrastructure spending is also likely easier as well – although I was already convinced that bipartisan attitudes toward spending had already seen a huge shift relative to the past cycle.
Further out, given the slim control of Congress, it is very difficult to see significant tax code adjustments on the agenda at all and certainly not this year, which will be all about getting to the other side of the pandemic. Next year could be another matter, but a full reversal of Trump’s corporate tax cuts is never going to be on the agenda. Likewise, green initiatives face a tough path .
While the reflationary reaction is all straightforward stuff, the most important development on the back of this election development is the break higher in US yields, with the US 10-year treasury benchmark yield trading north of 100 basis points for the first time since pre-pandemic and the 30-year likewise above 1.75%. The big level for the latter is actually quite close as the pre-pandemic range low was around 2%, while for the 10-year it is almost 50 bps higher in the 1.50% area. Eventually, a further rise in US yields would start to undermine the USD bear move unless the Fed starts to hint at capping yields or if other countries’ yield curves start to play ball in the same direction.
Chart: AUDUSD
AUDUSD and NZDUSD have been leaders in this USD bear run in recent weeks, with both posting new tops for the cycle yesterday and certainly in fitting both with the reflationary trade driven by a weaker US dollar and higher commodity prices, but also by the strength in the Asian countries relative to Europe and the US on avoiding as bad a second wave of Covid-19. The next major chart resistance for AUDUSD if this move holds does not arrive until into the 0.8100 area. The latest acceleration has actually seen the AUDUSD break above the upper bound of its trend channel. Interesting to see if the move lower in the US dollar can continue at the present pace if a) the risk sentiment dip turns into a wider route of some scale on this US election outcome and more importantly b) if US yields at the long end of the curve continue to rise aggressively. The latter would eventually slow the pace of USD declines unless the Fed rolls out the cavalry and hints that yields will be capped at some point.
The G-10 and CNH rundown
USD – weaker on the Blue Wave Lite scenario driving more aggressive US fiscal and hence US external deficits. The more US long yields rise, however, the more resistance comes in unless the Fed steps in with fresh guidance. A 77.5 reading in the Dec. ISM Manufacturing prices paid enhances the interesting in coming inflation releases.
CNH – China moving against Hong Kong opposition overnight, seeming to make a number of strong moves during the lame duck period of the US political cycle. The onshore rate is flat relative to the move of two days ago – so we can see how USDCNH is always its own “market”.
EUR – the EURUSD pulling to new highs and could be set for a run to 1.2500+ - but new fiscal in Europe and something resembling good news on the economic growth front would be helpful at some point.
JPY – the yen is a bit more of a reluctant fellow traveler in strengthening versus the USD when long US yields rise – still, USDJPY managed its lowest daily close yesterday aside from one day during the pandemic crisis last spring. The next obvious chart area there is 100.00.
GBP – sterling is sidelined by the ugliness of Covid and the drag of Brexit uncertainty – with the latest move in EURGBP back into the higher range. The structural setup for the UK is so similar to that for the US, but with such a different starting level. The UK race to vaccinate relative to the extra contagious Covid-19 strain on the loose there is what to watch over the next two months.
AUD – the AUDUSD actually accelerating beyond its trend channel on this latest move, as AUD draws on support from the reflationary narrative, its exposure to rising iron ore and other commodity prices and a stronger Asian economy, with only the recent trade spat with China on Australia’s stance on a number of issues the lone sour note in the background. Oh, that and private debt levels – but that’s not where we are in the cycle.
CAD – the Saudi move to independently cut yesterday indicative of the resolve to get the supply/demand balance for oil back in place and the surge takes CAD higher, if more slowly than other commodity dollar peers. The next major USDCAD level looming into view soon as 1.2500 approaches.
NZD – the kiwi keeping pace with the AUD as AUDNZD has traded back and forth across the 200-day moving average for weeks now. Still see the chart as having put in a low as long as we stay north of perhaps 1.0600 and prefer AUD as long as the reflationary trade is on.
SEK – the krona enjoying a surge in strength here after a squeeze earlier this week and EURSEK should test 10.00 soon if we avoid a consolidation in risk sentiment and can see the light at the end of the Covid-19 tunnel in coming weeks.
NOK – the krone in a very good place with this latest surge in oil prices and EURNOK testing new post-pandemic wipeout lows – next area into 10.30, but really the huge 10.00 level eventually.
Upcoming Economic Calendar Highlights (all times GMT)
- 1300 – Germany Dec. CPI
- 1315 – US Dec. ADP Employment Change
- 1400 – UK BoE Governor Bailey to Speak
- 1445 – US Final Dec. Services PMI (Markit)
- 1500 – US Nov. Factory Orders
- 1530 – US Weekly DoE Crude Oil/Product Inventories
- 1900 – US FOMC Meeting Minutes
- 2350 – Japan Nov. Labor Cash Earnings
- 0030 – Australia Nov. Building Approvals
- 0030 – Australia Nov. Trade Balance
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