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: CNY stable after US cries manipulation
John J. Hardy
Chief Macro Strategist
Summary: After an already intensely ugly day across asset markets yesterday, the US labeled China a currency manipulator, a move that triggered a further panicky downdraft in risk appetite overnight before China kept the CNY fix within yesterday's trading range. This has calmed nerves considerably for the moment.
Trading interest
- Squaring USDJPY shorts from last week
- Delta hedging EURUSD call options
- Shorting EURCAD with a stop above 1.4870
More of the same or time for a pain trade?
Let’s recall where we came from and where we went over the last few trading days since last Wednesday’s FOMC meeting. That meeting saw a somewhat heel-dragging Fed (with Powell positioning the Fed cut as a “mid-cycle adjustment” to kick off the Q&A session rather than the first in a series before tripping all that and other guidance for the rest of the press conference). Asset markets quickly got over the disappointment, having just come from recent (and in the US’ case, all-time) highs and were rallying afresh Thursday when US President Trump suddenly wrong-footed everyone with the new tariffs on Chinese imports. Then we got China’s response in the cessation of agricultural imports and more importantly, in allowing the CNY to drift lower through the 7.00 level versus the USD.
In short, the sudden re-aggravation of the US-China trade policy showdown has thrown the market for a loop and seen a grotesque extension lower in global bond yields and other classic risk off responses like a stronger JPY and an ugly adjustment lower in global equities. The US S&P 500 index even managed a vicious 100-point down-day yesterday. This could very well continue, especially if China continues to allow an expansion in daily trading ranges for the CNY and allows it to move aggressively lower.
But markets operate on the basis of expectations more than on current levels. The USDCNY at 7.05 is scary because markets fear that the break of 7.00 risks a move toward perhaps 7.50 or even higher, not because 7.05 is suddenly that much more painful than 6.95. IF USDCNY merely putters around in the range here or only manages a crawling retreat of a few percent over a long time frame, the market may begin to second guess the vehemence of its reaction. So for the near term at least, suddenly the pain trade becomes a squeeze on all of the new long JPY, long bond, short equity trade if conditions suddenly stabilize and the markets acclimatize to the new levels and especially if China makes good on its word and merely allows the CNY to float into this new range without significant directional progression lower. The risk of this scenario is greater now that China has not re-upped the pressure with an aggressively lower fix in the CNY.
Chart: EURCAD
Suddenly, the pain trade here is that the panic over the escalation of the US-China suddenly eases as China merely allows the CNY to drift gently lower without generating any wider panic. If that proves the pattern and risk appetite can stabilize, EURCAD reached an interesting pivot level and could offer a lower beta way than in the JPY crosses to trade for a calming of nerves here in the near term. As well, the price action has turned tail in an interesting resistance area near the prior range lows.
The G-10 rundown
USD – the USD a bit mixed here, fading against the riskiest currencies as the market tries to put together a sentiment bounce on the more stable CNY but stronger against the JPY. Yesterday’s July ISM Non-manufacturing data point weak at 53.7 versus 55.5 expected and 55.1 in June, but we won’t have interesting incoming US data until next week.
EUR – technically, the EURUSD has reversed, but important for it to hold the 1.1150 area and we like the looks of a EURCAD short as a tactical trade in the event that risk appetite suddenly stabilizes here as China maintains a calm CNY.
JPY – the path to 100.00 in USDJPY lies wide open if the pain trade fails to materialize and global bond yields head lower and the risk asset market rout continues. But JPY longs risk a sudden train wreck if the recent mood swing is reversed and USDJPY trades back above 107.50-108.00
GBP – sterling pushing to new lows versus the euro as UK parliamentary forces attempt to gather to block a No Deal Brexit and the EU and UK sides are at a total stand-off as the EU side said again this morning that there is no basis for further Brexit talks.
CHF – the CHF direction will correlate with swings in risk appetite here and the direction of bond yields as USDCHF has neared an important support zone in the 0.9700 area
AUD – the Aussie relatively stable after the RBA failed to push the panic button and kept rates unchanged as most expected prior the recent aggravation of trade war risks. Still, the RBA did revise GDP and inflation forecasts lower. But at least a partially offsetting fundamental boost for AUD overnight was a record trade surplus print for June, at over AUD 8 billion far above expectations.
CAD – the loonie enjoying relative stability here and USDCAD possibly one of the first places to look if Trump pulls out all of the stops to weaken the US dollar – the pair needs to stay out of trouble below the 1.3250-1.3300 zone for bears to find traction.
NZD – an important RBNZ up tonight as the central bank is expected to deliver a 25-basis point cut and the market will look for further guidance. The employment and earnings data overnight stronger than expected across the board, and NZD ripped higher in response, but the move was quickly corralled – so a close post-RBNZ back near current levels (above 1.0375) begins to look supportive and point to a bullish technical reversal.
SEK and NOK – the downside for the Scandies has extended aggressively, with EURNOK testing the huge 10.00 level and EURSEK not far from its cycle highs of 10.85. The currencies likely to correlate with the immediate direction of risk appetite (the move beginning to look excessive unless yesterday’s all out panic extends – stay tuned.).
Upcoming Economic Calendar Highlights (all times GMT)
- 0730 – Sweden Jun. Industrial Orders
- 1600 – US Fed’s Bullard to Speak on US Economy
- 1700 – New Zealand QV House Prices
- 2230 – Australia Jul. AiG Performance of Construction Index
- 0200 – New Zealand RBNZ Official Cash Rate
- 0300 – New Zealand RBNZ Governor Orr Press Conference
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