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: EM under pressure as USD rises broadly
John J. Hardy
Chief Macro Strategist
Summary: The rising US dollar starting to impact emerging market currencies, which have recently enjoyed such supportive conditions. The Fed has been required to respond to spiking demand for USD liquidity and will increase its next repo operations, a theme that we will likely see repeated into year end due to regulatory rules for large US financial institutions.
Yesterday the market tried to piece together a recovery in sentiment after many saw the Trump administration’s account of President Trump’s phone call with the Ukrainian leader as less damning than initially thought, though that certainly depends on whose opinion you read in the hopelessly biased media reporting landscape. Trump also tried to make promising noises on the prospects for a US-China trade deal just a day after bashing China before the world at a UN speech.
Working against the recover in risk sentiment late yesterday, the US dollar rallied broadly, likely driven by ongoing liquidity issues. The Fed announced that it is increasing the size of repo operations in response to demand, doubling the size of today and tomorrow’s 14-day repos to $60 billion and increasing the overnight repo to $100 billion. There may be a lull in liquidity demand once we get past the quarter end date, but expect these operations to only expand from here as the large US financial institutions look to do all they can to shrink their balance sheets (for example, by not participating in repos) ahead of year end to reduce balance-sheet-size penalties they must pay as G-SIFI’s – global systemically important financial institutions. Today also sees an auction of 7-year treasuries after yesterday’s 5-year auction went reasonably smoothly. The last 7-year auction in late August was perhaps the weakest single Treasury auction for the cycle.
EM assets markets and currencies (very often the same thing) are finally waking up a bit to the stronger US dollar and put in a bad session yesterday. An interesting test for broader EM sentiment today as Mexico’s Central Bank meets and is expected to cut rates 25 basis points to 7.75%. These cuts can only continue as long as EM has the luxury of supportive conditions – which were about as good as they will ever get before the last few days.
Today we have a rather light economic calendar as we have a look at how markets deal with the pivot to quarter end and the run into likely accelerating USD liquidity issues into year end, US earnings season starting mid-October and the next chapter of Brexit and US-China trade talks. A pickup in volatility in October seems almost inescapable.
Chart: EURUSD
EURUSD saw a new low daily close for the cycle near 1.0950 and looks ready to test toward the 1.0800 level next if the seemingly unstoppable force of the rising USD liquidity issues are not countered forcefully enough by the Federal Reserve.
The G-10 rundown
USD – the USD strengthening appears an unstoppable force until the Fed gets ahead of the liquidity situation or the Trump administration picks up where the Fed can’t and intervenes.
EUR – the ECB’s Lautenschläger (of Germany) quit in protest against QE, apparently not wanting to serve under Lagarde as her last date will be Draghi’s last date. Does she fear that ECB policy only risks getting more unconventional and political under Lagarde?
JPY – the JPY not cutting much of a profile as risk appetite recovered and bond yields bounced – was passive in the face of a stronger US dollar yesterday as the US and Japan signed a partial trade deal overnight that does not yet put to rest fears that Trump eventually slaps auto tariffs on Japanese imports.
GBP – sterling on its backfoot as it should be given the intense uncertainty of how the Brexit situation unfolds, with each passing day bringing more damage to the UK economy via a weak credit impulse.
CHF – the franc backing down a bit as yields have poked back higher.
AUD – Aussie short rates look heavy in recent days and the August Job Vacancies data overnight the worst in years. AUDUSD could be set for test of lows here if nothing counters the strong USD pressure.
CAD – USDCAD stuck in one of its narrowest ranges ever and market feels asleep at the wheel here – asymmetric downside risk on any combination of weaker US and/or CA data, oil prices continuing lower, or weakening risk sentiment. Technically, USDCAD needs to clear 1.3300+ resistance again.
NZD – the RBNZ keeps policy expectations modest as Governor Orr spoke against the likelihood of unconventional easing overnight – may drive a bit more consolidation in NZD crosses but doesn’t change our strategic outlook for AUDNZD.
SEK and NOK – searching for a pulse here. Need a sense that EU prospects are bottoming out and fiscal on the way to boost the Scandies. A shift to weaker risk sentiment would be a challenge for both currencies.
Upcoming Economic Calendar Highlights (all times GMT)
- 1230 – Final US Q2 GDP Revision
- 1230 – US Weekly Initial Jobless Claims
- 1330 – ECB’s Draghi to Speak
- 1400 – US Aug. Pending Home Sales
- 1430 – US Weekly Natural Gas Storage
- 1500 – US Sep. Kansas City Fed Manufacturing
- 1700 – US Treasury 7-year auction
- 1800 – Mexico Central Bank Rate Announcement
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