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: Next two weeks pivotal for whether FX can find a pulse.
John J. Hardy
Chief Macro Strategist
Summary: Inflation talk is all of the rage and crude oil is on the move, but volatility in FX is very low on tactical and longer term uncertainties on the nature of the US recovery and how the Fed will react. For the tactical side of things, the next two weeks, or really thirteen days, through the June 16 FOMC meeting will be critical for whether the Fed can stick to its approach through white hot inflation numbers and possibly confusing labor market data.
FX Trading focus: Three things to watch through June 16 FOMC meeting
Another day brings another bout of bottled up, inconclusive market action, as nearly everything is mean reverting within a range or against recent trends, of which there are too few. As noted in the summary for this article and in yesterday’s FX Update, the market is on very uncertain footing on the outlook for the US dollar as the Fed continues to ever-so-cautiously hint that the taper discussion is finding its way into their consciousness. Until we get a signal from the Fed or some forcing from drama in commodities (especially crude) we may be stuck in limbo across the board in the major currencies.
Three things to look for from now until the June 16 FOMC meeting. First is whether the ISM Services employment sub-index is also weak and the ADP payrolls data and/or official Nonfarm payrolls data Friday suggests that the jobs market comeback is disappointing. That sets up a possible worst possible outcome for the Fed from here: the risk of stagflationary outcomes in which inflation continues to march higher, but companies are unable to either find the qualified workers to fill positions or to increase wages significantly for existing workers. Alternatively, very strong payrolls data is more straightforward and is the single data point most likely to trigger more taper talk sooner rather than later and a firmer USD. Second, the May CPI release is up next Thursday and could prove the highest print of the cycle, with the headline expected at 4.6% and the core year-on-year at 3.4%, which would be the highest since the early 1990’s and hard for the Fed to ignore – setting up a massive focus on the next batch of Fed forecasts. Third and finally: the oil price as oil prices are a key inflationary input and crude has seen a breakout above important range resistance this week. The Fed may start losing its cool if WTI is trading well north of 70 dollars a barrel ahead of the meeting.
Chart: EURUSD
An interesting test ahead for USD pairs as noted above as EURUSD has stalled out in a tight range after breaking above 1.2180 over two weeks ago. As noted above, anything that finally moves the Fed’s actual rate expectations sharply higher could support the USD within the recent range here, at least seeing the pair testing back toward 1.2000, while stagflationary data (hot inflation, weak payrolls growth) could keep the pressure on the US dollar.
HUF: let’s talk about what is actually moving. HUF has been on a tear higher since the central bank finally signaled last month that rate tightening is in order, placing Hungary at the head of line as the country in Europe that will be the first to hike rates. I write “finally” because the negative real yields in HUF were rising to ugly new extremes after the country printed a heady 5.1% headline CPI reading in April. Contrast that with a deposit rate not far above zero. The HUF was on the defensive in part on that negative real rate story in addition to the fact that Hungary has been one of the worst hit by Covid 19 in Europe. With the central bank shoring up the currency, the real yield situation could calm considerably in the next six months, given the HUF is over 6% higher versus the Euro since the weakest levels of March. The hunt for yield is likely a chief driver of HUF upside here, and it is worth noting as the market prices lift-off for the policy rates at the June 22 meeting, yields for HUF bonds has dropped, perhaps on unhedged bets (hedged ones make no sense) from foreigners looking to pick up yield now that the central bank has showing an interest in maintaining price stability. The 10-year Hungarian bond yield has dropped 30 bps to 2.62% since the highs, and yield spreads on foreign currency bonds have tightened a bit as well.
It all looks fine, but at least one note of caution for HUF enthusiasts is in order here, in addition to the likely prospect for a relative shallow path of interest rate hikes from the Hungarian central bank: EU troubles. The EU Court of Justice announced today that it is rejecting Hungary’s challenge to overturn a European Parliament vote to probe into whether Hungary measures up to the EU’s democratic standards. That decision cannot be appealed. The timeline is absurdly slow, as the original so-called Article 7 procedure to investigate Hungary for undermining the rule of law was passed way back in September of 2018, although post-pandemic measures up the risks for Hungary and Poland, which is also the subject of an Article 7 probe, in that only a majority of EU member states need to find the countries in violation of norms for the EU executive to suspend EU funding. (Under the old rules, 26 out of 27 member countries had to vote guilty, with Poland and Hungary vowing one another to block a vote.) EURHUF shorts might consider selling covered puts – have a hard time seeing EURHUF much below 340.
Table: FX Board of G-10+CNH trend evolution and strength
The table below presented merely per habit – trends are very weak in most currencies.
Upcoming Economic Calendar Highlights (all times GMT)
- 1215 – US May ADP Payrolls Change
- 1230 – US Weekly Initial Jobless Claims
- 1345 – US Final May Markit Services PMI
- 1400 – US May ISM Services
- 1600 – US BoE Governor Bailey to Speak
- 1905 – US Fed’s Quarles (Voter) to Speak
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