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: Risk sentiment rebounds despite hefty yield pressure.
John J. Hardy
Chief Macro Strategist
Summary: The US January PCE inflation data came in far hotter than expected at the core, which took US treasury yields and Fed tightening expectations higher still and prompted a USD rally extension, particularly against the yield-sensitive JPY. But risk sentiment held the line in late trading last week on Friday and has sprung back strongly in today’s European session. It will be tough to sustain both higher yields and resilient sentiment for much longer.
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FX Trading focus: Higher yields clearly JPY-negative, but USD reaction is muted on resilient risk sentiment. Sterling focus on post-Brexit settlement on Northern Ireland border, AUD focus on commodities and China re-opening narrative.
The hot core US PCE inflation data excited a fresh USD rally extension as US yields spiked to new highs at the short end of the US treasury yield curve. The Fed is now marked for three-plus 25-bp rate increases and a peak Fed funds rate of over 5.40%, with about 25% probability that the Fed will have to “re-accelerate” the pace of rate increases with a 50-basis point hike at the March 22 FOMC meeting. The rally was felt heaviest against the JPY after Kazuo Ueda’s nomination hearing on Friday suggested a cautious stance on normalizing the Bank of Japan’s monetary policy. The USD rally has since faded slightly, most likely because risk sentiment has managed to absorb these developments and hasn’t broken down. If sentiment can continue to hold the line despite higher yields, the US dollar might even weaken further for a spell – but I have a hard time believing that sentiment can hold up if yields continue to pull higher, and particularly if longer yields join in and the 10-year yield threatens the cycle high above 4.25%.
Next tests for how the markets treat incoming data are the US Feb. ISM Services survey not up until this Friday, the March 10 (very late!) jobs report, the February CPI up on Tuesday March 14 and the FOMC on the 22nd. And then there is the geopolitical backdrop – a huge concern, but one that could downshift to a slow burn rather than providing headlines in coming days. All in all, it’s a tough environment for tactical direction calling after Friday failed to trigger a sentiment capitulation.
Chart: GBPUSD
GBPUSD and many other USD pairs have dipped of late on the persistent shift higher in Fed expectations, but most have yet to take out the supports established around the beginning of this year, important pivot points for USD traders. In GBPUSD’s case, that early January pivot low is down at 1.1842, and the tactical drama has been the cat-and-mouse testing of the 200-day moving average over the last three weeks, with today offering the latest of those tests. The zone from here down to 1.1840 is critical for the near term outlook, with risk sentiment likely an important coincident driver of what happens next. A special twist here as well on the incoming announcement on the shape of the post-Brexit settlement on the Northern Ireland border – hard to see much pent-up anticipation on this issue in financial markets or for sterling, but let’s see if it sparks a reaction. EURGBP is also pivotal after a recent sell-off on a strong UK Services PMI for February, but with no follow-on momentum yet. For GBPUSD, sterling bears need risk-off and a close below 1.1840, while bulls will watch for an impulsive rally bar or two that takes the action back above 1.2150-1.2200, although the massive overhead resistance line and range high is the well-defined 1.2450 area etched out by the tops in December and January.
The Asian session overnight continued to show the stumbling of the China re-opening narrative, or at least the evidence that the market is enthusing to that narrative, fading. Metals prices have rolled over badly and AUDUSD tested the waters south of 0.6700 briefly this morning, finding support so far just ahead of the early 2023 low of 0.6688. The next level there is perhaps the 0.6547 area, which is the 61.8% retracement of the entire rally sequence from 0.6170 to 0.7158.
Table: FX Board of G10 and CNH trend evolution and strength.
The USD rally still in the driver’s seat, and the misfiring China reopening narrative evident in AUD-, silver and even in CNH-weakness (particularly relative to the USD when most regimes of last 10 years had the CNH showing directional beta to the USD.
Table: FX Board Trend Scoreboard for individual pairs.
AUD weakness showing up in more and more pairs here. The most extended trend is the USDCNH rally at a strength rating of +6.9.
Upcoming Economic Calendar Highlights
- 1000 – Eurozone Feb. Confidence Surveys
- 1330 – US Jan. Preliminary Durable Goods Orders
- 1530 – US Feb. Dallas Fed Manufacturing Activity
- 1530 – US Fed’s Jefferson (Voter) to speak
- 1700 – ECB Chief Economist Lane to speak
- 2350 – Japan Jan. Industrial Production
- 0000 – New Zealand Feb. ANZ Business Confidence
- 0030 – Australia Jan. Retail Sales
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