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 thaw reaches important resistance
John J. Hardy
Chief Macro Strategist
Summary: The smaller currencies have bobbed higher as the market acclimates to USDCNY over 7.00 and risk appetite recovers. Leading the pack is the Aussie at the moment, and across markets, this recovery in risk sentiment has reached pivotal levels.
Trading interest
- Maintaining long AUDNZD with stops below 1.0420 for 1.0625 and eventually 1.0700
- Abandoning long spot EURUSD idea – maintaining hedged EURUSD call
- Positioning (half position) short AUDUSD ahead of 0.6825 with stops above 0.6900. Looking to add next week on signs of bearish local reversal.
The general market temperature has dropped a couple of notches over the last couple of trading sessions as China has kept the USDCNY rate reined in at less than a percent above what was seen as the critical 7.00 threshold. The complacent view is that China may only allow the rate to creep higher from here if the USD continues to break higher elsewhere. In official basket terms, the renminbi is still some distance from its lows (due to weak Asian EM FX members that are heavy in the official RMB basket), which China can point to in defense of the USDCNY move.
The lack of new inputs to further increase alarm has allowed smaller risk-correlated currency across EM and within the G10 to rebound sharply, if not yet strongly enough yet to indicate a full reversal. Not entirely sure what the market is waiting for here, but the recovery from the downdraft in risk sentiment from the Trump-China exchange is reaching important resistance levels (basic barometer for the move the 61.8% retracement of the S&P500 sell-off – which was near yesterday’s highs). Within the G-10 currencies, AUDUSD is our proxy, with the key 0.6830 resistance area now heaving into view.
Elsewhere, it is an important day for Canada, with the latest jobs data and housing-related data points – see our calendar highlights at the bottom of this post. The 1.3300+ area highs in USDCAD are critical resistance and a break could potentially unleash a rush to the highs for the cycle if data points to BoC cutting regime kicking into high gear.
Chart: AUDUSD
After breaking to new lows since the global financial crisis (and even below the flash crash lows from the beginning of this year), the AUDUSD has rebounded back to the critical 0.6830 area resistance of that major prior low as risk sentiment has tried to stabilize here. So today and for next week, bears will have to decide whether to establish fresh positions here for a go at new lows – from here to 0.6850 or so is the area for testing the potential for further downside, with discomfort that a reversal is upon us rising if the price action is taken back above 0.6900.
Bonds stabilize after brief rout
Yesterday we dedicated considerable attention to whether the rally in especially long duration sovereign bonds is getting overdone now that the entire German yield curve out to 30 years had dipped below the zero bound. While yesterday did see a considerable correction, long bonds found support later in the day on a surprisingly strong US auction of 30-year T-bonds, where there was more demand – if still modest by historic standards – than at the prior auction of the same maturity. This despite the recent collapse in yields that has taken the 30-year yield close to record low yield of 2.09% from 2016.
The late bond rally took the US 30-year rate below the 3-month rate at one point earlier this week, inverting the entire curve, while the 2-10 portion of the curve has scraped new lows at 10 basis points. Expectations for the Fed remain on a cutting path – with a 100% odds for a September rate cut, with 33% looking for a larger 50-basis point move. The expectation for December for the Fed funds rates has dipped just below 1.50% - so two and a half cuts priced in. US President Trump indicated his ongoing displeasure with the Fed yesterday in a series of tweets.
I would suggest that an equity market sell-off beyond recent lows combined with a significant USD surge could see the Fed forced to panic with an unscheduled rate cut before the September 18 FOMC meeting. Either that, or the Trump administration will move with stronger medicine on the USD under such circumstances.
EU fiscal outlook questions heating up.
Two stories yesterday buffeted the euro in their own way, first on the positive side on a brief newsflash from Reuters (citing an unidentified senior government official) that Germany would consider expanding its fiscal outlays if this expansion was linked to climate-linked green spending. But the German finance ministry was out saying that there has been no decision to alter its balanced budget policy – we need to see EU fiscal for the Euro to sustain a strong recovery. Later in the day, the euro dipped and Italy-Germany yield spreads rose sharply as the leader of Italy’s government party Lega, Matteo Salvini, said that the government coalition is dead and that new elections are necessary. Stay tuned there, but Salvini obviously looking to strengthen the Lega’s hand and engage in a full-bore confrontation of the EU leadership over the need for fiscal expansion, likely with new centre-right coalition partners. The most recent opinion polling as the Lega showing a stunning 38% popular support for Lega, up from around 17% at the election, while the Five Star Movement has collapsed to around 17%, down almost half of what it got at the 2018 election.
Upcoming Economic Calendar Highlights (all times GMT)
- 0830 – UK Q2 GDP Estimate
- 0830 – UK Jun. Manufacturing Production
- 0830 – UK Jun. Visible Trade Balance
- 1215 – Canada Jul. Housing Starts
- 1230 – Canada Jun. Building Permits
- 1230 – Canada Jul. Unemployment Rate / Net Change in Employment
- 1230 – US Jul. PPI
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