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: USD still hanging in there. Next couple of sessions key.
John J. Hardy
Chief Macro Strategist
Summary: Weak data sees a significant drop in Treasury yields and a slightly weaker US dollar, with the USDJPY volatility distinctly underwhelming and the greenback fighting back this morning. With a chunky mark down in Fed expectations ahead of tonight’s FOMC meeting minutes, it may be hard for the market to mark Fed expectations lower for now and thus time for the US dollar to possibly take a stand.
FX Trading focus: Fed expectations about as low as they can get for now?
Yesterday saw a batch of weak US data points that shoved US yields lower all along the curve. The April New Home Sales dropped sharply to a 591k annualized rate versus 750k expected and a sharply downward revised 709k in March (from 763k). The S&P Global initial Services PMI for May came in weaker than expected at 53.5 vs. 55.2 expected and 55.6 in April, while the Manufacturing PMI was in line at 57.5 vs. 57.7 expected and 59.2 in April, a bit odd in that we have now seen three weak regional surveys after yesterday’s ugly May Richmond Fed manufacturing survey flashing -9 versus +10 expected and vs. +14 in April.
The 2-year US treasury yield dropped over 15 basis points at one point yesterday in the wake of the data and the US dollar was taken to new local lows, although interestingly, it has put in a show of resilience today as discussed for the EURUSD chart below. With the FOMC minutes up tonight set to like see very little in the way of new changes to the Fed rhetoric, and perhaps reminding us on the contrary how hawkish the Fed has become (despite Powell tapping the brakes by ruling out 75-bp rate hikes at the May 4 FOMC presser), US yields may have bottomed out here or are very close to doing so now that the market is only looking for two further 50-bps for the next two meetings and then looking for the Fed to more likely switch to 25-bp hikes thereafter. It was particularly interesting to note that the big yield move at both the long and short end of the US treasury yield curve failed to generate much follow through lower in USDJPY, which only managed 126.36 on the 127.00 break and is trading right at 127.00 again as of this writing.
Chart: EURUSD
The EURUSD rally managed a run to just shy of 1.0750 late yesterday on the tailwind of the ECB expectations solidifying for exiting negative rates by end Q3 (even if all of this fuss has not seen any notable adjustment in EU yields), while the Fed expectations have been marked down significantly, particularly after yesterday’s batch of weak US data. The strong turn in the price action this morning taking the pair back to where it was trading prior to that weak data yesterday suggests that the US dollar taking a stand here. The bearish reversal potential here picks up if the price action takes us back below 1.0600.
The UK reported a very ugly initial May Services PMI reading of 51.8 versus 57.0 expected and 58.9 in April – a vicious reversal of fortune. This underlines the risk that the UK is in the vanguard of economies set to weaken first for this cycle, as supply-side limitations and the higher cost-of-living pressures as well as the weakening fiscal impulse work their way into the economy. As we have emphasized, the UK economy also runs enormous structural deficits – GBPUSD could be ready for a roll-over already now and a look at the massive 1.2000 level eventually.
The RBNZ hiked 50 basis points as a large majority of observers expected, taking the rate to a G10 leading 2.00%. The bank forecast the rate to reach 3.95% for the cycle versus 3.35% previously, triggering a solid bump at the front end of the NZ yield curve and boosting the kiwi overnight, with AUDNZD to new local lows, while NZDUSD got close to bumping up against the former range lows of 0.6530. The reversal this morning that has taken back all of the overnight upside looks like a potential place for NZDUSD bears to set up shop for a run back lower as the global tightening, the recent mark-down in Fed expectations notwithstanding, will continue and as argued above, Fed tightening expectations may be bottoming out here.
Table: FX Board of G10 and CNH trend evolution and strength.
Trend reading levels are generally low. The Swiss franc has gotten far more out of the lower yields than the Japanese yen, somewhat curiously this time around (perhaps energy price related). The US dollar is down, but not yet out, and a strong rally bar could see something building there again as we emphasize that the USD has worked into some pivotal support areas.
Table: FX Board Trend Scoreboard for individual pairs.
A few interesting pairs to watch for the status today include AUDNZD, where the drop lower signals a new downtrend potential if the move hold, while USDCAD continues to try to hang in despite dipping several times south of 1.2800 – an impulsive rally need there to set the focus back higher, but the bulls have not fully capitulated there. Finally, EURJPY is an interesting one to watch for the JPY potential to pick up if longer yields remain suppressed on concerns for the global economic outlook. The EURJPY chart certainly needs to resolve soon, one way or another.
Upcoming Economic Calendar Highlights (all times GMT)
- 1100 – US Weekly Mortgage Applications
- 1105 – Japan Bank of Japan Governor Kuroda to speak
- 1515 – UK Bank of England’s Tenreyro to speak
- 1615 – US Fed Vice Chair Brainard to speak
- 1800 – US FOMC Minutes
- 1800 – US 5-year Treasury Auction
- 2110 – New Zealand RBNZ Governor Orr to speak
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