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: Wondering if strong US dollar chooses new victims
John J. Hardy
Chief Macro Strategist
Summary: As global yields have risen recently, the chief victims among currencies have been the lowest yielders and traditional safe-haven currencies like CHF and JPY, but we are curious to see if continued US dollar strength and weak risk sentiment begin to weigh more heavily on traditional pro-cyclical currencies this week, where the calendar highlights of the week are the two treasury auctions on Wednesday and Thursday.
FX Trading focus: USD and US yield wrecking ball still swinging – new victims?
A brief update today, as tomorrow I will be hosting an FX webinar you can sign up for to get a full interactive update from yours truly.
The short summation of last week is that Fed Chair Powell failed to push back rhetorically against the rise in US yields, which has unsettled the market and triggered both weak risk appetite and a much stronger US dollar. My chief point of curiosity this week is whether the victims of the stronger US dollar will shift more towards the pro-cyclical currencies like the commodity dollars and EM rather than the recently struggling low- and negative yielders, especially JPY and CHF. Such a development this week would likely require that risk sentiment continues to crater while further yield rises are somewhat muted.
We noted in this morning’s Saxo Market Call podcast that the correlation between equities and treasuries has gone positive of late, which would seem to aggravate volatility levels. At some level, however, I would expect that if deleveraging continues in risky assets would help put a bid into sovereign bonds, especially if commodities finally find themselves under some selling pressure as well. This is a tactical idea only – the $1.9 trillion US stimulus passed with minor changes by the US Senate at the weekend will mean a screaming hot US economy in months to come if US consumer behavior reverts to anything resembling normality.
Next steps for this market are likely the US 10-year Treasury auction on Wednesday and T-bond auction Thursday followed by the FOMC meeting next Wednesday. There are no Fed speakers between now and then as the Fed maintains radio silence.
Graphic: FX Board of G10 trends and momentum
Note the momentum shift in favor of CAD and NOK over the last week and overnight on the latest spike in oil. That market is on fire after the weekend attacks on Saudi facilities that fortunately did not result in any production declines. But even if oil prices are headed much higher still, is it time for that market and other commodity markets to consolidate a bit here under the weight of the US dollar advances and weak risk sentiment? I don’t want to make that call, but I have to imagine the backdrop is getting far less friendly here for these currencies on the least hitch in the reflationary story or a consolidation in commodities, as risk sentiment has already cratered of late – there is a possibility of a bit of catch-up trading to the downside for the G10 smalls (ex SEK, which has no commodity angle).
Chart: AUDUSD
A very technical support was found late last week in AUDUSD before it bounced at the 38.2% retracement of the rally off the November lows. If the Aussie is dragged lower here by some more consolidation in key metals markets and the rather scary recent descent in Chinese equity prices, the next critical area is 0.7400, just below which is arguably a mission critical Fibo retracement for keeping the medium term focus higher for AUDUD. A break of that would point to 0.7000 – let’s take one development at a time, though, watching risk sentiment, the two treasury auctions this week noted above and then next week’s FOMC meeting.
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